April 5, 2018 //
“You don’t have to be a genius or a visionary or even a college graduate to be successful. You just need a framework and a dream.” Michael Dell (Founder, Dell Computers)
Over two decades in the business, we have worked with several hundred midmarket acquirers. Their most common struggle is understanding the complex, interconnected decisions that characterize a corporate acquisition:
• To acquire or not?
• Which target?
• How much to pay?
• How to structure the deal, and the combined business for maximum benefit?
Without reliable ways to organize their thinking, many acquirers over-focus on one factor – such as price – while skating past an even more important one – strategic fit, or what to do with it once they take possession. They may fall prey to opportunism, jumping at a target simply because it is available, or get caught up in a competitive chase.
We have synthesized our experience into a powerful framework to help clients work through their acquisition decisions in a disciplined way. This article is the first of a series that we will share this year, introducing the framework and examining each step.
Drucker said, “my greatest strength as a consultant is to be ignorant and ask a few questions”. Beginning with questions positions a potential acquirer in a space of openness and creativity, removed from limiting assumptions about the need for an acquisition. But as Clayton Christensen notes, “management teams aren’t good at asking questions. In business school, we train them to be good at giving answers.” Questions may feel like a delay, or an admission of incompetence. They are not. So let’s start with them.
When an acquirer can answer four essential questions, s/he is ready to move forward:
1. What is the purpose of the acquisition? (What is our goal?)
2. What is the value in the acquisition? (What does it have?)
3. What is the value of the acquisition? (How much do we pay?)
4. How will we integrate the acquisition? (What will we do with it?)
Why would you make this acquisition? What is the rationale? “Growing the business” is not good enough. The best acquisitions fit with a company’s strategy.
In later articles, we will dig deeper into corporate and acquisition strategies. For now, consider: if you are looking to grow your business and don’t have a strategic imperative, how can you assess if an acquisition makes sense? Imagine a business that builds parts for the aerospace industry. If they express interest in buying a homecare company, we would ask, “how does a homecare company enhance your ability to manufacture parts for the aerospace industry?” Beyond growing the company, there’s no purpose to it. If the same company considers buying an aerospace parts manufacturer in Europe because several of their customers have European operations and are looking for a closer supplier, that might make a lot of sense. The sharper your purpose, the better you can answer the next three questions.
We must then understand the target company’s value drivers. Value drivers like:
• A results-driven management team
• Exclusive customer or supplier relationhips
• Proprietary products and intellectual property
• A broad, loyal, satisfied customer base
• Impeccably maintained facilities
• A reasonable growth optimization strategy
• Industry leading supply chains
• Stable and improving cash flows
But you should get as specific as possible. For example, a target with an important new technology, a strong, complementary customer base, a location, logistics delivery process, or engineering capacity that you don’t have, it will be uniquely valuable to our aerospace parts manufacturer. There is a flip side to this analysis that is often overlooked. Says Roger Martin, “companies that focus on what they are going to get from an acquisition are less likely to succeed then those that focus on what they have to give it.” What do you bring that will make the acquired company more effective, more competitive? Is it the capital for growth? Access to your current markets? Exceptional strength in people development, innovation, or distribution?
This one question is really three. What are the company’s value drivers? What makes this target worthwhile to me? And what do I bring that unlocks or generates unique additional value? Pinpointing a target’s sources of value to you is the starting point in quantifying what you would be willing to pay.
Contrary to popular wisdom, the value of a business is actually set by the buyer and not the market. What do we mean by that? Any acquisition will have an economic impact on the buyer’s business.
The question is, then: what is the economic impact on operating results? Followed by: what is the maximum amount a buyer should pay for this? This maximum amount is determined based on the value it creates to the buyer. Naturally, this is different for each buyer.
This maximum value is the most a buyer should pay for an acquisition, regardless of published trading multiples.
Having identified the maximum acquisition price, the analysis moves to a negotiating strategy. Your advisory firm is primary on this one. Here we assign a monetary value to the target company. How much should you pay? To answer this question, we work with clients to:
• Quantify the value sources identified above
• Determine appropriate market multiples
• Assess the target company using different valuation methodologies, and interpret the resulting ranges
• Tailor valuation approaches to the acquirer’s strategy for the new company, recognizing that improving performance, for example, is priced differently than reinventing a business model
• Analyze risks and sensitivities
• Benchmark values against the market
Ultimately the correct price of a company is not an objective and absolute number. It will change based on what an acquirer can afford, and what value the deal holds for that particular company. In the spirit of asking good questions, this is a topic to discuss and explore.
When it comes to integrating an acquisition, we see companies:
• Say, “it’s already successful, so we’re not going to make any changes”.
• Set unclear goals, and only vague plans to realize them.
• Underestimate the time, effort and resources required for successful integration.
We will examine this important topic in detail in the months to come. But let’s start with some time-tested lessons from GE Capital, a company that has made hundreds of acquisitions, and contributed significantly to the business community’s understanding of how to integrate them.
1. “Acquisition integration is not a discrete phase of a deal and does not begin when the documents are signed. Rather, it is a process that begins before due diligence and runs through the ongoing management of the new enterprise.
2. “Integration management is a full-time job and needs to be recognized as a distinct business function, just like operations, marketing, or finance.
3. “Decisions about management structure, key roles, reporting relationships, layoffs, restructuring, and other career-affecting aspects of the integration should be made, announced, and implemented as soon as possible after the deal is signed – within days, if possible. Creeping changes, uncertainty, and anxiety that last for months are debilitating and immediately start to drain value from an acquisition.
4. “A successful integration melds not only the various technical aspects of the businesses but also the different cultures. The best way to do so is to get people working together quickly to solve business problems and accomplish results that could not have been achieved before.”
These four essential questions give rise to the framework that we at Stillwater Capital use to guide our acquisition practice and bolster our clients’ success. Next month we will begin an in-depth exploration of this framework, beginning with the importance of strategy and how to ensure strategic alignment in an acquisition.
For more information, contact:
Doug Nix, CPA, CA
T/ 905-845-4340 x.211