Generating revenue growth for companies is more challenging to accomplish than cost cutting through a restructuring process. Acquisitions are therefore often perceived by senior management teams to be a more certain method of achieving their growth objectives. Whilst there is a greater willingness to complete deals, there remains a degree of uncertainty in the market as a large proportion of acquisitions fail to generate shareholder value for the acquirer. This is due to a combination of:
- Lack of realisable synergies;
- Unrealistic expectations, particularly regarding revenue potential;
- Too high a price paid and value transfer to the selling shareholder; and
- Ineffective integration planning and execution.
Many companies have been able to acquire successfully, to integrate diverse businesses and to generate value for all their stakeholders. Shareholders of both private and public companies are becoming more vociferous. Therefore, management teams must have a realistic plan to achieve the acquisition benefits. The recent bid battle between Disney and Comcast emphasises the current scepticism of shareholders on potential synergies. With the valuation of Comcast in decline following the announcement of the bid, the management team decided to withdraw their offer for Disney having failed to convince shareholders of the benefits.
Our aim in this newsletter is to review the key aspects required for successful transactions. Senior management, in particular, need to take a holistic approach to the entire acquisition and integration process. Careful planning is essential from the outset with one combined execution team.
Implementing a successful acquisition strategy
A clear strategic rationale is the first step to ensure a successful acquisition. The chances of success are significantly enhanced when the following are taken into consideration:
- Business synergies, where an acquiring company’s core competences are accentuated;
- Increasing revenues, particularly through access to additional markets both for existing and new products;
- Consolidating the business sector with a focus on the potential for cost savings; and
- Stronger barriers to entry from new entrants.
There have been countless examples of destruction of shareholder value by companies through diversification into unrelated business areas. For example, AT&T made an expensive, and ultimately, unsuccessful move into the cable television industry from the telephony sector in the late 1990’s. This failure was a result of the diversification into a business sector too far from their core competence magnified by the fall in the valuation of related companies.
The initial approach
Once an acquisition strategy has been agreed by the company, a small team is assembled including specialist business development, financial and operational personnel. Financial advisors should be appointed as early as possible to work with the team in researching and approaching potential targets, or merger partners, with the initial intention of selecting a short list of one to three candidates for more advanced discussion and negotiation. The advisors act as a catalyst to the process and their experience in completing similar transactions is crucial in overcoming the hurdles.
At this stage, creative discussions can take place between the parties at a senior level on growth strategies and on the vision for the combined business.
It is tempting at an early stage to focus on the price of the transaction; however, it is crucial to build momentum for the deal, for personal relations to strengthen and for all parties to believe in the strategic rationale, prior to moving to the next phase.
The due diligence process
Due diligence is the most time consuming and least creative part of the M&A process. Whilst fact checking is important and lends credibility to the management team, it is crucial to incorporate due diligence into the integration planning and to keep the same team involved throughout the transaction.
Due diligence can be separated into a number of areas depending on the complexity of the business. The main areas of focus are: accounting, legal, commercial, systems and human resources including pensions. The review will also provide the opportunity to deepen the understanding of the operating managers in the business.
A significant amount of time must be spent on commercial due diligence. Discussions with key customers and suppliers, joint venture partners and with competitors provide invaluable information on the prospects for the business. Often these more commercially sensitive discussions are permitted only after exclusivity has been granted to one party.
Whilst the devil is in the detail and the information gathered is critical to the decision on whether to proceed with the transaction, senior management must also take a more strategic view of the opportunity and use the acquired facts in the negotiations.
Pricing and final negotiations
The majority of acquisitions over the last 20-30 years have not created value for acquiring shareholders. There are many reasons for this phenomenon including the irrational exuberance as to the strategic importance of the deal, weak integration and simply paying too much for the business. In the excitement of the endless opportunities that an acquisition brings, it is essential to have a disciplined approach to the valuation of the business and to be able to walk away from a transaction at the appropriate time. There are several valuation methods that are employed including discounted cash flow, earnings and operating profit multiples as well as analysing comparable transactions.
The intrinsic value of the business is the net present value of expected future cash flows independent of any acquisition. This is the stand alone value and the basis for negotiations. Any price paid above the intrinsic value represents a premium to be shared between the target company and the acquirer’s shareholders. This premium includes a market premium and the potential synergy value. These synergies comprise of revenue enhancements, cost savings including financial engineering and tax benefits as well as process improvements.
The recent pharmaceutical acquisition of Aventis by Sanofi-Synthelabo of France highlights the transfer of value between shareholders. After three months of heated negotiations, at the eleventh hour, Aventis convinced Novartis, a potential white knight, to enter into negotiations. This resulted in Sanofi raising its bid by 14% to win control of Aventis. The higher price paid intensifies the pressure on the Sanofi management team to make the acquisition work. This transaction also highlights the importance of having alternative options such as a white knight in the final negotiations to achieve the best outcome for the selling shareholders.
Once terms have been agreed and the final agreement signed, there is typically a one to three month period before all the documentation is completed and the approvals received. A surprising number of deals fall apart at this stage and whilst there may be legitimate reasons such as a material adverse change in the business, it is also vital for the acquirers to sell the deal to the company’s stakeholders and to maintain the momentum to ensure there is rapid closure.
Effective acquirers, such as GE, have perfected their ability to integrate companies rapidly into their organisation. The key elements in a successful integration are as follows:
- Begin the integration process before the deal is signed with a combined due diligence and business integration team.
- Dedicate a full time individual with decision making powers to manage the entire process.
- Ensure constant communication to minimise the loss of morale. Reaching to the second tier of management as fast as possible and clarifying their positions reduces the possibility of significant defections.
- Focus on a rapid integration process. There needs to be clear decision making authority from day one. A 100 day plan is required and tough decisions, particularly on personnel issues, have to be taken at the outset. Paralysis in decision making must be avoided.
- Integrate not only the business operations but also the corporate culture. This is particularly important in cross border mergers.
- Poor integration planning and execution is one of the major reasons for value destruction in mergers and acquisitions and senior management must devote all the necessary resources to overcome the hurdles.
Successfully acquiring and integrating businesses only occurs through a disciplined process and experience. A clear strategic rationale is required at the outset with identifiable synergies in combining the businesses.
A combined acquisition and integration team is required, which is supplemented by the necessary advisors to provide an independent view. Thorough due diligence must be undertaken which is critical both to the final negotiations and to the integration.
It is important to note, in the excitement of the deal, that often more value can be generated for shareholders by walking away from a transaction than by pursuing a merger or acquisition of limited strategic benefit.
In any case, courage and tenacity are required to become an accomplished acquirer.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.