Generating revenue growth for companies is often more challenging to accomplish than a cost cutting exercise through a restructuring process. To achieve more rapid growth, senior management often opt for acquisitions if they perceive this will meet their growth objectives. Over the past 3 years there has been an M&A boom fuelled by low cost debt and accommodating equity markets which has extended from the public to the private sector.
Many companies have been able to acquire successfully, to integrate diverse businesses and to generate value for all their stakeholders. However, shareholders of both private and public companies are becoming more vociferous if their expectations are not met. Private equity firms have the ability to finance the acquisition of even the largest businesses. Therefore, management teams must have a realistic plan to achieve the acquisition benefits.
We will review the key aspects required for successful transactions. Senior management needs to take a holistic approach to the entire acquisition selection, financing and integration process.
Implementing a successful acquisition strategy
A clear strategic rationale is the first step to ensure a successful acquisition. The chances are significantly enhanced when the following are taken into consideration:
- Business synergies, where an acquiring company’s core competences are accentuated;
- Increased revenues, particularly through access to additional markets for existing and new products;
- Consolidating the business sector with a focus on the potential for cost savings;
- Enhanced barriers to entry against new entrants; and
- Effective leadership, especially with a new CEO running the business and needing to motivate the management to deliver the new strategy.
There have been countless examples of destruction of shareholder value by companies through diversification into unrelated business areas. An example relates to Hewlett Packard and their many difficulties with post acquisition integration from Compaq to autonomy. The company required several changes of leadership over the past 15 years.
The initial approach
Once an acquisition strategy has been agreed by the company, a small team should be assembled including specialist business development, financial and operational personnel. Financial advisers 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. It is vital at that stage to separate the operating management of the existing business from the M&A team in order to ensure the continuing focus on the existing business.
The due diligence process
Once interest has been ascertained in the business and ideally a period of exclusivity has been agreed, the due diligence process can commence. If a price needs to be disclosed at this stage then this should be as flexible as possible. Due diligence is the most time consuming and least creative part of the M&A process, but can have a direct influence on the final price achieved. It is also 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 the impact of pensions. The review will also provide the opportunity to evaluate the quality 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 competitors provide invaluable information on the prospects for the business.
Pricing and final negotiations
There are several valuation methods assist the negotiation process. These include 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.
However detailed the financial analysis has been, the final price will depend on a negotiation between the buyer and the seller. It is essential to have a disciplined approach to the valuation of the business and for the buyer or for the seller to be able to walk away from a transaction at the appropriate time.
With the large variety of new financial instruments developed, there are a variety of financing methods available:
- All cash deal. This is often the preferential route for selling shareholders. The purchaser can use internal resources or can raise funds from the banking, insurance or hedge fund sectors. A mixture of senior and subordinated debt can be raised. Alternatively, the bond or equity markets can be employed. Lenders are often willing to provide substantial sums, up to 5-7 times EBITDA for strongly cash generative businesses with assets to provide as collateral.
- Share transaction. Companies can use existing or new shares and use these as payment to the selling shareholders. If the prospects of the combined business are strong and there is potential liquidity in the shares, then this could be an attractive option for the selling shareholders.
- Hybrid options. A combination of cash, increased debt and shares could be used. For a larger transaction, bonds convertible into equity can be also considered.
Once terms have been agreed, the financing arranged 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.
Post acquisition integration
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.
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 multi disciplined advisory team. Thorough due diligence must be undertaken which is critical both to the final negotiations and to the integration process.
Reviewing the alternative financing options at the outset can provide attractive alternatives.
Finally, it is important to note that in the excitement of the deal more value can often be generated for shareholders by walking away from a transaction than by pursuing a merger or acquisition of limited strategic benefit.
The views expressed in this newsletter are those of DC Dwek Corporate Finance Limited and are provided for information purposes only.