Part 4: Mergers and Acquisitions (M&A)
Expanding your business - ways to drive growth
The final part of this four-part blog series concludes our look at the ways in which businesses can stimulate growth.
Growing your business through Mergers and Acquisitions
In the first two parts of this series we looked at ways of growing a business with initiatives designed to increase sales. And last time we considered vertical integration - growing business by expanding the capability of your company in the supply chain. That brings us nicely to the final topic that we are going to talk about - Mergers & Acquisitions (M&A).
This is when two companies come together to form one. There is a clear distinction between the two terms. From a legal standpoint, a merger is a legal consolidation of two separate businesses into a single entity. An acquisition is when one firm takes ownership of another’s stock, equity interests or assets.
The drivers of M&A
As markets become more mature, we often see a situation where a handful of large players dominate the market. The quest for growth to deliver profit and dividends may cause M&A activity to increase, meaning that Mergers or takeovers are kind of a last port of call in saturated and mature areas of the economy. Good examples of this are the telecommunications and media sectors.
Between them, two large evenly matched companies may own a substantial piece of the market. Competing against each other is expensive. Why go to the expense of slugging it out when it makes better financial sense to consolidate? This is a ‘merger of equals’ and the stocks of both companies' are withdrawn, and new stock is issued in the name of the consolidated business.
In tough times strong companies see opportunities to exploit the weak, and often act to buy other companies. Frequently, the aim is to create a more competitive, cost-efficient organization and boost shareholder value. Meanwhile, companies targeted for acquisition often seize on the opportunity to be purchased, especially if they are of the mind that they are swimming against the tide.
In such a takeover situation, the purchasing company becomes the owner of the other business. The company that has been acquired ceases to exist. It is absorbed, and the buyer's stock continues to be traded while the target company’s stock does not.
Bringing two businesses together frequently releases economies of scale. Frequently, streamlined operations, optimized inventory and rationalized headcount all pull up on the bottom line and provide an indication of growth.
Record levels of M&A activity
Globally, M&A is running at record levels with year-on-year figures for 2017 and 2018 showing an increase of around 40 percent. The trend has been driven by a few main factors, including record stock prices and relatively cheap borrowing. However, the most important factor is technological change.
The coming wave of automation technologies using Machine Learning and its more advanced relative, Artificial Intelligence (AI) have really got companies looking at their mid to long term strategies. Some companies are using M&A to remake themselves to avoid being caught out and left behind by their competitors.
M&A for growing vertically and sideways
When we discussed vertical integration, we talked about investment and adding new upstream and downstream capability from scratch. However, the task of growing your company through pursuing a strategy of vertical integration doesn’t necessarily mean you have to go to the trouble of building new capabilities from the ground up. You could always identify an existing business that already does what you want to get into and then set the goal of merging with or acquiring it.
Besides using M&A to achieve vertical integration, you can also use M&A to grow sideways by merging or acquiring competitors. Rather than tussling with competitors, why not buy them? You do need to be in a position of strength, or at least on equal terms. If your business is underperforming or ailing, it is unrealistic to expect to purchase the market leader. They are far more likely to turnaround and try to swallow you!
If you acquire complementary businesses to diversify services but that are neither upstream or downstream in the supply chain, that could also be considered sideways growth
Some M&A deals and their outcomes
M&A is not without pitfalls. In June 2016, writing in HBR, management thinker Roger L. Martin suggested “M&A is a mug’s game, in which typically 70%–90% of acquisitions are abysmal failures.”
There are some good examples to back this point of view. Here’s some noteworthy deals of recent years and their less than successful outcomes:
- 2015 - Microsoft wrote off 96% of the value of the handset business it acquired from Nokia for $7.9 billion the previous year.
- 2012 - Google unloaded the handset business it bought from Motorola for $12.5 billion for $2.9 billion
- 2011 - News Corporation sold MySpace for $35 million after acquiring it for $580 million six years earlier
- 2012 - HP has written down $8.8 billion of its $11.1 billion acquisition of Autonomy
Buyer beware! Pay due diligence…
The acquisition of Autonomy by HP is a truly cautionary tale. Within a year the deal had gone bad. HP announced that it was taking the $8.8 billion hit as an accounting charge. It cited "serious accounting improprieties" and "outright misrepresentations" by Autonomy.
The man behind Autonomy, Dr. Mike Lynch, countered that the problems were due to HP's running of Autonomy, and suggested there was "internecine warfare" within the organization.
The UK Serious Fraud Office (SFO), and the U.S. Securities and Exchange Commission (SEC) and the FBI came in to investigate. Just over two years later the SFO closed its investigation due to low chances of successful prosecution.
In the final analysis, some key reasons behind this spectacular failure were:
- Over eagerness of HP executives to get deeper into software services
- Over inflated valuation of Autonomy
- Cultural misalignment between the two organizations
- Sharp accounting practice by Autonomy to support its record of double-digit growth
Whether you are running a great big corporation or smaller or mid-sized business, the pitfalls of ill-conceived M&A are well documented. ‘Window dressing’ a business - that is making it seem better performing than it really is as old as the hills. It can be a fine line between optimism and dishonesty. Just how do you identify fact from fiction?
The best approach is due diligence, a process of detailed investigation prior to signing a contract or starting an ongoing business relationship. The aim is to identify any potential problems or unexpected liabilities.
But it’s not all bad news…
Despite the evidence suggesting that M&A is a risky enterprise, there have been some notable successes. But success can be a long game, in fact a very long game!
- Google bought Android for $50 million in 2005 the platform that enabled it to become the biggest name in smartphone and mobile device operating systems, one of the world’s most important product markets.
- Apple purchased NeXT in 1997, saving itself and laying the foundation for its future success and the creation of the world’s first company with a market cap. of $1trillion. However, an awful lot of things had to happen to enable Apple to get where it is today, and in the midst of it all was the forceful, driven vision of one Steve Jobs.
- Berkshire Hathaway acquired GEICO in a rolling acquisition under the stewardship of the legendary investor Warren Buffet. This took a considerable amount of time - 45 years to be precise, from 1951 to 1996. GEICO is now the second biggest US automobile insurance company, turning over more than $25 billion annually.
Driving growth through merging or takeover
Like vertical integration, M&A is sometimes seen as something that’s suited to larger enterprises, and that’s probably due in part to the fact that big business tie-ups are very big news indeed. But M&A works for companies of all sizes.
If you are entertaining the idea of using M&A to grow your business, think about:
- Doing your homework by conducting a detailed investigation yourself
- Hiring qualified auditors with a brief to be totally forensic
- Being a cynic - like with anything else, if it looks too good to be true it probably isn’t!
This is the final blog of this short series on expanding your business and driving growth. You can discover more great content from Breeze PM on our blog index page.