An Introduction To M&A Frameworks
MERGERS & ACQUISITIONS (M&A)
The M&A framework is used when companies are looking to acquire or merge with competitors. Examples of M&A type cases include:
Our client is a multinational corporation that operates hypermarkets, discount department stores, and grocery stores. It is also considering acquiring an online furniture retailer, and wants us to determine if this is a good strategy or not.
Our client is a U.S. agrochemical manufacturer that is considering acquiring a regional specialty chemical producer in Indonesia. Should they do so?
First things first, the most important objective we need to understand is our client’s goal. What does this mean? Well, in some M&A cases the client is the acquirer, in others your client is the one who wants to be acquired.
In the case of the former, we know that all acquirers are interested in increasing cash flow (re: increasing profits) after purchasing the business. However, their longer term plans may differ depending on the type of client you’re dealing with.
A corporate acquirer (most common): a multinational firm or a portfolio holding company will own 100% of the target. Most plan to operate the target for a period of time, with plans to integrate it into current operations (re: improve supply chains/manufacturing/product development, acquire key talent/management, source new patents/technologies, enter new markets, etc.). Some acquirers may intend to strategically resell the target (re: acquire at a low cost, sell later at a higher price, and profit off the difference). Defensive acquisitions – buying a company to keep intellectual property from competitors – can occur as well.
A financial acquirer (somewhat common): a private party or a private equity fund will own 100% of the new company. Their goal is usually to sell the company for a significant ROI to another private party or through an IPO. To do so, they will rarely integrate the target into anything – rather, they’ll strip out costs and pump cash to grow top-line revenues and profits.
A financial investor (least common): a hedge fund will own a non-majority share of the new company. Their goal is to influence the value of the shares and sell them for a higher price than they purchased them for.
Depending on the client’s goals, the direction of the case may vary widely. That being said, below is a general approach to how you should go about tackling an M&A case:
Does the target company (re: company being acquired) operate in an attractive market? Is it a good market?
What are the target company’s current capabilities? Is it a good company? Are there any potential alternatives?
What are our client’s current capabilities? What is its acquisition rationale, financial situation, and M&A alternatives (re: JV/strategic alliance, grow organically as opposed through M&A, etc.)
What are the synergies and risks via acquisition? Do synergies > risks?
What should our client’s ‘post-acquisition’ strategy be?
IS THIS A GOOD MARKET
What are the characteristics of the market in which the target operates in? This is highly similar to the first part of a Market Entry framework, but you can add a little flair in your analysis by tailoring your language to fit M&A — consider both the client and the target company’s markets; they may operate in similar markets (horizontal monopoly), or they could be quite different (vertical monopoly).
Market size — see market entry example.
Market growth rates — see market entry example.
Competitive landscape — see market entry example.
Customers — see market entry example.
Additional factors (PESTLE) — see market entry example.
IS THIS A GOOD COMPANY
How attractive is the target to be acquired? Key elements to consider include: current and future financial position of the target, important assets or capabilities owned by the target, quality of the target's management team, target / buyer culture fit, etc.
In every case, the client is looking for upside potential – that’s never in question. What is in question, however, is how the client is seeking to achieve this when engaging in M&A. You’re thus usually looking at one of the scenarios below:
First, the target company is a top performer – well-positioned, a brand leader, a hot up-and-coming upshot startup, etc. – and you know you’re going to make money on it. How would you be able to tell? There are 3 key indicators:
You can clearly see revenue growth (historically and projected)
You can see profits and/or profit margins growing (historically and projected)
You can clearly identify its market share (and whether it’s growing or declining
Alternatively, the target company isn’t attractive capability-wise but rather because it’s cheap. As the old investing adage “buy low, sell high” goes, in this scenario the target company has a lot of room for improvement, but the price the client would pay for it reflects its lackluster status. It’s not performing well now, but the client wants to know if it has the potential to perform well in the future.
In this case, you will want to assess revenue, profit margin, and market share growth among comparable peer companies (re: target’s competitors), and then particularly focus on market share – is there a potential to increase the target company’s share of market? If so, then the target might be worth more in the future, and is therefore currently undervalued.
Some other factors you may want to look into can include:
Market position (re: market leader, 2nd place player, etc.)
Customer Concentration (does a single customer account for most of the company’s revenues, or is concentration lower and more equalized)
Supplier relationships (what is the company’s relationship with suppliers, how many suppliers does it work with, is it reliant on any of them, etc.)
Barriers to Entry (how hard is it to enter this market/industry)
Reputation and brand loyalty
Product/regulatory/technology risks
IS OUR CLIENT CAPABLE OF ACQUISITION
The buyer: What's driving the buyer to make the acquisition? Key elements to consider include: acquisition rationale (e.g. is target undervalued, etc.), acquisition financing, buyer's acquisition experience, acquisition timing, etc.
You want to understand if the client has the capabilities and financials in place to even execute an M&A deal in the first place.
Why is it engaging in M&A? Has it already evaluated other alternatives - such as growing/building its business organically and/or engaging in joint ventures/strategic alliances - or has it only considered M&A?
How does it plan to finance its acquisition strategy? Will it raise debt? If so, how does it intend to do so? What is the buyer’s acquisition experience? Is this its first time?
You can spend the least amount of time in this section, as the M&A case - for the most part - will have you focus on industry analysis, target analysis, and synergy/risk analysis. On that note, let’s move on to the next section.
DO THE SYNERGIES OUTWEIGH THE RISKS
What is the combined entity’s synergies and risks? Key elements to consider include: value of individual and combined entities (re: does the combined total equal more than the sum of its individual parts), cost synergies (‘hard’ synergies), revenue synergies (‘soft’ synergies), and the M&A deal’s biggest risks of failure.
HARD SYNERGIES (cost-based)
Analyze headcount and identify any redundant staff members that can be eliminated (i.e. the new company doesn’t need two CFOs, two CMOs, etc.)
Look for ways to consolidate vendors/suppliers and negotiate better terms with them (re: purchase goods/services at lower prices through bulk orders)
Reduce head office or rent savings by combining offices
Reduce costs by sharing resources that aren’t at 100% utilization (i.e. trucks, planes, transportation, factories, etc.)
Geo-arbitrage: Reduce labor costs by hiring in other countries (if relevant)
Shared Information Technology: Each company may have proprietary access to IT that would allow for operational efficiencies if applied in the other firm.
Supply Chain Efficiencies: Similar to IT, if either company has access to better supply chain relationships, there may be cost savings that the merged firm can take advantage of (on both sides, for both acquirer and acquired)
Improved Sales and Marketing: Better distribution sales and marketing channels may allow the merged firm to save on costs that were being expensed by each individual firm when they were separate
Research and Development: Either firm may have had access to research and development efforts that, when applied to their counterpart firm, will allow for better development or room to cut costs in production without sacrificing quality
Patents: If the acquirer used to pay the target firm a fee for access to its patent, a merge may transfer the right of that patent to the acquirer
SOFT SYNERGIES (revenue-based)
Patents: Similar to the cost-saving effect of a patent, access to patents or other IP may allow the merged firm to create more competitive products that produce higher revenue than if they were separate
Complementary products: Both individual firms may have been producing complementary products pre-merger. These products can now be bundled in such a way to produce higher sales from their customers.
Complementary geographies and customers: Merging two firms with varying geographies and customers may allow the merged firm to take advantage of the increased demographic access, generating higher revenues.
Operating efficiency improvements from sharing “best practices”
RISKS INHERENT IN M&A
Differences in culture: culture conflicts are the most common reason for M&A failure. Employees are the core strength of a business, and if there is no cohesive integration and cooperation between the acquirer and the acquired, employees from the acquired company will leave the company en masse.
Lack of transparent communication: the acquirer should clearly communicate the terms of the deal to the other acquired. One should fill the communication gaps and share all details pertaining to each firm’s market share, consumer base, product/service details, and relevant personnel.
Miscalculation of asset value: many complex calculations are made in order to fairly value the target company. Even minor errors can lead to heavy losses, as the client may over-pay and thus suffer financially.
Employee lay-offs: an inevitable consequence of M&A is mass lay-offs. An inability to assess the value of certain employees may lead to companies firing the wrong people, and keeping the redundant/low-performing ones instead.
Legal Risks: anti-trust laws and regulations concerning M&A must be obeyed. If there are any discrepancies (re: courts rule that this is an illegal monopoly, the deal violates certain labor laws, etc.) then not only will the deal fall apart but the client will be thrust into intense legal scrutiny.
Synergies don’t come through: cost/revenue synergies don’t manifest and the newly combined entity suffers from low performance even though the client paid a premium for acquiring the target company.
WHAT IS OUR POST-ACQUISITION / EXIT STRATEGY
A critical part of every M&A deal is the post-acquisition strategy. After the client buys the company, how will they make the acquisition pay back the investment they made and then some? Here, you’re evaluating the upside potential of the target– identifying areas the client should focus on and the numbers they can achieve.
How can our client increase the target company’s value — can we increase prices, increase volumes sold, decrease variable/fixed costs, etc.?
Exit Strategy — after the client has increased the value of the target company, what do they plan to do with it? Sell? IPO? Continue to operate? Spin-off? Expand?