COVID-19 is disrupting deal-making throughout the world. But for those who are well-capitalized, the pandemic may be an opportunity. Private equity groups and certain well-positioned companies are likely to gobble up companies left vulnerable by shutdowns and consumer uncertainty.
The Coming Buying Frenzy
Only the strong and smart will survive. In the US, retailers like Walmart, Target, and Amazon will certainly emerge stronger, as they’re among the few still able to carry on with something approaching “normal” business, through online and steady grocery sales.
Venture capital is holding back, which affects investment, and tech startups are quickly running out of cash. Within three months many Silicon Valley startups backed by venture capital will find their funding exhausted. Those that survive will be camels rather than unicorns, as the focus switches to weathering the pandemic.
Acquisitions and mergers will almost certainly increase these next few months, as companies and investors focus on what’s next. But one thing’s certain, the best strategies in this buying frenzy will still be based on sound principles. For those in a position to target companies for takeovers or mergers, Valuation: Measuring and Managing the Value of Companies, a book by Marc Goedhart, Tim Koller, and David Wessels will prove invaluable. Experts in A&M, they’ve established six effective strategies:
- · Improving the target company’s performance
- · Removing excess industrial capacity
- · Creating market access
- · Acquiring skills and technology
- · Exploiting a company’s scalability
- · Picking early winners
There’s no magic formula for successful acquisitions, but there are some well-defined approaches that companies should consider, as they to what creates value. One thing’s for certain, however, you won’t achieve value by overpaying.
Acquisitions that seek to improve the target company’s financial performance are most common. You buy a business, reduce costs radically to improve profit margins and cash flow, and thus accelerate revenue growth. The most successful private-equity companies buy, improve, then sell off their acquisitions, though it’s easier done with companies and industries that deal with smaller profit margins. It’s a lot easier to boost the profit margin for companies with lower margins.
Excess Industry Capacity
Mature industries inevitably produce more than markets can handle, as evidenced by the recent glut that slumped world crude oil prices, resulting from overproduction by Saudi Arabia and Russia, along with the coronavirus pandemic. To balance this, many companies shut their least productive factories after acquiring a company to reduce oversupply. Removing excess capacity naturally raises the price of goods or services, and can create benefits for the whole industry, though it’s generally the seller’s shareholders who benefit most.
Accelerating Market Access
It’s common that smaller companies, especially startups with innovative products, find it difficult to bring products effectively to the market. Bigger companies invariably have more sales and marketing capacity. IBM used this strategy, swallowing up 43 smaller companies to support its software business, spending over $15 billion from 2010-2013. IBM estimates these acquisitions accelerated revenues by over 40% for two years after buying them. With mergers, each companies’ strengths can make the combined entity stronger, as evidenced by Procter & Gamble’s acquisition of Gillette, which allowed both companies to introduce products in new markets more quickly.
Acquiring Tech & Skills
Bigger technology-based companies often purchase other companies to augment their own products and services. By assimilating smaller tech startups, they get innovations without the hassle of development, avoid royalties and patents, and keep new technology from competitors. It’s a strategy Microsoft used to become a behemoth.
Apple similarly bought Siri – the iPhone’s AI assistant – then bought Novauris Technologies, which made speech-recognition technology, to augment her usefulness. Seeing the market moving away from iTunes’ model of purchasing and downloading music, and towards streaming, Apple acquired Beats Electronics for its music-streaming service.
IT companies merge and acquire each other similarly. Using key technological acquisitions, Cisco Systems grew from $650 million to $22 billion between 1993 and 2001, partly due to buying out 71 companies, for which it paid nearly $25 billion. When it comes to tech, IT consultancy Wavestone US approaches mergers and acquisitions through a prism of companies’ IT functions, seeking to normalize these six primary dimensions:
- · Organization
- · Process
- · Infrastructure
- · Applications
- · Suppliers
- · Financials
Factoring in the company’s business strategy, Wavestone helps companies determine which technological elements to integrate while identifying redundant processes. In this way, they help businesses make rational decisions when consolidating.
Creating value often looks at ways to create economies of scale as a way to justify M&A between large companies. More often, two big companies operate at or near maximum efficiency, and combining isn’t likely to lower costs, so merging makes little sense. Yet in some cases, companies gain value when purchasing a subscale company. For example, since costs for developing new cars is so high, the grouping of Volkswagen, Audi, and Porsche makes sense. It allows some sharing between platforms, as the VW Toureg, Audi Q7, and Porsche Cayenne are basically built using the same fundamentals.
One last winning strategy involves identifying new industries or product lines and acquiring based on these. This requires investing early, before competitors recognize the potential, and gambling on an array of possibilities, knowing some will fail. Above all, it takes patience, while nurturing the acquired business. This is what many angel investors do, taking a chance on new ideas or products, and there are myriad examples of this type of acquisition growth in the tech industry.
Conclusion: Buy Low
But the key to making acquisitions and mergers worthwhile is buying companies for less than they’re worth. It’s something that Warren Buffett, along with his company Berkshire Hathaway, has made his life’s work. Buying companies when they’re undervalued is a sure way to A&M success. And that’s how cash-rich companies and private equity groups will do it: look for businesses whose assets are undervalued due to the pandemic, and acquire them.