The number of Australian companies considering mergers and acquisitions as a potential growth strategy is steadily rising. Domini Stuart discovers what businesses need to consider before embarking on the acquisition trail.
Ready access to low-interest finance, strong interest from overseas buyers, new funds raised by private equity firms and a growing focus on growth have all helped to inject new energy into the merger and acquisition (M&A) market.
The latest Deloitte CFO Survey found that 60 per cent of the 50 respondents plan to pursue M&A activity over the coming year.
“The last six months have been particularly strong,” says Peter Cook, a partner in corporate law firm Gilbert + Tobin’s Corporate Advisory group. “We’ve seen a number of very large transactions including Transurban’s $7 billion acquisition of a string of Brisbane motorways, South African Woolworths’ $2.2 billion takeover of David Jones and the $1.2 billion sale of property arm DTZ to private equity group TPG. Transactions of this size tend to feed off each other and build confidence in the market.”
There has also been a sharp rise in the number of initial public offerings (IPOs). “Many of these are investments that private equity firms are keen to exit,” says Mark Calvetti, head of corporate advisory for accounting and advisory firm William Buck. “The window into the market has been closed to them over the past few years but, again, we’re starting to see transactions worth billions of dollars.”
Confidence also appears to be trickling down into the middle market. “When the global financial crisis (GFC) hit, a lot of people who wanted to sell their business suddenly had to put that plan on hold,” Calvetti continues. “They either couldn’t find a buyer or weren’t prepared to accept the lower multiples. Now the multiples are creeping up again and the market is becoming more active.”
But we are still a long way from the overheated M&A environment we saw in 2006. “Back then, people were throwing caution to the wind and seemed to be making acquisitions for acquisition’s sake,” says Dr Katherine Woodthorpe FAICD, professional non-executive director and former CEO of the Australian Private Equity and Venture Capital Association (AVCAL). “This time round acquirers appear to be thinking more carefully about how targets might add value to their strategic vision.”
The best way to grow
A sound strategy for growth begins with a deep understanding of the business. “An acquisition is not always the answer to your business problems,” says Dr Eileen Doyle FAICD, director of Boral, Bradken and GPT and deputy chairman of CSIRO. “Directors need to think about what you could do to grow organically and then assess the real value of an acquisition. If it is the right way forward, you need to be very clear about your business strategy and ensure that any acquisition target would reinforce that.”
M&As can enable a number of different outcomes. “Expanding vertically by buying upstream suppliers or downstream purchasers can give you more control of your supply chain,” says Calvetti. “Expanding horizontally by buying a company in the same industry can strengthen your business with good people, superior technology and assets like better marketing or research skills. Or you could choose to diversify by buying into a completely different industry.”
Directors should be prepared for M&As to be a long-term process of identifying and observing potential targets. “Watching their performance over a period of time allows you to gain an understanding of what they would bring strategically to a merged entity by way of new products, new customers, new business segments or new geographical markets,” says Woodthorpe. “If yours is a smaller company without the resources to carry out such research on an ongoing basis it could be useful to engage a consultant to review such opportunities on your behalf.”
The board must also identify and consider the full spectrum of associated risks. “I think one of the biggest mistakes is looking only at the bare economics of a deal and not taking other factors into account, such as major cultural differences between the two companies,” Woodthorpe continues. “Companies that have acquired others purely for their bottom line have often been disappointed.”
The right price
Few of the private companies that make up much of the middle market have the same high standards of corporate governance as larger, publicly-listed companies. This makes pricing them a very different process.
“Even the very large private companies are owned by one or a small number of people and their accounts may not be audited,” says Calvetti. “There may be private expenses running through the business that need to be normalised to portray a correct picture of the underlying profits and, when valuing these businesses, you also have to consider specific discounts – for example, a business that is very dependent on the owner, another key person or one particular client has a higher level of risk. Even where private companies issue stock it can be difficult to establish the value of the shares and they can also be hard to sell so, generally, these companies are less liquid. You really need to know the business well if you’re going to make appropriate and well-informed adjustments.”
There is also the challenge of putting a price on potential synergies. “In terms of M&As, one plus one should always be greater than two,” says Doyle. “When you understand that equation you can decide on the highest price you’re prepared to pay for the benefits and negotiate within that framework.”
For a private vendor, objective calculations might only be part of the story. For example, if it is a family business, emotional issues might have an impact on the price. “You might want to consider mechanisms such as earn-outs,” says Woodthorpe. “These will keep a founder involved in a business and ensure that everyone is rewarded if the merger succeeds.”
Calvetti has also noted a trend towards selling part of a business. “We are seeing owners in their fifties and sixties who do not want to retire completely, selling 40 or 50 per cent of the business,” he says. “They are then transitioning out of the rest over four or five years.”
Finding a balance
It is easy to underestimate the impact of emotions on an auction process. But, as Cook points out, if you are emotionally committed to an acquisition, it can be hard to pull back.
“I have seen a few people get caught up in ‘deal fever’,” he says. “If you believe you have to win at any cost you’re likely to end up paying far too much.”
On the other hand, you can also lose out by being too cautious. “The board should be ready to take advantage of good opportunities when they arise,” Cook continues. “And, if you’ve identified a target as strategically important for future growth, you might have to consider paying more than you’d hoped. I’ve seen boards live to regret passing up an acquisition where the target went on to increase in value and slip out of reach, or where it was snapped up by a competitor which then forged ahead.
“It takes confidence in both the company and the market to make decisions of this kind – and you should never be in too much of a hurry to do thorough due diligence. Obvious as it sounds, you need to make sure you are buying what you think you are buying.”
Due diligence should include an assessment of how the processes, systems, people and cultures can be shaped into a cohesive entity. “Mergers affect everything,” says Karen Isely, director of Isely Associates International, which addresses leadership, culture and communication issues through all stages of M&A transactions.
“Whether you are the acquirer or the target, these events are disruptive, often dramatic, and they can be catalysts for significant change. Focus and productivity are always at risk in anticipation of a merger, during the execution of the deal and right through implementation,” she says.
“And, while the future rarely remains the same for anyone touched by a merger, these inevitably are pivotal career moments for senior executives, bringing either kudos and professional advancement or the harsh reality of having to reinvent. Paying attention to matters of people and culture can make the difference between success and failure.”
A common mistake is to concentrate on cultural fit rather than cultural impact. “To address risk, the board first needs to consider whether the acquisition will speed up or slow down the journey towards the culture that best supports its strategy then, second, if or how well the groups will be able to work together,” Isely continues. “And, of course, boards can only answer these questions if they have a genuine understanding of the culture of their own organisation.”
Early preparation is also crucial. “If a team is not ready on all fronts at the start of a transaction, making up for lost time presents a huge challenge – and lost time is lost value,” Isely adds.
A merger can be disruptive well before it is finalised. “The prospect of M&A activity creates anxiety and uncertainty throughout the organisation, so it is vital that both parties keep discussions confidential until the deal is sealed,” says Calvetti. “Employees often start fearing for their jobs and decide to pre-empt possible retrenchment by looking elsewhere – and it’s bound to be the best people who are snapped up first. This can trigger a vicious circle of a high turnover, demoralisation and lack of commitment.”
It can be very difficult to keep M&A activity quiet if the process is being managed internally. An outside advisor can help by placing strict controls around who receives what information and Woodthorpe recommends that all boards invest in the best independent advice they can afford. “M&A activity places such heavy demands on senior management that it can easily distract them from their primary task of running the company,” she says. “Independent advisors can help to ensure that the business runs smoothly and remains profitable. They can defuse any emotion and provide objective advice on pricing and strategy. And they can also help you to put an effective integration program in place.”
Seven common M&A mistakes
- Focusing on economics at the expense of other critical factors such as culture or leadership capability.
- Not being prepared or confident enough to act quickly when the right opportunity arises.
- Getting caught up in the emotion and the drive to win at any cost.
- Acquiring a business that looks good but is not aligned with your business strategy.
- For a potential seller, failing to calculate or understand the true value of your business.
- Failing to do adequate due diligence.
- Going it alone rather than employing an independent advisor to help minimise risk and extract the highest possible value from the process.
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