Growth through acquisition
September 2005
Colin Chinery examines the pros and cons of expanding your business through acquiring or merging with other companies
There’s no business like the acquisition business. In just one month last year companies around the globe fired off take-over bids totalling £77.7 billion. This is inter-galactic arithmetic. Count it off at the rate of one number a second 24 hours/364 days and it would take you 4,598 years, the age of the Great Pyramid.
Deals are brokered and spurned in locked suites, on discreet fairways and in the public bear pit. But on High Street, UK we know Tesco has been in talks with the National Lottery Commission which could see the supermarket colossus replacing Camelot as Britain’s lottery operator, while ITV plc has been fielding a $6.6 billion bid from US media giant Time Warner. And after a scorched earth war of share-buying and public opprobrium, US financier Malcolm Glazer finally got the Reds into his bed, and Manchester United now share paternity of sorts with the Tampa Bay Buccaneers.
Interestingly Glazer’s take-over at Old Trafford contravenes in spades at least one of the tenets of successful M&A (merger and acquisition), namely cultural synergy and not upsetting the natives. What drives Glazer may be guessed at, but the logic of conventional mergers and acquisitions includes increasing market share, gaining new facilities, technologies, and possibly markets, an enlarged skilled workforce and management quality, economies of scale or product synergy, risk diversification and command of supplies and outlets.
In a competitive environment businesses must continually improve performance. City and shareholders demand it, employees hope for it, and for many companies the quickest and most powerful route to growth is through merger and acquisition.
And there is no shortage of facilitating cash. Mike Deacon, Director of Bibby Asset Finance points to the current flush of venture capital money. “The VC boys in the City are very active and doing what I call stage two and three deals. They are looking at mature and existing businesses needing a lift up the ladder – a lower level tier where they are looking to grow, and the existing founders or funders are wanting to get out. And at the bigger end there’s a lot of M&A activity generally, a lot of deals, a lot of consolidation. And this for several reasons such as market share, overseas competition and market competition. If you’ve got a niche, people like to buy into it because they see profit and high value margin businesses.”
Sue Grist, director at consultants Egremont agrees, and says leveraged transactions are especially favoured among the many financial backers looking for deals. “They are in competition for any company where there is a chance of a reasonable return. Recent successes have persuaded many management teams to go down the buyout route.” But she adds a warning. “Rather like the internet boom, they can be making decisions based on undeliverable promises of riches in future.”
In the retail sector lowest cost provider and specialist are the two current success strategies, “within fashion retail value providers such as New Look and Primark are performing well, specialists and luxury are faring better than average, and those in the middle are having a very difficult time.”
With many product sectors now in price deflation, producers must sell more units each year to stay still on sales. This, says Sue Grist, against a backdrop of increasing occupancy costs, wage and pension costs etc and a commoditisation of many product sectors. “Companies are pushing to acquire to consulate central support functions and gain critical mass in order to reduce prices and capture share.”
The staging posts of M and A are: vision and a defined strategy, a convincing “Why?”, targeting, due diligence and establishing a price, followed by negotiation and deal. But if buying a business has been described as the easiest task in management, integration and making a success can be a highway of pitfalls. Critical to this end are great leadership and management and clear organisation and motivated people.
The Why? is crucial, the question that commands others. What strategic aims must be achieved for the purchase to be justified? Does it make financial sense? How quickly and effectively can the purchase be integrated and how long for it to work?
“Do everything to lay the ground rules first,” advises Mike Deacon.” Then get your money in place, and then effectively implement. But too often people tend to implement and then think about the money afterwards.” Mergers and acquisitions are popular and macho, but sometimes organic growth makes more immediate sense. There are hazards in waiting however if growth takes too long in a fiercely competitive market.
But with surveys reporting between 70 and 90 per cent of all acquisitions failing to deliver anticipated shareholder value, and 40 per cent actually destroying it, M and A’s track record is as flawed as a rail operators timetable.
“The most significant cause of failure,” says Sue Grist “is lack of cultural fit followed by a lack of integrative leadership. Most companies have no difficulty with driving out the cost-saving synergies – sometimes they move too fast and invaluable experience and insight is lost as acquired head office staff are quickly made redundant.”
When you buy a business, says Mike Deacon, “the greatest value is its people, and the ability to innovate, create and develop. The economics of a value deal is merely a buyer-seller discussion, a Mexican stand-off between shareholders. But if you don’t carry the people with you from the beginning, you will never realise the full potential of what you purchased.”
But the muscle-building macho of M and A can be deceptive, a charade staged by deep insecurity, much of it personal. With the average tenure of a CEO globally now just 2.75 years, Sue Grist sees more acquisitions being driven as a defensive measure “to hide underperformance, to extend the life of CEOs, to please analysts demanding action.”
Mike Deacon agrees: “The greatest dynamo is fear – fear of interest rate and commodity price rises, fear of the world economy, fear of competition. M and A in the main are not driven by better development growth or for the greater good of Man. People grow to protect themselves.”
WHY ACQUIRE?
Nigel Stokes is MD of DCM, a well-established engineering company in Coventry. “Like all businesses in this sector we have experienced increasing competition from cheaper overseas suppliers. Rapidly growing pressure from our customers who were constantly looking for cost down targets to be met, with faster turnaround times and shorter production runs prompted us to take a hard look at the business some years ago. A change of direction was needed.”
While adopting a strategy of investing in new technology to compete with and beat overseas competition, DCM also needed to consider its place in the engineering food chain. “Being a sub-contractor in a shrinking and highly competitive sector is a tough place to be, so we wanted to look at ways of us spreading our influence up the supply chain.
“By acquiring businesses that would effectively become DCM’s customers we were able to achieve a degree of upward integration that has helped us to defend our competitive position.
“The choice of acquisition targets was fairly simple. We were on the lookout for businesses that could be supplied with precision parts by DCM, but ones that were also performing below their potential. This was the case with Drop-On Carriers that had a great concept – a universal bike-carrying system – but needed to invest in new product development and marketing.”
Location was another criterion. “Management has to be a hands-on affair and without constant attention from senior management, focus and energy can drop off. That’s why these two acquisitions worked so well – being within a few miles of each other and close to DCM’s site in Coventry meant that I – and the senior team – were there whenever issues needed to be resolved.
Nigel Stokes never underestimates the time/cost factor. “Most acquisition targets have at least one skeleton in the cupboard waiting to come out! Luckily, that has not been the case with either Precision Point or Drop-on Carriers as we got to know the businesses very well before we made an offer. Knowing your acquisition target from the inside out is important before you even begin to think out the worth of the company.”
But while professional advice and guidance is de rigueur in major deals, many SME acquisitions like these evolve almost like marriage, from close personal knowledge.
“I am not a great fan of using professional advisers unless they can demonstrate real added value to a process. When it comes to evaluating an acquisition I prefer to use my own knowledge of the market and a gut feel. You know when a potential acquisition makes sense.
“Sure, I agree advisers can be very worthwhile when looking at complex acquisitions involving due diligence, pensions and intellectual property rights, but my experience of the M&A market tells me that if you know the acquisition target well enough, you shouldn’t need to spend that much on professional advisers.”
Is the DCM scanner still on? “We are always on the look-out for potential acquisitions, as long as they fit with our vision of vertical integration.”
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