Companies that are active acquirers are continually evaluating transactions across a wide range of sizes. Some employ criteria on the size of the M&A target, and the answer to the question posed here would be useful in refining such criteria. Likewise, the answer would give companies positioning themselves for a sale an idea of which acquirers might find them most attractive.
In a recent article from the McKinsey Quarterly, Growing through deals: A reality check, the primary conclusion is that “the size and frequency of deals matter less than how companies execute them.” This conclusion makes perfect sense, but it’s based on a sample of acquirer performance by number and aggregate size of deals completed.
What is more difficult to determine, especially quantitatively, is the optimal size of an individual transaction (as opposed to the aggregate of multiple deals). Based on my experience, an acquirer should look for targets between 5% and 30% of its size in terms of enterprise value. Note that I use enterprise value as opposed to equity value in order to more closely reflect the operations and operating cash flow of the company.
Acquiring a company smaller than 5% usually isn’t going to “move the needle” enough to be worth the opportunity cost of finding, executing, integrating, and operating the business. Even a “5% company” that triples in value wouldn’t likely result in a significant impact on the acquirer’s overall value, particularly relative to organic growth and other initiatives.
There are clearly some exceptions to the greater than 5% guideline. Small acquisitions might make sense in order to secure key technology and/or an expert team (e.g., many of Google’s and Facebook’s deals), a bolt-on product that accelerates time-to-market, or a business that provides lift to the acquirer’s core business. With respect to the latter, a significant revenue synergy is sometimes projected but rarely achieved.
On the other end of the scale, there can be a number of reasons for transactions where the target is larger than 30% the size of the acquirer. However, these are less common and high risk, particularly “transforming” transactions (as opposed to merely large ones), and mishandling either the transaction or the subsequent operations can have dire consequences.
I view the large transactions as exceptional situations which good acquirers can absorb every few years at most. Even AT&T’s $39 billion pending acquisition of T-Mobile, generally viewed as a large transaction (and the largest of 2011Q1), only represents approximately 16% of AT&T’s enterprise value.
Acquirers, let me know what you think.