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Friday, July 01, 2011

The Optimal Size Acquisition
Is there an optimal size acquisition, either on an absolute basis or relative to the size of the acquirer?

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.

Why 5-30%?

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.

Tuesday, April 27, 2010

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Tuesday, June 16, 2009

Who Can I Trust on This M&A Deal?
In a recent segment of the Wall Street Journal’s Deal Journal Video: The Dark Arts of Investment Banking, Evan Newmark remarks, “… for the people involved, the incentives are almost always to get the deal done.” This captures a well-known problem in dealmaking, but what is the solution?

In many cases, even company management has an incentive to complete a transaction (larger empire, financial incentives, etc.). For this article, geared toward the CEO decision-maker, let’s assume that he or she actually wants impartial advice on a contemplated M&A deal. Who can be trusted, and how should the opinions received be filtered?

Starting with the group specifically hired to advise on the transaction – the investment bankers – they of course have the most deal expertise and experience, but they also have the most to gain from a completed deal. With some investment bankers, I’m not sure they have ever met a deal they didn’t like. The key here is to read between the lines – look for whether their justification of the transaction passes the “red face test” and for their level of conviction.

On the buy-side, outside counsel also has an incentive for the deal to happen because it would likely have follow-on work in getting to closing and beyond, as well as recognition for a completed transaction. On the other hand, on the sell-side, outside counsel may be less excited about completing the transaction and losing a client. However, in both cases, their financial incentives are not nearly as strong as those of the investment bankers. Therefore, if a senior member of the legal team has the big picture of the company, industry, and the transaction, and also has the business savvy, then he or she might be able provide a valuable opinion.

The internal Corporate Development executives are likely to have both the insight and the background to provide good input. In most cases, they won’t have strong financial incentives based on completed transactions (for this very reason). In addition, the more experienced ones have done enough deals to avoid letting personal desire get in the way of corporate responsibility. So, generally they will be impartial.

Other internal executives, including Finance and the relevant GM should also be able to provide unique perspectives on the transaction. The Finance executives may tend to be risk-averse, and the GM may have conflicting personal agendas (lots of disruption, but a larger empire), but both have a depth of company knowledge that is essential to a good decision.

Finally, be on the lookout for any member of the team (including yourself), in “deal heat,” in which the desire to complete and momentum behind a transaction trump debate over the difficult decisions.

In the end, like may high-level decisions, it’s about synthesizing the opinions of a diverse team into a decision, and taking into account the motivations behind those opinions. In the case of M&A transactions, the motivations can be particularly powerful because the stakes are so high.

(On a side note, the fact that I now work in the most conflicted of the above groups is not lost on me. Despite that, I do my best to make sure my impartial internal dealmaker viewpoint comes through loud and clear.)

Tuesday, January 20, 2009

Selling a Company During Tough Times – Part 2, The Deal
Proactively selling a company during this difficult economic environment is a delicate operation. How does one pursue the sale of a company without appearing desperate?

The previous article (below) covered what to do differently in locating and engaging with potential acquirers. This one will touch on how to handle the deal execution phase differently during tough times.

1. My opinion on valuations.
At the moment, I believe there is a large disconnect on price expectations between buyers and sellers. In my view, each side is only partly right. With the publicly-traded stocks down approximately 40% from just 6 months ago, combined with the lack of other potential acquirers, buyers should expect lower prices, but not necessarily the “fire sale” levels they are seeking. On the other hand, sellers that have alternatives and a bright future have a valid case for using previous valuation methods, but they would be hard-pressed to justify that their valuation is immune to the huge downswing in the public markets.

2. Focus on the terms that are most important.
Most likely, one of those will be deal certainty (in addition to price). More than ever, it is key to avoid letting a signed deal fall through. To the extent possible, minimize the period of time between signing and closing, closing conditions, and any other easy exits that favor the buyer.

3. Be flexible during the negotiation.
Like always, seek to understand the other side and what they need, not just what they want. Use that knowledge to find ways to break logjams during the negotiations. Likewise, be flexible on those terms that are not on the critical list.

4. Consider alternate deal structures.
For example, maybe a strategic investment or other structure short of an outright acquisition meets the goals of both parties.

5. Maintain the highest level of integrity during the deal process.
Of course, this is always important. However, the consequences of a lapse in judgment are particularly high now. It’s likely there are few alternative acquirers, so don’t take any chances of alienating one.

This time of economic difficulty and uncertainty presents a challenge for both buyers and sellers, but transactions that make long-term strategic sense can still get done.

Friday, December 05, 2008

Selling a Company During Tough Times – Part 1, The Search
Proactively selling a company during this difficult economic environment is a delicate operation. How does one pursue the sale of a company without appearing desperate?

There are still potential acquirers out there. However, the field is much smaller, with many buyers conserving cash, unwilling to issue “undervalued” stock as consideration, or simply focused on business execution. Therefore, the likelihood of generating interest from multiple parties is much lower.

This article will cover a few tips on what to do differently in locating and engaging with potential acquirers. A subsequent article will touch on how to handle the deal execution phase differently during tough times.

1. Be visible.
Of course, it’s much better for a company to be approached by a potential acquirer than to market itself for sale. It’s particularly important to be more visible to competitors and others in the marketplace. Ideally, this means more than just PR, but tangible activity related to the product or service that is noticed by competitors, partners, and others in the industry.

2. Do your homework.
Spend extra time researching and thinking about which companies are logical buyers and why. It’s very difficult to convince a buyer to make an acquisition they wouldn’t otherwise, but even the best acquirers sometimes need help to fully develop the strategic rationale, especially now. The more sense the deal makes for the potential acquirer, the more proactive they’ll be about pursuing the deal.

3. Think beyond the obvious.
Because there are fewer buyers, it’s important to think beyond the most obvious ones. Without going too far astray, part of the research and thinking should be dedicated to identifying adjacent or related sectors where there might be a buyer that is a good fit.

4. Pay attention to which companies are healthiest.
There’s no point in wasting time with potential acquirers that are clearly not in the market. Time is better spent taking the most thoughtful approach to finding feasible buyers and understanding the strategic rationale for each.

5. Be careful about bluffing.
There are more reasons than ever why a buyer may not be able to engage at a given time. There’s very little point in trying to create a false threat/deadline in order to force a buyer’s hand. The good news is that the dynamic environment means they could become more interested in a short period of time. My recommendation is to keep on their radar and be ready for that time.

Most of the tips above still apply during a growth economy, but they are especially relevant now.

Friday, June 06, 2008

Due Diligence in Reverse
Companies in the midst of being acquired expect the potential acquirer to perform a thorough due diligence review. But what level of due diligence on the acquirer, or “reverse due diligence,” should they demand?

There are several aspects this question.

Cash as consideration

First, for the investors / shareholders, does the health of the acquirer affect the consideration received? In the case of an all-cash deal, it’s pretty clear that it doesn’t matter. As long as the acquirer has access to the cash and provides adequate comfort that the transaction will close, not much further is necessary or can be demanded. But if the consideration is the stock of the acquirer, some level of investigation of the acquirer is called for.

Stock as consideration, large public company as acquirer

If the acquirer is a large public company, a request for reverse due diligence may be met with a curt, “Please refer to our website and to www.sec.gov for everything you need to know.” In fact, the stock of large or heavily traded public company can be treated much like cash, as it has a more concrete value and can be readily sold. Thus, the same public information available to institutional and individual investors should suffice.

Stock as consideration, smaller public company or private company acquirer

If the acquirer is a public company with a low trading volume or is a private company, the issue of reverse due diligence certainly comes into play. Investors in the target company expect to understand the value of the new combined company. However, the acquirer, feeling like they are the party that is “paying,” will expect the review to be limited. To me, a reasonable middle ground is for the acquirer to provide information consistent with what it would provide a similar size cash investor in the company.

Additional considerations for the executive team

For the executive team, there are additional concerns regarding the health, future, and vision of the acquiring company. For some of the team, they will have a moral expectation and financial incentive to stay with the combined company for a period of time, so they are betting personal opportunity cost over and above the risk incurred by the other shareholders. The team should understand and be comfortable with the future direction of the combined company, much as if they were interviewing for their future positions.

Overall, the issue of reverse due diligence is highly situational, ranging from cases when it is completely inappropriate to cases when it absolutely should occur. It’s important to identify which of the above instances is relevant in order to take a responsible yet reasonable position.

Sunday, September 30, 2007

Should We Make That Strategic Investment?
As a large technology company, is investing in a smaller commercial partner a great opportunity strategically and financially, or is it a distraction and a waste of resources?

I’ve seen quite a bit of discussion on the subject of whether a small, growing technology company should take a strategic investment from a larger company in the same industry. However, I’ve seen much less that addresses the pros and cons from the standpoint of the potential strategic investor. For that matter, looking at the issue from their perspective should be informative for both sides.

Assume a scenario where the “strategic investor” is planning to enter into a commercial partnership with a “growing company” (as I’ll refer to each of them throughout). Frequently, the growing company is in need of funding, visibility, and credibility, all of which the strategic investor can provide. The subject may turn to whether it makes sense to pair an investment and deeper relationship with the commercial partnership.

In evaluating the pros and cons of such a transaction to the strategic investor, there are several factors that weigh on each side of the decision.

The benefits to the strategic investor are:

1. Realize some of the value it is helping to create

Financially, the investment allows the strategic investor to capture some of the value that it adds by directing business to the growing company and due to the “halo” effect the growing company receives by virtue of being associated with a more significant player.

2. Achieve a closer relationship due to an ownership interest

If the strategic investor is interested in developing a closer relationship with the growing company, an ownership position and board seat / board observer is an ideal way to accomplish this. This may be beneficial as a form of due diligence for a future acquisition, or it may be helpful from the standpoint of technology learnings and cooperation.

3. May provide an “inside track” for an acquisition in the future

While this type of investment is unlikely to provide a legal path to control or much in the way of preemptive rights, it can provide an easier path to an acquisition in the form of practical benefits. The strategic investor will have greater knowledge of the status of the growing company’s progress, and may become aware of other potential suitors at an earlier stage.

4. May act as a slight deterrent to competitors as partners or acquirers

While restrictions on partnerships or acquisitions by competitors may not be part of the legal agreement, there may be a practical benefit here as well. Competitors may assume that the growing company is firmly connected to the strategic investor and may therefore focus elsewhere. (Of course, this type of issue could be of concern to the growing company.)

The downsides to the strategic investor are:

1. High-risk and non-core investment

From a purely financial standpoint, venture-type investments are typically outside of the strategic investor’s core business, and small investments are unlikely to produce meaningful returns on an absolute basis.

2. Growing company can become a distraction

Access to a new partner is a two-way street, and it’s likely that the growing company will be interested in speaking to and working with various divisions within the strategic investor. While the exchange can be helpful for both sides, it can also become a drain on resources relative to the core mission of the strategic investor.

Taking all these factors into account, I believe that this type of strategic investment can be useful in select situations where it is important to establish a deeper relationship with a growing company, possibly in preparation for an acquisition in the future.

Wednesday, August 29, 2007

Four Important Things to Know Before You Sell Your Company
The idea of selling your company, receiving a huge payment, and then relaxing on a quiet beach sounds very attractive – what’s not to like? However, it’s important to know what to expect before making the decision to sell.

Here are a few of the basics to be prepared for when contemplating selling your company:

1. Be patient

Even with interested buyers, the process of getting to an acceptable price for both parties and getting the buyer comfortable enough to pull the trigger can take 3-6 months. Of course, the length of time to close a deal can vary widely. I was involved in SBC Communications’ acquisition of Pacific Telesis, which took only 1 month from the beginning of due diligence to announcement. On the other hand, I’m currently involved in a nine-party transaction which has been brewing for 8 months (and counting).

2. Get expert assistance

I’ll admit that this is what I do, so the statement is self-interested. However, I truly think that it is ill-advised to try to “go it alone” when the stakes are so high. It’s likely that you, others on the executive team, board members, and VCs have been exposed to M&A transactions, but there is much more involved in managing a successful deal. Get your advice from somebody who is truly an expert, even if that means calling on a friend or a contact on an informal basis.

A knowledgeable M&A attorney is also an essential member of the deal team (but is not likely to be able to fill the role described above). In addition, be prepared to engage tax and accounting specialists as needed.

3. Dedicate enough time

Even with an M&A expert to provide advice and manage the deal team, you (and other members of the executive team) should plan on dedicating enough of your own time, particularly if many of you will be staying on post-deal. In management meetings that are part of the due diligence process, potential buyers will want to hear directly from you. In addition to providing the detailed knowledge about the business and where it is going, there is no substitute for the enthusiasm of the team in charge.

4. Get organized

A potential acquirer wants to see that you have knowledge of and control over the business. Therefore, have all the relevant financial, accounting, legal, and operational information organized and ready to go.

Selling a company can be a grueling process, but with the right preparation, expectations, and support, you can make good decisions about if and when to start down that path.

Tuesday, June 05, 2007

Which Comes First, the M&A Strategy or the M&A Execution?

The obvious answer to this is that M&A strategy comes first, and M&A execution follows the strategy. I agree with this as the ideal and preferred method for determining acquisitions, but I’d argue that there is actually room for the reverse as well, with proper discipline.

Clearly, the textbook order of progression is:

1. Corporate strategy
2. M&A strategy
3. M&A screening and targeting
4. M&A execution

This methodology should be the foundation for setting and executing on a company’s M&A priorities.

However, a potential acquisition can be extremely helpful in sharpening M&A strategy, as it provides a current and live possibility to qualitatively and quantitatively analyze. So often, the exercise of setting strategy is performed too much in a vacuum, devoid of real-world issues, and allowed to progress indefinitely.

To be clear, I am NOT recommending that M&A activity drive strategy, but I am suggesting that M&A activity can and should help refine the strategy. As far as which comes first, the two are not mutually exclusive. Rather, it is an iterative process in which learnings from M&A execution feed back and inform the M&A strategy, so the process looks something like the diagram below.

There is a level of discipline required in doing this. M&A professionals should not have license to run off in all directions. They need to focus on the general areas set by the corporate strategy, but they should have the ability to perform a “quick screen” on companies outside of the stated target area.

Likewise, the corporate strategy should not dictate an M&A plan so set in stone that it does not have the flexibility to evaluate “out of the box” opportunities within the range of reason, or to spur a dialogue about new acquisition targets that can help refine a company’s M&A strategy.

In my experience, greater freedom in M&A execution, combined with using key learnings from actual and potential transactions, can enhance the standard serial process of strategy-execution and result in better deals.

Monday, May 14, 2007

Planning Ahead to be Acquired
In Mergers & Acquisitions, a logical corollary to the acquiring company asking itself “What am I buying?” is the selling company asking itself:

“What am I selling?”
A company should be run as an ongoing business, not with the express purpose of an exit. However, there are measures that can be taken to increase the odds of eventually being acquired.

One of those is to determine the companies most likely to be potential acquirers and what each of those companies would view as the seller’s most important attributes. In other words, think a step ahead to how the various potential acquirers would answer the “What am I buying?” question.

A list of possibilities, outlined previously, is:

· Product, service, or technology, or a platform that can support additional products
· Customer base / traffic that is attractive or significant
· Distribution channels or hard to duplicate partnerships
· Human resources, such as the management team, development team, or other technical expertise
· Intellectual property
· Brand or reputation
· Fixed assets or property
· Financial characteristics

Next, be sure that those key attributes of the company become or remain strengths. For example, assume it is likely that potential acquirers will focus on a particular service of the seller because it would provide a time-to-market advantage relative to the acquirer developing the service itself. In that case, one of the company’s priorities should be making sure that particular service continues to develop in a way that will be attractive to potential acquirers.

Again, focusing on the attributes most likely to provide an exit should be merely one priority among the many that a growing business juggles, but the strategy discussed above can make the difference in ultimately becoming a compelling acquisition target.