Mergers and Acquisitions (M&A) Target program for buyers

Mergers and Acquisitions (M&A) target identification program

In this blog, we shall look at building an program to identify a right mergers and acquisitions (M&A) target for acquisition.
As M&A is increasingly used as an inorganic growth strategy by companies, acquirers need to build a criteria to identify the right target company for acquisition based on strategic fit, price, culture and Integration.
The deal team is tasked with building a pipeline that comprises a list of potential target companies to reach out for acquisitions.These target companies are ranked based on the list of criteria that is important for acquirers.

Right mergers and acquisitions (M&A) target identification

An acquirer would be looking to an acquisition to achieve the following objectives:

• To have a higher Return on Investment on the acquisition where ROI should far exceed the Cost of capital.
• The acquisition should give minimal risk and at the same time a higher ROI.
• The acquisition should not lead to any friction either through attrition of key employees and customers post the announcement of the deal.
• The acquisition should complement the long term business strategy of the acquirer.

It is necessary that the acquisition program should be aligned to the acquirer corporate strategy.This is generally done by performing a SWOT analysis on the acquirer to understand its strengths and weaknesses. Post the analysis, the acquirer identifies criteria for acquisitions.
The acquisition should expand the acquirer customer base, strengthen its presence in new and existing markets, provide access to new products/technology/capabilities. In other words, the acquisitions should improve the overall standing of the acquirer market position.
Despite this strategic rationale, some acquirers react to opportunistic acquisitions from Investment bankers, Investors, Deal Brokers, Analysts and from senior management of the Target company.This results in acquirers approaching wrong targets that neither strengthens the acquirer capabilities nor addresses its weakness.The approach to address this issue is to have a pre-acquisition criteria that is a combination of Financial and Strategic criteria in place to identify a right target company.This eliminates the unnecessarily effort spent in evaluating a wrong target company.

Mergers and acquisitions (M&A) target Criteria

The acquisition criteria for Target Identification can be grouped into:

1. Financial Criteria
2. Business Criteria
3. Transaction criteria

Let us look at Financial criteria.The following criteria generally observed is:

Mergers and acquisitions (M&A) target criteria 1 – Financial criteria

Large vs Small Target firms by Revenues

• Smaller acquisitions generally have a higher success rate than Larger acquisitions.
• Public companies that make large acquisitions need to be accountable to their shareholders as they would expect growth from this deal.

Gross Margin

• Targets that have consistent high margins year on year have a competitive moat through their highly differentiated product offering, high demand for their services from customers or when they are operating in a very attractive niche market.

Growth

• Target historical and projected Growth

Mergers and acquisitions (M&A) target criteria 2 – Business Criteria

Products/services

• What is the target selling?
• What is the quality of the target products/services?

Customers

• Who are the target customers?
• Is the target customers from B2B or B2C segment?
• Is the target customers SMB or Enterprise wide?

Distribution

• How does the target sell its products?
• Is it through direct selling or through partners?

Geographic Footprint

• What is the target presence globally?
• In which countries and geography does the target company have offices in?

Brand

• What is the customer perception of the target company?
• What is the brand perception of the target products/services?

Management

• What is the quality of the Target Management?
• Will the target management continue post acquisition?

Culture

• Is the target company bureaucratic or entrepreneurial?
• Is the decision making centralized or decentralized?
• Does the target firm have a command and control structure or collaborative culture?

Employees

• How is the skill set of the target employees?
• How is the hiring process for recruitment?
• Does the target employees operate in a country that has tough labor laws or unions presence?

Mergers and acquisitions (M&A) target criteria 3 – Transaction Criteria

Valuation

• Does the transaction multiple have a floor and ceiling between which the target company is evaluated?

Profitability

• What is the Return on Invested Capital, Return on Assets, Return on Equity and Payback period?

Integration

• How difficult is it to integrate the target company?
• Target companies that are more than 25% of acquirer size or that has different operating models are more complex to integrate.

It is important to rank these criteria based on how important it is to the acquirer and then assign a weightage for the same.This process needs to be completed before sourcing a target company and in building a pipeline.

Building an mergers and acquisitions (M&A) target pipeline

• Once the acquisition criteria is finalized, then sourcing target companies and building a pipeline would happen.
• This is a very arduous process and takes a lot of time in evaluating a target company based on the criteria and then including them in the pipeline.The pipeline building generally takes more than a year to come up with a quality set of targets.

Acquirers that do not invest their time in this activity would look at opportunistic acquisitions from bankers and other third parties.This will lead to issues in selecting a wrong target company that does not support acquirer long term strategy or improve shareholder value.
Building an acquisition pipeline requires good communications with acquisition sources like CEO, CFO, Boards, Corporate Development officers, Investment bankers, sales and business development executives who can be tasked with identifying acquisition targets.These targets are then evaluated against the acquisition criteria to build an initial pipeline.
Hence building an acquisition pipeline takes a lot of time.Acquirers that do not have capabilities or right resources can look at other growth alternatives.
If an acquirer who has limited experience and capability to do acquisitions wants to do acquisitions, then they can employ the services of consultants who have industry expertise on the target industry, can liaison with target management and support in valuing the target company and come up with a deal structure.
This can free up acquirer bandwidth by releasing resources and also having a constant deal flow.
Disadvantages of engaging a consultant are:

• The consultants do not have enough knowledge about the acquirer way of Working.
• Consultants are expensive and charge by hourly basis.
• Since consultants have a transaction fee structure, sometimes they many bring deals that are not in the best interests of the buyer.
• As consultants negotiate on the behalf of the acquirer, the acquirer stands a chance to build long term relationships with the target companies.

Hence acquirers can engage consultants only when they are looking to do a sporadic acquisition. For acquirers that have M&A as a growth strategy, it is better to build an inhouse team with required capabilities.

Conclusion

1. Having an mergers and acquisitions (M&A) target program to build a pipeline of high quality target companies using a predefined acquisition criteria will help acquirers choose the right target company for acquisition.
2. Sourcing the right target company based on the acquisition criteria will also nip acquirers opportunistic tendencies of choosing a wrong target provided by bankers and brokers.
3. Acquirers that have M&A as a long term growth strategy will have an inhouse M&A team tasked with all capabilities. Acquirers that do sporadic acquisitions can engage third party consultants.