How to crack the code of Digital M&A

Digital M&A

In this blog, we shall discuss on digital M&A, Mergers and Acqusitions,  how companies need to have a different strategy when acquiring digital companies as acquisitions involving digital companies are different compared to a conventional scale acquisition.
To get most value from their digital acquisitions, synergies play an important role.Intangible drivers like Social media influence and scientific acumen of the digital company plays a key role in justifying it’s high valuation.Acquirers should leverage target firm’s less tangible drivers to grow their business and at the same time use their own strengths to grow the digital firm.
Traditional synergies like cost and revenue synergies are equally important.Hence drivers like headcount reduction and cross sell revenues still play an important for value addition.The acquirer also needs to ensure that the target unique value creation attributes is preserved once they start to integrate the target firm with the acquirer.
Taking the right steps to identify, quantify and extract the less tangible sources of M&A is key to cracking the code of digital M&A.

Acceration in Digital M&A dealmaking

They are two reasons why large incumbent companies go for acquiring digital targets.

  • Digital disruption has impacted every industry which prompts every firm to build their own digital capabilities. Companies looking to build digital capabilities internally realize that the rapid rate of digital innovation render their solutions incomplete even before they are fully implemented.
  • Traditional companies struggle to hire digital minded millennials to their workforce due to the differences in culture, business and operating model.

Hence digital deals constitute 30% of the total M&A and more than two third firms outside tech sector look to acquire digital capabilities.

Identifying the right Digital M&A deal

  • Soaring valuations of digital assets makes it tougher for companies to justify their boards/shareholders to spend high price for a digital acquisition.Further a digital acquisition does not provide scope for cost synergies as compared to a conventional deal.Integrating a digital asset is risky due to divergent culture, business and operating models between the target and acquirer.
  • Hence companies need to justify high valuations through non traditional synergies like leveraging Digital marketing capabilities, automation and Artificial intelligence. These synergies are intangible and hence difficult to quantify. Hence investors are skeptical whether the acquirer will be able to deliver on synergies target as promised during the deal announcement.

Identifying digital M&A targets in non-traditional ways

  • Before looking at M&A, acquirers need to decide which capability it lacks in to effectively respond to digital disruption. Acquirers need to have strong clarity on technology trends affecting its business, it’s current competitive advantages and future strategy.
  • This detailed assessment provides acquirers the parameters for digital assets that it intends to acquire.These criteria might include the need to strengthen existing services/products, expand to new markets/geography and expand to adjacent sectors.
  • The criteria for digital targets should focus on evaluating traditional data that is linked to the financial performance and non-traditional data that is linked to the future performance of the company.
  • Non-Traditional data indicators would include the rate at which target is acquiring new customers and social media sentiment relating to the target.
  • Strong digital companies have built IP expertise, issued patents, written publications and have strong collaborations/industry connections.
  • Acquirers need to keep in mind these strong attributes to identify the right digital targets.

Evaluating a Digital M&A Target valuation with a digital mindset

  • When evaluating an acquisition, deal makers first determine the enterprise value of the target company.Then they develop a business plan which identifies the costs and revenues synergies generated by integrating the target company with the acquirer.
  • If the enterprise value and synergies exceed the acquisition price, then the deal is considered positive.This conventional approach discounts two categories of revenue synergies which are critical to justify higher valuation multiples of digital acquisitions.
  1. Accelerating the Target – Acquirer can support the target long term growth by providing it access to capital, customers and new markets.The acquirer should have a business plan for the target that leverages acquirer strength for the target to expand and add substantial value.
  2. Growing the Acquirer core – The acquirer can take advantage of target capabilities to come up with new business models and add new service lines that add significant value which can help the acquirer expand its core business.

Identifying Non-Traditional Synergies in digital M&A

To assess Non-Traditional synergies, three sources of value needs to be considered:

Capabilities and Specialists Knowledge

  • Acquirers leverage targets capabilities and its specialized knowledge to accelerate it’s own growth. The target company can have strong expertise in Digital marketing, Analytics and in Design.
  • There are digital tools in market that quantifies the target expertise and its strength.For instance, LinkedIn is a valuable tool to prospect the target employees.An high percentage of employes with PhD qualification in the target company can give an idea to the acquirer of target expertise and capabilities.

Stakeholder Influence

  • The breadth and depth of target relationship with its customers, suppliers and partners is an indicator of target success.The acquirer can extract this value by cross selling its services to target customers.
  • High customer satisfaction and positive reviews on target services in social media can give an high confidence to the acquirer they can cross sell their core services.

First Party Data

  • A digital company often collects data about its customers and suppliers which is then analyzed to make decisions regarding better service offerings for customer, strengthen its relationships and drive better capital allocation investments.
  • An acquirer can replicate this target analysis and data collection skill to analyze and improve its core offerings.
  • The acquirer needs to ensure that the target is compliant with GDPR when collecting data from its customers.

To gauge the potential value of the acquisition, acquirer can assess if the target capabilities can be built inhouse along with potential impact of the competition acquiring the target.The acquirer can compare the target with other potential acquisitions to come up with a business case on why acquiring the target is the best option available.This can help the target to convince its board/shareholders on the significance of the transaction.

Present your offer differently to woo the Digital M&A targets

  • A digital target will often have more than one acquirer bidding for it resulting in an auction like situation.The deal team when reviewing the target need to identify the traditional and non traditional sources of value creation along with areas of risks.
  • An acquirer needs to differentiate from its competitors with a value proposition that adds value to the target management and investors.For instance, A VC investor would be interesed to exit the target firm with a high exit multiple where as the founder is interested in an owner that provides capital when required, so that they can focus on running the business.
  • Hence it is critical for acquirer to articulate the growth opportunities and other benefits arising from the proposed transaction. An acquirer needs to motivate the target management with an end vision that can result in accelerating the target business and at the same time growing the core.An acquirer needs to have a roadmap on how it is going to create value and share this roadmap with acquirer investors and shareholders. The acquirer and target needs to build a joint business case on how it is going to achieve the synergy targets and whether they are going to retain the target management going forward.

Preserving value through the right Digital M&A Integration strategy

A right integration strategy is needed to preserve the value of the target company and not erode the high value that justified the acquisition.
The pace of integration needs to be balanced so that high speed in integrating target with acquirer business does not affect the target business.By imposing the acquirer policy and processes on the target company can suffocate the target growth which can result in the risk of departure of key employees of target management.
Some of the best practices that can be followed for integrating and operating an acquired business are:

Preserve the digital M&A Target culture

  • The acquirer should retain the key employees of the target by providing retention agreements. In addition, the acquirer should allow the target company to operate independently with arm’s length management. In order to prevent imposing the acquirer policy and process on the target, the acquirer can introduce a simple governance structure.In order to preserve and retain the culture, the acquirer show allow the target employees to continue to work from the same location.
  • At the same time, the acquirer should plan on investing in capabilities and funding to accelerate the growth of the target business.This growth plan should be developed jointly by both companies as equal partners.

Co-operate and Grow

  • Once the acquirer and target become familiar with each other processes and systems, the next step would be to carefully manage the transfer of knowledge and capabilities between one another.
  • The integration speed should not be too hurried and large scale transfer of employees from acquirer to the digital target needs to be discouraged as this may affect the target culture resulting in exits of employees.
  • The right approach would be to identify temporary assignments where both employees from target and acquirer can work together.In addition, conducting workshops regularly between employees of target and acquirer would help in sharing the best practices and in identifying opportunities for collaboration.

Integrate over time in digital M&A

  • In the final phase of integration, the acquirer can bring in a management team to manage the acquired company.This transition needs to be done carefully. Initially non core functions like finance and backoffice functions needs to be integrated.
  • The integration team needs to assess whether core target functions like innovation needs to be integrated or allowed to function standalone.If the risks to integration are high which can result in poor performance of the target company, then it is preferred to allow the high critical functions of target to run independently.

Conclusion

  • More companies look at digital M&A to acquire digital companies to survive digital disruption.These acquisitions gives acquirers access to digital capabilities to establish an agile operating model, foster culture focused on innovation and attract digitally minded workforce.
  • Digital targets are expensive and there is more competition from acquirers for similar assets.Hence buyers need to have an empowered integration team which can achieve synergies targets and value creation.
  • Companies that crack this code are well positioned to achieve superior shareholder returns.


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