Value creation in M&A
Value creation in M&A is the goal, driver, and test of any M&A deal. M&A is not a cheap or straightforward way of realizing growth. It usually is the most dangerous and least probable to succeed. Still, if executed well, it prevails the most reliable way to expand immediately comparable to other organic options.
In publicly listed organizations, value rises (or drops) get continuously observed after a deal announcement. Market responses show trust (or lack thereof) in the acquirer’s capability to achieve synergies and increase value, weighing factors such as the price paid, reliability and ability of leadership, and the apparent overall success of integration and the business post-close. Besides, initial feedback from crucial customers can give a good sign – particularly in private acquisitions (these are the exclusive real indicators accessible until operational performance data, and financial results begin to collect).
Generating a value creation strategy at the commencement of target evaluation, then analyzing and perfecting it into the pre-deal activity, is an important activity that should begin to push both the deal process and integration design and planning. Achieving so will warrant that you:
- Create value expectations/estimates that are more practical;
- Concentrate on the essential value drivers through due diligence (to examine their achievability), across valuation (to develop hypotheses and learn sensitivities) and into deal negotiations (to know the strategy and red lines);
- Quantify fundamental aspects and timings in the “synergy Map”;
- Add negative synergies and value creation costs (i.e., costs to realize synergies) in the overall valuation model;
- Focus/prioritize adjustments to the operating model, and the ensuing initiatives that involve the integration plan;
- Are particular in the communication of value creation goals to employees and the businesses post-close;
- Recognize initial alarm signs of a transaction that it should no longer get continued.
Value Creation Phases in M&A
Value creation should underpin and develop all other M&A activities – not merely due diligence, but including the deal-making, and of course, integration design and planning, communications, and integration execution. The value creation method comprises three discrete phases. Each phase involves decision features that affect value creation. The stages are:
- Acquisition Decision
- Expectation Setting
- Value Achievement
How the value gets generated will depend on several circumstances, such as:
- The critical basis and purposes of the deal;
- The position of products/services in their lifecycles;
- The financials of the target;
- The alignment of the strategies of the acquirer and the target entity; and how likely it will evolve post-close. If there is a considerable variation in pre-deal strategic thinking, value creation might be late or painful to realize;
Value Creation Potential in M&A
For a transaction to achieve adequate results for the business and its shareholders, the value generated must transcend all costs associated with the acquisition and consequent integration – all as measured on a time-discounted and risk-adjusted basis. A typical situation is to underestimate expenses and to exaggerate value potential – hence resulting in a deal that doesn’t “payback” over time and is not accretive. This phenomenon is known as the “synergy trap.”
This leaning leads us to the idea of an Acquisition Premium. The acquisition premium is a price over and above the stand-alone value of the target. Assuming that their company is presently worth more to the acquirer, sellers customarily demand a premium to get paid. Acquirers need to be vigilant and estimate for themselves what premium – if any – is worth paying. Recognize, the greater the incentive, the higher the responsibility placed on integration to produce synergies to pay it back. While a deal premium can get acknowledged as the value to the acquirer of the brand, IP; eventually, it’s nothing more than a representation of the synergies targetted for capture.
An acquirer uses the stand-alone target value, adds in the different types of synergies (i.e., revenue, cost, capital). After that, deduct the cost of achieving the synergies (i.e., charges incurred across the integration process) and any negative synergies, they end up (on a non-risk, non-discounted basis) with the best price they should spend for the target. If an acquirer settles under this price, they stand a possibility of generating value from the deal. If they decide to pay anything above this, they require to clutch more synergies out of the transaction. Otherwise, risk the likelihood of an agreement that misses delivering on value.
Nonetheless, overpaying for an acquisition persists in the commonplace. A company will spend too high a premium if it:
- Exaggerates the synergy potential;
- They disparage the work and costs associated with the integration and across value creation activities.
If the synergies an acquirer defines as feasible from an acquisition (including negative ones, costs) are cheaper than the “premium” commanded by the seller, they should walk away since the deal will never measurably illustrate an adequate return.
Costs to Achieve
Value creation is not inexpensive, and it’s a given that high fees will expand as a consequence of value creation activities. It’s hence crucial to recognize and precisely evaluate costs to accomplish to realize upside synergy targets and so to reach a net synergy number/target. Typical examples of expenses include:
- Headcount addition/decrease, adjustments to staff – recruitment, redundancy costs and trade union conflicts;
- Project expenses;
- Rebranding (signage, packaging);
- Legal expenses;
- Acquisition of latest equipment;
- Recreation of marketing and promotional materials (including, e.g., websites, internal forms);
- Travel expenses for executives and the integration unit;
- Usage of third parties to assist integration (e.g., consultants, systems integration experts).
Unintended negative synergies may emerge when a business concentrates too densely on integration activities to the disadvantage of day-to-day operations.
Hence, customer focus might be missed – with orders and sales negatively affected, for example. Customers might avoid a supplier that grows too dominant as a consequence of M&A and defect to a competitor. When such a “dip” in sales happens, its expansion and outcome will possibly get credited to several constituents, such as:
- Urge, focus, and retention of staff in the merged organization;
- The degree of change in operational structure and people;
- Quality of product/service, customer service;
- The status of the acquiring company;
- The hurdles integration is giving to the business (e.g., as a decision of core IT systems changes, new process introductions);
- The unanticipated exit of essential personnel (e.g., sales individuals);
- Preservation of tacit/institutional expertise in the business.
Lack of customer focus due to integration can drive to a speedy and sharp revenue decline in service and customer business. This fall occurs, especially where acquiring new business is based mostly on personal relationships; the order cycle gets compressed. If the correct “business disruption” metrics are being strictly monitored, with swift responses to correct any concerns set in place, the situation may be recoverable. Conversely, in instances where order sales cycles are long-drawn, it’s simple for management to manifest a false sense of safety and believe everything is going great given a long order backlog. But, the delay in the system can ultimately present itself out, pointing to a sales drop further down the line that is both unexpected and unrecoverable.