- October 4, 2022
- Posted by: Ramkumar
- Category: Mergers And Acquisitions
Managing The Mergers And Acquisitions Process
When any company looks at M&A as a growth strategy to acquire capabilities, customers and talent, there is an assumption that the firm should have evaluated alternatives like organic growth and alliances before deciding on M&A as the best strategy. After that, the buyer hires bankers or will have its corporate development team identify target companies that satisfy the strategic rationale for the acquisition. During the subsequent steps – The valuation and Negotiation phase, the buyer estimates the target worth and strives to reach a price agreeable to the buyer and seller. Then the buyer gets access to the seller’s data room after it gives the seller the offer, where it does due diligence on the data to verify its valuation. Finally, after the buyer and seller agree to a price and structure, they close the deal. After the deal’s consummation, the buyer needs to integrate the target organization with the buyer to extract synergies. This post gives insights into my experience of managing the M&A process optimally.
Valuation and Negotiation
In an M&A deal, mainly when strategic buyers are involved, the valuation, negotiation, and integration depend on the underlying synergies. Thus, the valuation must incorporate the integration challenges, and the integration planning must focus on the deal’s value drivers.
In an M&A deal, valuation is subjective and depends on how much the buyer is willing to pay. Thus, negotiation is crucial to align to a price to which both the buyer and seller agree. So, the price that the buyer pays the seller is different from the target’s intrinsic value and gets determined by the relative bargaining position of the buyer and seller. Thus, valuation in an M&A deal is often a range where the lower bound is the target’s intrinsic value, and the upper bound is the target’s intrinsic value with synergies. In addition, the market price often indicates the equity value when a target is a public entity.
The buyer can value the target with a DCF approach, comparables and look at the recent transaction multiples. The transaction multiples often reflect the premium the buyer pays and indicate synergies that it can extract from the acquisition. I believe the DCF approach is the best for valuing the target company and synergies, but deal multiples can serve as a bargaining tactic for the buyer.
We can further break down the synergistic value of the deal as follows:
Synergistic Value = NPV (Synergy Impact on Target) + NPV (Synergy Impact on Acquirer)
If the target brings 50% of synergies and the buyer brings the other 50%, the upper bound of the price that the buyer can negotiate is the target standalone value and synergies that the target brings. In many cases, the target brings most of the synergies. In such cases, the target has the upper hand in the negotiation because it can combine with any other buyer and will eventually choose the buyer that pays the most.
The buyer must strive to reach a price between the standalone target value and the synergies that the target brings from this deal. The common negotiation tactics include targets using other offers to get buyers to raise the price and acquirers bringing recent transaction multiples in the sector to reduce the price.
Integration Strategy and Integration Planning
I classify the integration costs as synergy-dependent costs, where the buyer spends to extract synergies and synergy-independent integration costs, where the buyer needs to spend even when there are no synergies to realize. For instance, after the deal closes, the buyer has to integrate the target’s payroll, HR and IT systems, which incurs a cost but does not bring in any synergies.
In my view, integration is essentially an organizational design problem. After the deal closes, the buyer must design a new organizational structure that brings the buyer and seller organizations together to extract deal synergies. The integration planning must start when the buyer values synergies and should end before the deal closes. Once the deal closes, the buyer must start implementing the integration plan. Usually, the buyer designs an Integration management office that acts as a PMO to implement projects to extract synergies.
Usually, M&A integration is a complex process because of the following reasons:
- During integration planning, the buyer has limited access to the target’s data and builds an integration plan on that data. After the deal closes, the buyer owns the target and thus gets access to all the information. So with additional information, the buyer must refine the integration plan if the new information invalidates the earlier assumptions on synergies.
- The integration process must not affect the buyer’s regular business and should not distract the buyer’s senior management. When the integration impacts the buyer’s status quo business, it will deteriorate their standalone earnings.
- The integration phase brings uncertainty to the target’s employees, impeding their productivity. Usually, target employees start searching for jobs outside, and when more qualified employees leave, the deal’s value will reduce, primarily when the buyer acquires the seller for talent.
- In the case of Cross border acquisitions, cultural differences can exacerbate the above points and impede collaboration between the buyers and sellers.
Choosing The Optimal Level Of Integration
An effective integration strategy must balance the need for collaboration to extract deal synergies with minimizing disruption resulting from the deal.
Thus, the buyer must decide the following:
- Keep the target autonomous and independent of the buyer organization, with the target reporting to the buyer’s CEO.
- The target and the buyer’s divisions exchange information and collaborate, but the target does not report to the buyer.
- The target reports to the buyer, but the target retains its identity.
- The target gets absorbed into the buyer organization and rewarded on the same performance metrics as the buyer.
The buyer’s decision will impact the target’s employees, incentives, and work practices. The target follows its processes and rewards systems when there is limited integration. However, when full integration exists, the target process and incentives get standardized to the buyer’s processes.
When the buyer and seller have offices in the same city, the buyer can relocate the target employees to the buyer’s location to foster collaboration or decide to have them work in their earlier offices.
Case Study – A Framework for PMI Planning
To substantiate the proper framework for PMI planning, I have taken an instance of a transaction I did in the early part of my career.
The buyer wanted to acquire a start-up with software capabilities but didn’t have the brand and customer access to sell its software. The deal rationale is to use the buyer’s sales force to sell the target’s software to its existing customers. A part of the buyer’s strategy is to integrate its software with the target and make it interoperable to sell the end-to-end software to customers.
First, the buyer did a DCF valuation of the target to estimate its intrinsic value.
Standalone value of Target using DCF approach = 100 million
Deal Synergies = 60 million
We broke the synergies as follows:
- Additional revenues by selling target’s software to buyer’s customers using buyer’s salesforce = 43 million
- Additional revenues from Integrating the buyer’s existing software and target’s software by selling it as the end-to-end service = 15 million
- Cost savings by consolidating the buyer and seller’s sales force = 2 million
Thus, the buyer negotiation range for bidding is between 100 million (lower bound) to 160 million (upper bound).
The buyer identified recent transaction multiples and gave an offer to the target of 110 million. Further, the target depends on the buyer’s talented sales force to sell its product. So the buyer negotiated that it must get credit for most deal synergies.
While integrating the target’s business with the buyer, we first analyze the target’s value chain. Suppose the integration requires a modification of the target’s value chain, either by customizing their solutions to align with buyers or consolidating their business to derive cost savings. In that case, there are high chances of disruption.
We adopted the following integration approach to realize synergies:
- First, we integrated the buyer and seller’s R&D teams as they needed to collaborate on developing end-to-end end software to realize 15 million synergies. Here, we allowed the target’s R&D team to work independently on their software development but wanted them to collaborate with the buyer to build interoperable end-to-end software. Thus, we adopted a loose integration as we feared that tight integration could disrupt the target R&D division resulting in loss of talent.
- Then, we consolidated the target sales force into the buyer’s sales force organization to save 2 million in cost savings. Here, we adopted a tight integration and eliminated redundancies.
- Finally, we partially integrated the buyer’s sales force with the target’s R&D function to cross-sell 43 million synergies. The buyer’s sales force collaborates with the target’s R&D team is on sell their product. In this integration, there is no modification of the target’s value chain.
If the buyer chooses to credit all the synergies to the target, the purchase price is 160 million – a 60% premium to the target shareholders. However, if the buyer chooses to retain synergies to itself, the price must vary between 100 million (the buyer takes 100% credit for synergies) and 160 million.
When managing the M&A process, the buyer must avoid the following mistakes:
- Do not fixate on one target, have alternatives, or end up overpaying.
- Value the target with its discount rate and not the buyer’s discount; you risk overpaying for it, especially when the buyer has a lower cost of capital than the target.
- Do not treat PMI as all or nothing. For example, when the buyer leaves the target independent, it does not realize any synergies, while if it does full integration, it risks potential disruption leading to loss of synergies. Thus, an integration strategy varies on the deal rationale.
- Start PMI earlier and do not wait for the deal to close. Successful integration requires planning, so it is better to start earlier.
- The buyer must adopt a multi-phase integration process in complex deals when new information arises, and the buyer must make changes to the integration plan.