Map Making: Evaluating Your M&A Landscape

You might have heard CEOs and investors waxing lyrical on the nuances of their M&A landscape. Overhead in passing, this could be mistaken for a neighborly conversation about manicured lawns and bedding plants. They are, of course, actually discussing the company’s prospects for merging with or acquiring another business.

For this edition of SPT, we’re focusing on the why and how of identifying and evaluating inorganic growth targets.

While deals aren’t an everyday occurrence, months – if not years – of preparation goes into making sure the deals that do happen are successful. Read on to hear our blog-sized thoughts on this millions-of-dollars-at-stake journey.

ACCELERATING GROWTH

Your business’ long-term success depends on growing (and sustaining) revenues and profitability.

There are many hyper-focused strategies for boosting near-term profits – nowadays frequently branded as “growth hacking” – but their impact will typically be short-lived.

If you want to create a sustainable increase in revenue - e.g. by adding new products, service lines, markets, and users - you’ll need to consider another option: mergers and acquisitions.

M&A can be motivated by many things: finding business synergies, expanding into a new market overnight, adding new products without waiting out the development time, picking up talent you couldn’t otherwise hire (aka acquihires), acquiring valuable intellectual property, or picking up infrastructure, sales relationships, and market share.

By combining with another company, you can also merge resources and expertise, setting the merged business up to compete more effectively with established players.

WHY MAP?

The M&A process can often take anywhere from six months to several years, and the odds of completing a successful acquisition are largely determined before the first target has been identified.

It’s vital to know what you’re after before embarking on the acquisition trail. A clear M&A strategy is required.

Attractive companies usually don’t sit around long, waiting to be acquired. To seize a high-growth M&A opportunity, you need to strike when the time is right.

In fact, the best acquirers are highly proactive, not reactive. They don’t wait for target companies (or their investment bankers) to offer them a deal. They are actively engaged in finding and evaluating targets.

Rather than just focusing on companies that are apparently available (like houses that are already listed for sale), develop a proper rationale for vetting acquisition targets. This will require some serious thinking but allow you to make more informed choices when the time comes.

Companies that have done their homework are better prepared to take advantage of acquisition opportunities whenever they arise.

Where to start? Build an inventory – colloquially known as a ‘map’ – of potential targets that make sense within your overall purpose, mission, and business strategy.

WHERE TO LOOK FOR FUTURE VALUE

A good acquisition strategy is built around a clear idea of what you expect to gain from making the acquisition. What is your business purpose for acquiring the target company?

We recommend picking four or five clear selection criteria - and setting realistic expectations. The odds of finding the perfect target aren’t zero, but this is ultimately a game of grading and ranking to arrive at a shortlist of possibilities.

Common screening criteria include:

• Size – Is the target business large enough to justify the cost of acquisition?
• Profitability - Will the target improve or dilute your margins?
• Type of Product(s) or Service(s) – Are they similar or complementary to your existing products? Will the combination result in a more coherent service/product portfolio?
• Market Segment(s) – Is the target business strong in complementary sectors, so that a combination would strengthen your company’s position?
• Location(s) – Does the target business have a successful position in a market or region that you’d like to penetrate?
• Customer Base – Would the acquisition give you access to new customers? Would it strengthen your position with existing customers?
• Synergies – How might you combine resources with the target company to reduce overhead or take advantage of complementary strengths?

Think about your position in the industry’s ecosystem. Where else along the value chain might you generate profit? What disruptive technologies do you see emerging and who controls them? What are your customers’ purchasing preferences and how might you better satisfy them? What additions to your portfolio would leave you with the strongest, defensible competitive advantage?

BUILD A LIST

Closing an acquisition is a lot like winning a new customer. First, you have to identify viable prospects, then you have to pursue them until you get one to close.

Based on the type of the firm you want to acquire, gather as much information as you can on the markets, companies, products, and services that you are targeting.

Then, speak with experts inside and outside your company and build an initial list of potential targets that fit your screening criteria. Encourage your leadership team to tap into their networks for information about likely prospects in your sector.

Consider companies that you already sell to or buy from. Many M&A transactions take place between companies that have an existing relationship.

Finally, if appropriate, share the details of what you are looking for with investment banks or corporate finance firms who sell similar companies. Even if they don’t have an active sell-side client on their books, they might point you to a target that you’ve so far overlooked.

PRIORITIZATION

The final step is to reduce the broad list of potential targets down to an actionable list of priority targets by grading and ranking them using your previously defined criteria.

You can then embark on a much more detailed analysis of the shortlisted targets. This should be a much higher quality review than the one used to build the original list of prospects.

At this stage you can continue refining your selection, and it’s often best to engage an external facilitator to help bring you, your leadership team, and shareholders into the same room and onto the same page.

This has the distinct advantage of building shareholder buy-in for the deal at an early stage and can also help spot other obstacles that weren’t initially apparent.

One of the biggest steps in narrowing down the list is valuing potential acquisition targets. This usually involves valuing the target on a standalone basis and then calculating potential synergies of the deal.

There are two types of synergies to consider. Hard synergies, also called operating synergies, are direct cost savings that are virtually guaranteed as a result of the merger – such as eliminating redundant staff. Soft synergies, also known as financial synergies, are less-certain revenue increases that you hope to realize after the deal closes.

NONTRADITIONAL TARGET SEARCHES

As data science marches inexorably across the business landscape, the search for acquisition targets is not immune. You can take advantage of third-party tools, such as Quid, to apply machine learning techniques to go beyond the traditional data that used to predict financial performance.

The algorithms factor in nontraditional data that might also be an indicator of the company’s future performance, such as customer growth rate, social media sentiment, grant funding, industry publications, intellectual property, scientific collaboration, and industry connections.

These insights can be used to create a broad new set of criteria for identifying and prioritizing potential targets.

Data science allows you to mine publicly available data and apply text analytics across multiple sources. For example, Quid uses natural language processing to create a thematic map of companies based on their common products, technologies, and services. Such analysis can highlight potential acquisition targets with great specificity.

By mapping nontraditional networks, such as those relating to patent citations, you can gain insight into a technology’s application to new markets. You will also see which players are most influential, growing most strongly, or most likely to collaborate with other companies.

NEXT STEPS

Is your company considering, or will it soon be ready to consider, inorganic growth through M&A?

• If so, develop or review a high-level M&A strategy by considering how you would most like to grow. This might include finding business synergies, expanding into a new market, adding new products or services, acquiring talent, acquiring intellectual property, or picking up infrastructure, sales relationships, or market share.
• Based on your M&A strategy, what criteria would you use to assess and rank target companies? Aim for 4-5 that you think are most critical to your business.
• If you have already developed an acquisition target list, do you think it is sufficient/complete? If not, consider what steps you might take to further populate your landscape.
• Consider whether involving a third-party might help expand and refine your M&A map, including applying data science to help identify targets.