By George D. Shaw, CPA
In the Part I - we explored assessing the target and determining the best Acquisition Integration Approach (Minimal, Moderate or Full) based upon certain characteristics of the target and the acquirer. In Part II - we will discuss Deal Value Drivers.
Whether the acquirer pursues an Acquisition Integration Approach of Minimal, Moderate or Full, the Acquisition Integration Road Map needs to identify the financial benefits ("Deal Value Drivers") associated with the acquisition, confirm these Deal Value Drivers in due diligence, and then put a detailed integration plan in place to achieve the desired operational and financial results.
Deal Value Drivers are critical assumptions the acquirer makes about the future financial performance of the acquired business post acquisition. The Deal Value Drivers are taken into account in the acquisition financial model and impact the purchase price the acquirer is willing to pay. Identifying and accurately assessing the right Deal Value Drivers may impact whether you get the deal or not. However, each potential acquirer is likely to have different Deal Value Drivers based upon what they think they can do with the target post-closing.
Deal Value Drivers should consider the long term impact of the target to the acquirer, and not just short term "Synergies." Deal Value Drivers can be categorized as long term or short term:
Long Term Deal Value Drivers
The more significant Deal Value Drivers tend to be longer term oriented and therefore involve a higher degree of implementation risk. Value creation tends to be back end loaded as compared to short term cost saving "Synergies." Some of the more significant longer term Deal Value Drivers include the following:
#1 - The Customer Base
The customer base is one of the most valuable assets purchased in an M&A transaction.
The acquirer must first understand the target by assessing the quality of the customer base. The customer quality assessment will analyze factors such as: customer size (large, medium or small), length of customer relationship, customer concentration risk, recurring revenue model, new customer acquisition rates, cost of new customer acquisition, customer turnover (and why?), vulnerability of the customer base to economic fluctuations, geographic concentration, international growth implications, competitive position in the market and the impact of future M&A consolidation.
In order to maximize the value of a customer base, acquirers frequently develop strategies to: explore selling additional products/services to acquired customers, sell acquired products/services to their own existing customers, offer complete product/services to customers to improve supply chain consolidation capabilities, enter new markets and aquire products/services to gain market share and pricing leverage.
Predicting future customer behavior is very difficult, especially given the fact that many revenue improvement strategies take years to implement.
#2 - Intellectual Property
Technology can be a key competitive advantage in many industries...but if you don't have industry leading technology you may putting the business at risk.
"Intellectual Property" includes not only trademarks, patents, and copyrights but also includes proprietary know how, "developed processes" and brands which can provide a competitive advantage. Intellectual Property allows the acquirer to obtain a new leading market position, complement existing technology, or fill in technology gaps. Companies with significant intellectual property tend to have highly innovative and entrepreneurial cultures. These cultures can be very difficult to build, but can be acquired in an M&A transaction.
#3 - Human Capital
Human Capital is becoming more important in business today as the US economy has become more technology and service focused. The search to find talent in today's market is very competitive, but critical to achieving future growth goals. The acquirer needs to understand the targets talent, including: how the company acquires and retains talent, existence of unique skills and competencies, systems of training & development, goals & measures, rewards & recognition, and leadership talent. A critical issue is whether the target has the talent and leadership for the acquirer to grow to the next level.
#4 - Product Integration
A major reason to pursue an acquisition is to acquire new and complementary product lines. The acquirer can leverage its distribution channel & operational systems to increase gross margins. An assessment of whether the products are complementary or competitive is required. Will the new products create distribution channel or brand conflict? Will the acquirer be able to transform custom products to standard products to reduce costs and improve gross margins?
All of the above Deal Value Drivers involve longer term implementation time frame risk, customer retention risk, as well as increased customer based behavior risk. However, they offer the greatest rewards for successful Acquisition Integration. These Deal Value Drivers also offer the opportunity of creating barriers to competitive entry and competitive differentiation advantages.
Short Term Deal Value Drivers
Shorter Term Deal Value Drivers are quicker to implement (but still offer long term financial benefits) and tend to be focused on cost savings Synergies in the areas of headcount reduction, elimination of redundant functions, and the leveraging of purchasing power. Common areas of focus (summarized by functional area) include the following:
#1 - G&A Leverage
- Finance - implement new process to rapidly consolidate and report financial results.
- HR - align wages, incentives and benefit programs.
- IT - transition to common/best IT platform, improve quality & frequency of information to support strategic business decisions.
- Legal - reduce outsource service cost and utilize lower cost internal resources.
#2 - Sales/Marketing Infrastructure
- Sales force and Reps- select best in class performers and rationalize headcount. Implement utilization of "house" accounts concept.
- Customer service & maintenance - leverage existing capabilities.
- Channel expansion - leverage web based customer business model, utilize national and international distribution capabilities.
#3 - Operational Efficiency & Economies of Scale
- Purchasing power - lower material supply costs.
- Supply chain - leverage lower costs and consolidation efficiencies.
- Combine facilities - eliminate duplicative facilities.
- Distribution network - take advantage of customer density distribution cost savings.
In analyzing the Deal Value Drivers, acquirers need to consider not only the estimated value attributed to a Synergy item but also the investments required, timing of Synergy benefit, and probability of success of the Synergy realization. As noted above, the revenue improvement synergies tend to be riskier because of the lack of control as they are customer behavior based. Cost savings Synergies can be easier identified and evaluated based upon the acquirers existing business operations.
Acquirers need to also consider negative Synergies for issues such as more generous employee benefits, better customer warranty and service requirements, overlap customers with multiple vendor requirements, brand channel conflict, revenue from competitors or conflicting suppliers with more favorable pricing.
Maintain a balanced approach in identifying both positive Deal Value Drivers and negative Synergies and factor both of these perspectives into the valuation model. Be careful to model timing of Synergy realization and a factor for the risk of likelihood of not achieving the Synergy target amount.
For more information on Acquisition Integration, contact George at gshaw@dgccpa.com or 781-937-5125.
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