There are as many reasons for M&As as there are companies that engage with them. Often, the stated reasons will camouflage the intended strategies, so unless you’re on the inside, understanding the real intentions can be difficult to discern. However, the difference between successful and unsuccessful strategies becomes quite obvious once the dust settles and companies increase their value, increase profits or, just as often, begin to decline.
Successful Strategic Acquisitions
Overwhelmingly, an acquisition strategy is most likely to be successful when it’s based on the word “value.” This includes improving the performance of the target company or improving its market penetration. Often, the additional value comes from synergy between the companies, like acquiring needed technology, or working to improve the overall market shared by both firms.
This is one of the most successful strategies used today. By cutting costs or, less commonly, increasing revenue, a company can greatly increase its value after an acquisition.
This strategy can be particularly effective when the target company operates on low margins and a low return on invested capital (ROIC). For example, if the target company has a 5% profit margin, reducing costs by 5% will double its profitability, greatly increasing the company’s market value. If the company has a 30% profit margin, a 5% decrease in costs wouldn’t be nearly as effective.
Improved Market Penetration
Small innovative companies and start-ups can be a great acquisition target if they have hot new products but lack the means to get them to market quickly.
Consider, for example, companies without an established distribution network or an adequate sales force. Online companies, like social media platforms or news services, may have an exceptional presence but have been unable to gain traction with their markets. For companies that possess the resources the target companies lack, these could be excellent investments.
If a target company has assets that the acquirer needs, it may be a better investment to buy the company outright, rather than to purchase the product licensing rights. Small technology companies are often prime targets for this reason. This strategy has the additional benefit of keeping the tech out of the hands of competitors. Additionally, the team that developed the tech is now employed by the acquirer and can be used for later developments.
Companies like Google, Microsoft, Cisco Systems and Facebook have been incredibly successful with this strategy. In 15 years, between 2005 and 2020, Facebook acquired a total of 85 tech companies, with more than $23 billion in purchases in its shopping cart, not including dozens of undisclosed amounts. In the majority of cases, the company was able to integrate the target company’s technology into its own operations, including its $1 billion purchase of Instagram in 2012 and its $2 billion purchase of Oculus Virtual Reality in 2014.
Reduce Excess Capacity
A company may initiate an M&A with the intention of reducing operations in an overcrowded market. For example, if demand for a product is declining, reducing overall production by 10% could improve the market. For one company to do this on their own would greatly hurt the company’s value. However, by acquiring a competitor and then reducing operations, the short-term hit in value would be much lower, while the new larger company could still enjoy the increased profitability in the long term.
The riskiest acquisitions are when there is no business strategy behind it at all, but rather only the personal interests of those running the acquiring company. These include all sorts of human motivations, from greed and revenge to mere personal interests, like, “I always wanted to own a sports franchise!”
Even when a strategy is well planned and expertly executed, there is always a high degree of risk. Three of the riskier strategies used today include roll-ups, reduced competition and the ever-alluring aim of diversification.
A roll-up strategy involves acquiring several smaller companies in the same industry to merge them into a larger company. The goal is usually to pool resources, reduce operational costs and increase revenues. The larger company will also have a larger geographical reach with multiple locations, as well as a broader range of products available than any of the small companies could have provided.
In some cases, companies use a roll-up strategy to reduce competition, with the belief that this will allow them to increase prices. While this can work, it’s seldom successful on a long-term basis. Even in a small market, if you were able to eliminate all competitors, there is always the real threat of a start-up emerging in the market to bring prices down again.
A common but increasingly dubious acquisition strategy is diversification. By acquiring a company in another industry, the acquirer can diversify its range of products and services and protect itself against downward economic trends in its own market.
The risk in market- or product-extension acquisitions, as well as in conglomerate mergers, is that the acquirer seldom has the expertise required for the target company’s market. Shareholders are seldom pleased with such an acquisition, since they can diversify their portfolios to reduce risk, without the need for a company to diversify its operations.
Even when the acquiring company does have the required expertise, the results are often disappointing. An example of this is Kraft’s takeover of Heinz in 2015, spearheaded by Berkshire Hathaway. While cost reduction (primarily labor) was a part of the strategy, its larger scope was to increase product offerings on the global market. Years later, this strategy has yet to bear fruit.
Preparation and Due Diligence
Even with an iron-clad strategy, not every target company will be the right fit for a seamless and profitable acquisition. For any firm starting out on using M&A as a road to increasing growth, it’s best to ensure you have a team behind you that can sort through the target company’s details to proactively measure risk.
A part of this process, of course, involves acquiring access to the target company’s financial records. For years, Caplinked has been the trusted choice of successful companies like KPMG, Microsoft and Goldman Sachs, to name just a few, to keep records safe while being accessible to all stakeholders involved in an M&A. Take a look for yourself with a free trial.
Babson College: Four Tests For Successful Acquisitions
Kansas State University: Improving the Odds of Acquisition Success
CFI: Motives for Mergers