The book “Valuation: Measuring and Managing the Value of Companies” by McKinsey partners Marc Goedhart, Tim Koller and David Wessels is a classic in the field of value creation by companies. Under the title “The six types of successful acquisitions”, the authors recently published an online summary of the chapter on acquisitions in the sixth edition of their book.
The authors begin by stating that there is no “magic formula” for a successful acquisition. But its chances of success are greater if there are well-articulated value creation ideas in advance. Less successful deals are often based, the authors say, on somewhat vague strategic rationales, such as “pursuing international scale” or “filling gaps in the existing portfolio”.
While empirical analysis has been carried out to examine specific (successful) acquisition strategies, its outcomes offer only limited insight. In part, the authors have found, that is because there is no good objective way for classifying acquisition strategies, which differ very substantially from each other. Moreover, the “officially communicated” strategy is often not the real strategy (which in many cases boils down to: cost-cutting).
The experience of the three consultants in advising businesses during acquisitions nonetheless provides significant insights. According to the authors, the strategic rationale of meaningful acquisitions matches one of the following six “archetypes”:
1. Improve the target company’s performance;
2. Consolidate to remove excess capacity from industry;
3. Accelerate market access for the target’s or the buyer’s products;
4. Get skills or technologies faster or at lower cost than they could be built;
5. Exploit economies of scale (subject to certain conditions);
6. Acquire promising companies in order to accelerate the development of the business.
Improving the performance of the target company is one of the most common strategies for value creation. Put simply: business A acquires business B, and then cuts costs there radically to boost margins and cash flow significantly. According to Goedhart et al, this is also the model favoured by private equity firms. Self-evident though it may be, the authors warn that this model is successful only at businesses characterised by a cost base that is (too) high and correspondingly low returns on invested capital (ROIC).
Consolidation can create value in mature industry sectors, where established parties are continually increasing production efficiency on the one hand, while new entrants expand supply on the other – such as Saudi Arabia in the petrochemicals sector. Supply can therefore outgrow demand. The authors have found that businesses are more readily prepared to shut down plants as part of an overarching acquisition plan than to downscale their own operations voluntarily. An evident drawback of this strategy is also that competitors will benefit from it – the free-rider problem.
Accelerating access to the market by means of acquisitions is a strategy that can be especially valuable for comparatively small companies with innovative products. For instance, in the pharmaceutical industry, a certain scale is considered to be indispensable in order to get a foot in the door of GPs. Conversely, however, it can also be profitable for large businesses to acquire small, specialised businesses within their sector to accelerate the profitable introduction of new products or services in the market. For instance, software giant IBM acquired as many as 43 businesses between 2010 and 2013 alone, for an average price of USD 350 million each. Profit rose after the acquisition at each of the acquired businesses within two years after the acquisition, sometimes by more than 40%.
Acquisitions can also be a way to obtain access to skills or (patented) technology faster or more cheaply. Apple’s streaming music business would never have got off to a running start without the acquisition of Beats Electronics, and, similarly, Siri, the voice-controlled assistant, was not developed by Apple itself but by an acquired business with the same name.
Economies of scale are very often mentioned as a source of value creation in M&A. The authors qualify this however: if both parties already have a high level of operational excellence, (even) more scale mostly fails to produce much in the way of synergies. The merger of, for example, United Parcel Service and FedEx would not be very productive, as both players are already among the most efficiently operating businesses in the sector.
Economies of scale mainly provide benefits if they permit both parties to share the high development costs of a new product. But ancillary benefits of more scale, such as back-office savings, are insufficient justification in the authors’ view for undertaking major acquisitions.
Archetype 6 is similar to archetype 4 in some respects, except that the former concerns acquisitions of parties that do not yet have a fully developed product (and therefore have no cash flow), and whose potential is not yet generally recognised in the market. Overall, the same considerations apply to these types of acquisitions as for any venture investor: they involve clear risks, require staying power and extensive nurturing by management.
At the end of the article, Goedhart et al also discuss a few other acquisitions strategies, which occur less frequently, such as the roll-up strategy (where a party very rapidly acquires and integrates small players in a highly fragmented market) or the transformational merger (where two parties combine in order to form an entirely different kind of business). The authors close with a sobering line of thought: however astute and well considered an acquisition strategy may be, anyone who overpays for an acquisition target will soon see their chances of value creation evaporate before their eyes.
Within the NPM Capital business portfolio, Kiwa is one of the fastest-growing companies. This is driven by a tightly coordinated buy & build strategy, says CEO Paul Hesselink in Capital Magazine.