Success and Pitfalls of Mergers and Acquisitions
A successful merger or acquisition is a highly effective way to deliver growth in shareholder wealth through increased profitability which leads to enhanced earnings per share and return on investment. The alternative is for a business to introduce new products or markets organically which can take years to achieve. Acquisitions can be an immediate and lower risk method for delivering growth.
The key drivers for management to seek merger and acquisitions opportunities include:
- accessing new markets, which include new products, services or geographic markets;
- increasing market share by acquiring a competitor;
- expand service offering to existing services with the acquisition of complementary businesses;
- control and/or integrate the supply chain with the acquisition of key suppliers or customers; and
- increase profitability through synergies, such as utilisation of unused manufacturing capacity.
The ultimate success of mergers and acquisitions are typically dependent on three key factors being:
- paying the right price;
- the successful integration of the two (or more) businesses; and
- effective management and planning pre and post-acquisition.
Value and Overpaying
Company executives and their advisors need to carefully assess the valuation of the target business giving consideration to:
- its current and projected earnings and whether or not such earnings are sustainable;
- the expected price and deal structure required to secure the target, particularly if the acquisition is to be made during a competitive sales process;
- the link between the proposed (or tangible) efficiencies and synergies and the valuation/purchase price;
- Use of vendor funding, including “earnout” consideration being paid to the vendors;
- the use of debt facilities in the maximum manner; and
- ensure adequate due diligence is completed covering earnings, earnings normalisations and potential synergies, and key risks including material commercial contracts, customers and suppliers contracts and trends, management and operational issues.
Overpaying for the target is likely to lead to a reduction in returns to shareholders, diversion in management attention from the core business, and potential financial stress that a poor acquisition may cause.
One of the key mistakes made by many potential acquirers is becoming “married to the transaction”. Management should be prepared to walk away from the deal in the event that the asking/required price is in excess of its valuation.
Integration and Realisation of Synergies
In our experience, the failure of a merger or acquisition will often come down to operational issues associated with integration of the business, including a mismatch of cultures, insufficient capacity to manage the acquisition, an inability to realise the planned synergies or the over gearing of the Group to fund the acquisition.
The evaluation of the transaction should involve key management establishing an integration plan for the target post acquisition. The 100 day plan is often considered the most important document to ensure the success of the transaction. The plan will set out actions from simple administration steps (such as changing contact details, registered office addresses etc.) to more strategic issues (merging branches, restructuring workforce).
It is also beneficial for the target management to be involved in the planning process as early as possible in order to:
- obtain their knowledge and experience; and
- align interests and ensure maximum buy-in from management and the target workforce.
The integration plan should also include all of the actions required to realise the planned synergies of the transaction which may include consolidation of premises, back-office system integration and restructure of the workforce, distribution channels and the supply chain. Often the failure to identify and address these issues early will result in a failure to implement at all.
To maximise the probability of a successful transaction after the deal has been completed, a dedicated manager should be responsible for the implementation of the integration plan. The failure to allocate sufficient and appropriate resources to manage the integration will almost certainly lead to the failure of the transaction.
Funding and Structuring
When evaluating the acquisition, it is critical that the company understands the projected free cash flows of the target, movements in working capital and capital expenditure attributes in considering the funding structure of the transaction. The analysis of the target’s cash flows should be completed without the proposed synergies due to difficulties in ascertaining the quantum and timing of the synergies.
The failure of the Company to understand the projected future cash flows may result in the business being over-leveraged, having a repayment term that is not aligned with the cash requirements of the target/merged entity, and future growth being constrained by insufficient cash. Additionally, the diversion of management attention from operating and growing the business to managing its bankers and cash flow is often the beginning of the end. Common options which can be used by the acquirer to reduce the debt associated with the transaction include the utilisation of cash reserves, capital raisings (including rights issues), issuing scrip consideration to the vendor, and including a component of deferred consideration based on the business reaching milestones.
Plan to Succeed
A high level of management involvement and buy-in in all stages of the acquisition process is the most critical factor in the success of mergers and acquisitions. Management’s key responsibilities throughout the transaction and integration process include:
- reviewing the valuation of the target and understanding and outlining other key transaction drivers;
- avoiding paying for synergies unless strategies can be implemented prior to transaction completion. Examples of this may include employee redundancies and premise closures;
- being prepared to walk away from the transaction;
- ensuring the transaction is funded appropriately;
- planning effectively and allocating appropriate staff to execute the integration plan; and
- leading the implementation of the one culture across the merged business.
PKF can assist with all stages of the merger and acquisition process, from the search and identification of targets on both the buy and sell side, assisting with valuation advice and initial negotiations, due diligence of the target, and post-acquisition integration planning.