Monday, September 17, 2012

Plain Talk About Acquisitions

This continues my effort to establish a practical acquisition framework.  Acquisitions are difficult for several reasons.  Unlike organic investments, they represent infrequent, large and concentrated commitments at premium prices with high transactions costs.  Furthermore, their relative size gives rise to integration issues.  Finally, information problems lead to surprises absent extensive due diligence.  Poor acquisitions are usually centered on poor strategic fit, integration problems, over estimated synergies (AKA over priced) and due diligence failings.  

Successful acquisitions also share some common characteristics.  First, they tend to be small.  Small is defined as something less than 15% of the buyer's total assets.  Small size reduces integration problems.  Next, premiums are modest.  This usually means making acquisitions earlier in the business cycle before prices increases.  Later cycle deals are more competitive and expensive.  Cash financed transactions are more successful for bidders than stock deals.  Finally, the target represents a good fit with the bidder.  Acquisitions are not strategy-they are a tactic to achieve a strategic goal.  

Successful acquirers tend to focus on the following questions:

1) Should I buy?  What strategic goal will be achieved by buying?  

2) What should I buy?  What target characteristics or screens am I seeking-e.  g.  size, location, products, etc.  ?  

3) How much should I pay?  This goes beyond the market price.  This is a question of affordability from a value viewpoint.  A useful measure is shareholder vale at risk (SVAR).  It is the premium offered as a percentage of the buyer's market value.  It represents the impact of failing to achieve the projected results to the buyer's shareholders.  SVAR is the amount of shareholder wealth the bidder's management is wagering on the deal.  

4) How should I pay?  This involves a choice among stock, cash or debt.  The decision has important accounting, legal, accounting, ratings, and regulatory  implications.  Remember, funding with an undervalued stock is just another way to over pay.  

5) How do I integrate after the close?  The basic choices are between absorption and preservation.  The botched Daimler-Chrysler absorption decision is an example of not choosing wisely.  

6) Am I sure to get what I wanted?  Due diligence and proper maintenance provisions in the sale and purchase agreement are critical to ensure you get what you want.  Disciplined, experienced due diligence teams focusing on accounting, tax, legal, and operating issues among others can avoid unpleasant surprises.  Bank of America's due diligence blunders at both Countrywide and Merrill are costly examples of rushed deals with inadequate due diligence.  

7) What is my negotiating  strategy?  Will you engage in auction transactions?  Have you thought through the probable competing bidders and their strategies-including how high they can bid?  Do you have draft term sheet and letter of intent ready?  

8) How do I protect my deal?  Once you have an agreement, you need to protect it against from competitors prior to close.  Citi Corp's failed in the Wachovia transaction to include  lock-up provisions.  This resulted in their losing the deal to Wells Fargo. 

9) What is the risk in the deal?  Assessing how you can get hurt upfront allows you to propose protective provisions.  

Acquisitions can be a valuable, albeit, risky growth supplemental strategy.  The framework discussed above is a way to impose discipline by asking the right questions, and to demand credible evidence of benefits before proceeding.  This, of course, makes it difficult to justify many proposals.  Nonetheless, such caution is warranted given the potential for harm in acquisitions.

Good hunting.  


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