Value-Creating Acquisition Strategies

Economic and financial studies come up short in identifying specific acquisition strategies that create ongoing value. However, companies have successfully deployed acquisitions to grow revenues, cash flow and create increased value. The rationale for an acquisition that creates value typically fits one of the following five strategies:

  1. Improves the target company’s performance;
  2. Consolidates to remove excess capacity from an industry;
  3. Accelerates market access for target’s or buyer’s products/services;
  4. Acquires skills or technologies faster or at a lower cost than can be built organically;
  5. Picks industry/market winners early and helps them to develop their business.

If an acquisition does not fit into one of the above strategies, it is unlikely to create value. The acquisition rational should be able to specifically articulate of one of the above strategies and not a vague concept like growth or strategic positioning. Although growth and strategic positioning may be important, they need to be translated into something more tangible. Furthermore, even if your acquisition conforms to one of the strategies, it still won’t create value if you overpay or don’t deliver on the value creation plan. The following is a brief discussion of the above five strategies.

Improve the Target Company Performance

Improving the performance of the target company is one of the most common sources of value creation. Put simply, you buy a company and radically reduce costs to improve margins and cash flows. In some cases an acquirer may take steps to improve revenue growth. Delivering improved target performance is what the best Private Equity firms do.  It is easier to improve the performance of a company experiencing low margins and low return on invested capital (ROIC) than it is to improve the results of a company experiencing high margins and high returns. 

Consolidate to Remove Excess Capacity from an Industry

The combination of higher production from existing capacity and new capacity from new market entrants often generates more supply than demand and as a result margins and overall returns get pushed down. It is typically not in any company’s interest to close a plant, or eliminate/reduce a line of business. However, companies often find it easier to shut plants and reduce lines of business across a larger combined entity resulting from an acquisition of a prior competitor versus reduce the size of their own company.

Accelerate Market Access for Target’s or Buyer’s Products

Often, relatively small companies with innovative products or services have difficulty reaching or capitalizing on their market potential. Smaller companies may not have the advanced abilities to launch products or the large sales forces and distribution channels required to reach their target customers. Larger companies may already have in-place the sales and management capacity to radically accelerate the sales growth of a smaller company’s products or services.

On the flip side, a buyer may not have the internal expertise for bringing a new or complementary product/service into their existing market. Acquiring a company that does have such expertise can keep out competition and accelerate revenues and profits and generate higher returns in a given market than would be the case if they were to build the expertise organically.  

Acquire Skills or Technology Faster or at a Lower Cost Than They Can Be Built

Companies have successfully used acquisitions to assemble a broad line of products/services and build leading market share. Strategically acquiring from without rather than building from within has enabled these companies to expand their target markets and increase revenues, profits and value at a much faster pace and with higher return on capital.

Pick Winners Early and Help Them Develop Their Business

Companies have also had success with making acquisitions early in the life cycle of a new industry or product line, long before it becomes apparent to most others that there is significant upside opportunity. This strategy requires a disciplined approach by management in three dimensions. First the company must be willing and have the capital to make the investments early before competition and the market realizes the target’s potential. Second, the company will need to make multiple bets and expect some to fail. Third the company must have a long-term view and the expertise to grow a target’s potential.

Acquisitions are both an important source of growth for companies and an important element of a dynamic economy. Acquisitions that put companies in the hands of better owners or managers, or that reduce excess capacity, typically create substantial value for the economy as a whole and for companies and their investors. Harvest CFO Consulting brings to companies experienced and highly-skilled CFOs to assist and enable CEOs, investors and business leaders to deliver value with and from good acquisitions.

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