To buy or not to buy, that is the question…
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A 2014 Deloitte survey polled 2,182 executives at US companies and 218 executives at PE firms to understand trends and plans for M&A over the next two years. Apart from an increased buoyancy brought about by a surge of cash and low interest rates, 9 out of 10 respondents said transactions completed in the last two years had not generated their expected value or return on investment.
The first thing you learn about M&A in business school is this - over 80 percent of mergers and acquisitions fail. Yet Deal Logic reports a total of 67 $10bn+ M&A transactions have been announced globally for a combined total of $1.86tr in 2015 YTD, more than double the $803.4bn announced in the same 2014 period, and is the highest annual volume on record.
Deal activity is also at the highest level on record, surpassing previous years record set in 2006, which saw 48 deals. Being an M&A investment banker is still the most wanted role in IFAP, our flagship Financial Analyst Course at Imarticus.
To understand ‘Build or Buy’ or ‘ Make or Buy, or why Reliance might choose to build their own telecom company Jio but choose to buy Network 18 rather than build their own media company, we need to understand a little bit more about why companies buy in the first place.
Companies exist to fulfill two major requirements - increase revenue year after year in a sustainable manner, and create value, or profits, year after year in a sustainable manner. But how companies grow depend on where they are in their lifecycle- Startup vs Mature, what resources they have access to and finally, their inherent nature and attitudes towards risk taking.
Organic Growth or ‘building from within’ has some distinct advantages. Businesses that pursue organic growth are inherently prudent and willing to nurture. They don’t like biting off more than they can chew and find, in the long run, they prefer a longer ‘time to market’ than face the ‘boogie man’ that is post M&A integration.
But in this day and age where ‘time to market’ is quite literally ‘money’, there is a reason why Facebook prefers to buy Whatsapp rather than nurture Messenger- the customer has no reason to wait and the market is unforgiving. So they look to buy.
‘Buying’ or ‘Inorganic Growth’ has distinct advantages – a shorter time to market which helps you leapfrog your competitors and gain immediate access to market share, assets, proprietary technology, patents and bulk revenue by adding instant customers.
If you’re a startup, establishing a track record is time consuming and acquiring a platform, if you have the money, beats having to do it yourself. Of course, if you don’t have the cash, you have no choice but to ‘build’ rather than ‘buy’. In some cases, ‘buying’ a cheap distressed asset can provide you with a cheaper alternative to building from scratch. But many startups bootstrap their ideas to harness control and secrecy.
In many cases, inorganic growth is the only way to grow especially in infrastructure where you need to ‘buy’ experience because you can’t pitch for tenders without prior experience, a particularly infuriating problem that is solved by ‘buying’ qualifications.
Then there is the overriding need to consolidate. What is the point in building capacities, when your industry is facing a demand crunch? Adding capacity will only make it worse; the industry has to buy and reduce supply and create scale economies to survive.
But with M&A looms three major risks, the key one being ‘Winners Curse’, were you overestimate synergies in your single-minded mission to win the bid. Case in point – Tata Corus, where Tata paid Corusa premium of over 68 percent over the average closing market share price over the twelve-month period.
When companies merge or acquire, the shareholder value expected to be created through synergies calculated by well meaning investment bankers and bean counters - be it in the form of economies of scale, best practice sharing, and the melding of capabilities and opportunities, often go to the seller in the form of control premiums.
Let’s assume you do manage to get away with paying a small control premium, you might still stumble in Due Diligence. Think Suzlon Energy, which bought RePower to gain access to proprietary technology only to realize that German Regulations restricted it from transferring it out of the company due to a legal issue; someone in the legal DD team obviously dropped the ball.
Then there’s the final hurdle- integration, a word that sends a chill down every line managers spine. The Investment Bankers have left the room, the lawyers are busy invoicing you, and you suddenly find yourself married to someone you find you don’t have that much in common with, only this someone comprises over a thousand individual characteristics.
A classic textbook failure was of course the 2002 merger of HP and Compaq. Compaq tended was market-oriented and aggressive, while the traditional HP emphasized teamwork, consensus and long-term view. What did they do? They called in a shrink; consulting firms helped HP conduct 144 focus groups and 150 interviews in 22 countries. These firms discovered that the situation was ready-made for massive culture clash. The marriage was never going to work.
Whichever path a company chooses, ‘build’ or ‘buy’, success is brought about by skillful execution and integration, as evidenced by the Disney Pixar M&A, a marriage made in cartoon heaven or Reliance’s take over of Network 18, which might raise questions about media independence but is no doubt a key play by Reliance, a company known for its reluctance to ‘buy’.
There is no right way to grow, but it does seem like ‘buying’ is the zeitgeist as companies are flush with cash and the effects of the 2008 global crisis are receding in our collective memories.