M&A – Asking the right questions before the deal! Part 1 of 2

By Hal Craig, Trout Creek Consulting, LLC

The questions asked are often as important as the answers given.  The right questions elicit data, stimulate thought, uncover insights, reduce prevarication, and lead to better decisions.  This is the first of two parts about questions to ask before making a merger or acquisition.  
 
According to The Wall Street Journal and data from Dealogic (June 14, 2018 article), year-to-date M&A deal announcements, at $2.1 trillion, are up 56% from the comparable period in 2017.  Total 2018 deal activity could concievably break 2007’s record of $4.3 trillion.  LBO firms have more than $1 trillion in cash to invest.  The average leverage for 2018 buyouts is 6.36x EBITDA, this is approaching the modern high of 6.49x EBITDA set in 2007.  The S&P 500’s trailing twelve month PE, based on reported earnings, of 25 has expanded by ~50% since 2013 while US GDP has increased by ~21% over that same period.  This is obviously above the S&P 500’s historical mean PE of ~16. 
 
In summary, M&A activity, leverage, and valuations are up with plenty of money on the sidelines looking for deals.  These points suggest that it is time to revisit a few questions that acquisition-minded executives and boards should ask themselves.
 
I hope that you find the following brief list of M&A-related questions useful.  They are intentionally structured in a digital, yes/no format to facilitate their use in a check-list should the reader so desire. 
 
M&A questions to ask and answer before doing a deal:
 
Do we know why we are interested in this target?  For the strategic buyer, the answers to this question include access to raw materials or markets, an enhanced pipeline of new products, additional manufacturing capacity years ahead of what the permitting and construction process will allow, the synergies of consolidating redundant capabilities, alignment with macro trends and unmet needs, diversifying away from declining or less attractive existing business lines, securing capabilities that enable future growth, and defensive moves given a changing competitor-customer dynamic.  For the financial buyer, the answers to this question include taking advantage of an underleveraged balance sheet, a sum-of-the-parts is greater-than-the-whole valuation, backing a business with solid management and growth prospects that has been ignored by its current owner, and the turnaround upside of bringing operational improvements to a poorly-managed company.  Carefully answering this question is important because it is possible, in a bidding war and the subsequent pursuit of synergies, to destroy the key reasons that made the target attractive in the first place! 
 
Do we know (a) how we will make money from this acquisition, (b) how much money we will make, and (c) when we will make this money?  Buyers should know, in some detail, how they will make money from an acquisition before they submit their first round bid.  They should be able to convincingly state the value drivers that need to be enabled, nourished, and maintained and the value destroyers that need to be minimized or stopped.  Buyers should also define their “walk-away” price.  This last point is crucial to ensuring that the buyer doesn’t get caught up in the acquisition process, overpay, and then face the common “Winner’s Curse” where the acquisition doesn’t create the hoped for value.  “When” the money will be made is key as buyers search for a timeframe to make money along the continuum between “accretive next quarter with a 1 year payback” and “all the money is in the terminal value.”
 
Do we understand the impact that macroeconomic and geopolitical factors will have on the target and our merged business?  It’s important to understand, or at least have a sense of, whether these big-picture-beyond-our-control factors will have a positive, negative, or neutral impact on the target and the merged business.  Areas to check include exports, imports, supply chain, debt financing, the ability of customers / consumers to purchase your products and services, your ability to provide certain offerings and maintain / change / improve your overall value proposition, and the impact on competitive intensity.  It’s also important to think about the near, mid, and long term aspect if these factors persist.  Macroeconomic and geopolitical factors to assess include:

• Tariffs and trade wars (e.g., the current US disputes with China, Canada, Mexico, and the EU; evolving trade agreements that don’t include the US)
  
  
• Rising interest rates
  
  
• Business performance throughout the economic cycle (there will be another recession sometime)
  
  
• Rising and falling energy costs

 
Do we understand the impact that digital will have?  Will the impact be positive, negative, or neutral?  Do we have a strategy to compete in the digital world?  Digital in this context includes AI (artificial intelligence), data analytics, the Internet of Things, and how digital will impact, enable, and change supply chains, value propositions (e.g., direct-to-consumer home delivery, shopping via apps versus shopping in brick-and-mortar stores), customer engagement, customer behavior and expectations, competitors including new entrants, innovation, health, smart homes and cities, and other areas.

Have we considered the impact that Amazon might have?  Is Amazon a competitor or channel partner now or in the foreseeable future?  Will this have a positive, negative, or neutral impact on the target and our merged business? 
 
Please check back for Part 2 which will cover cultural fit among other questions.