What are buyers looking for in acquisition targets? The objective of an acquisition is to create value. This is accomplished by improving profitability and/or reducing risk; both enhance earnings quality and drive value. More specifically, acquisition objectives can include achieving economies of scale or economies of scope, vertical integration, securing access to talented management, unlocking underutilized assets, gaining access to proprietary technology, increasing market power, shoring up weaknesses in key business areas, geographical or other diversification, to reach critical mass for an IPO or to achieve post IPO full value.
Below we list the rationale for paying a premium behind five recent real-life transactions.
To Maintain or Improve its Competitive Position: This may be the most common motivator for acquisitions by large companies such as Oracle or Cisco. With the rate of change in the tech sector as fast as it is, it is a lower risk strategy to wait until a new solution is proven and a sector leader has emerged than pursuing this organically. Acquisitions of this nature achieve a number of risk reducing objectives including strengthening customer relationships.
To Improve the Revenue Mix to Higher Valued Revenues: Ever since hosted recurring revenue models (SaaS) came into existence, revenue quality has been a hot topic. In this case the buyer was a public company and a large share of its revenues were of a product reseller nature. These types of companies typically have a large customer base that they want to sell more products and services to. The goal is to improve revenue quality. Potential revenue quality improvements include moving from distribution to higher margin VAR (consulting), or from consulting to support/maintenance (recurring revenues) and, ultimately from support/maintenance recurring revenues to sticky, mission critical recurring (cloud application) revenues. Acquisitions of this nature create value by improving revenue quality resulting in a higher valuation multiple.
To Fix Underperforming Parts of the Business: In this case, a large company had a small division that fulfilled a necessary component in the value chain. The division had HR challenges and was underperforming. Not only did the seller have a superior technology but it also had a very knowledgeable management team that would become a great asset to the buyer. The buyer was able to pay far in excess of any other interested party and stood to benefit much more as well. Finding a buyer that can benefit from multiple aspects of a seller’s business is rare but when it happens, a very good deal is possible.
To Unlock the Potential of Underutilized Assets: In some cases, proprietary resources such as R&D, patents, proprietary processes and technologies and even personnel are underutilized because of limited access to capital or other constraints. Acquisition by a more, well-resourced company can unlock value in these assets. Acquisitions of this nature typically achieve revenue and/or margin improvement.
To Achieve Full Value as a Public Company: Reverse Takeovers (“RTOs”) are an active part of going public in Canada. However, in some cases, once public, the company’s share price languishes as there isn’t sufficient value or liquidity to attract analyst coverage. With publicly traded shares as available currency, an acquisition strategy will increase the share float and diversify the investor base. In time, costs will have to be rationalized or synergies achieved in order to evidence margin improvement. The stronger business attributes combined with improved trading liquidity will realize full value over time.
While the situations outlined above sound like textbook cases, in the real world, the stars don’t line up to create a premium sale as often as one might think. The timing has to be just right, where the buyer-target fit is considered a high priority and the target business is of sufficient size (and that typically means having grown beyond start-up) to be worth the effort. A managed sale process can bring a number of interested parties to the table and help identify the rationale to drive exceptional sale value.