Tag Archives: acquisition

Five Recent Examples of Acquirers Paying a Premium

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.

How Much Information (and when) Do I Share With Potential Buyers?

There are four phases of progressive information release to smaller and smaller audiences in the acquisition/divestiture process.

The first document used is called a teaser and is typically only one to three pages in length.  The teaser is a “blind” (i.e. no information from which the company identity can be deduced) overview of the acquisition opportunity and is sent to pre-approved qualified buyers whereupon interested parties must sign an NDA to receive a CIM.   The teaser is constructed so as not to be able to identify the company specifically and can be sent to as many as hundreds of potential acquirers (particularly as there are thousands of private equity funds out there).

The second document is the Confidential Information Memorandum (“CIM”) where the number sent maybe several to as many as twenty or more.  CIMs are only sent to qualified buyers who have signed an NDA.  CIMs vary in level of detail but typically range from 40 to 100 pages.  A CIM describes the nature of the business (i.e. product/service range, revenue model etc), suppliers, customers, competitors, a management profile, high level financial information such as historical revenues and EBITDA and a balance sheet.  In many cases it will also describe the market the company competes in and the competitive dynamics and growth opportunities the company faces.

One must appreciate that a CIM is a selling document and therefore opportunities tend to get more time than threats.  However, it is important to provide all relevant information in a CIM because potential buyers will be asked to issue an expression of interest based on the CIM and they will then be afforded due diligence to verify for themselves that all that is represented in the CIM is accurate and complete.  Customers, key suppliers or key management are not necessarily mentioned by name in the CIM.  The CIM undoubtedly raises questions which are typically answered by the agent or in concert with management.  It is important to protect competitive intelligence at this point as there will be only one successful buyer and this company should not be put in a position where its competitors now know sensitive information about the company.

The third stage is one where, based on an acceptable expression of interest, seriously interested parties are afforded a management presentation.  Only the top three to six (depending on the price range, the quality or potential threat of the bidders) are typically selected for this phase.  At this point more detailed information is shared with the goal of securing a LOI that will contain as few conditions as possible.  The dance here is one between protecting sensitive information and disclosing enough information to ensure that the final LOI is one that will be quickly translated into a purchase and sale agreement.

The final stage is exclusive due diligence and closing.  At this point the seller is an open book, so it is of utmost importance to have a high level of confidence in the selected party.  Private companies are typically not ready for due diligence.  Such a detailed level of record keeping is not required and generally not a priority for private companies.  The agent will usually issue a due diligence request list early in the process and it often takes some time for the company to prepare the information.  Each request is different but some items to expect include: monthly financial statements, a receivables aging list, revenue analysis by customer/by product/service, customer/supplier/strategic agreements, details on patents/IP/software architecture, employment policies and contracts, details on any environmental/legal claims and more.

Four Companies That Know How to Acquire

There have been numerous studies on the difficulties of successfully completing acquisitions.  Some studies note that 50% of all acquisitions fail.  I won’t debate what is a success or failure and over what time frame it should be measured here; what I will do is review four leading Canadian software companies and examine their acquisition records.  The four companies are Constellation Software Inc., The Descartes Systems Group Inc., Enghouse Systems Limited, and Open Text Corporation.  I have reviewed the acquisition transactions where financial metrics were available for the period from May 18, 2006 (the IPO date of Constellation Software) to September 30, 2014 and the following summarizes the results.

Acquisition Summary

The four companies had a combined Enterprise Value (EV) of $1.2 billion in 2006 which grew to $14.9 billion as at September 30, 2014, each generating double digit annual returns.

The challenge in attributing this value creation to an acquisition strategy is that not all acquisitions disclosed payment terms.  Of the 172 acquisitions completed in total, 82 had disclosed financial terms.  What we can assume about the acquisitions without financial disclosure is that they would have been relatively small.  The Ontario Securities Commission requires the filing of a Business Acquisition Report (BAR) when the target size is greater than 20% of the pro-forma combined company.

In looking at each company specifically, we discover a number of interesting metrics.

Of the 22 acquisitions with disclosed financial metrics completed by Constellation, only one was of a size (as measured by enterprise value) greater than 10% of the size of Constellation.  The average size of the acquisitions, taking out the one bigger one, was 1.7% of the size of Constellation.  The median target acquisition price paid was 1.2 times revenues and 5.1 times EBITDA.

Of the 23 acquisitions with disclosed financial metrics completed by Descartes, three were larger than 10% of the size of Descartes and the average size of the acquisitions, taking out the three bigger ones, was 3.0% of the size of Descartes.  The median target acquisition price paid was 2.8 times revenues and 8.8 times EBITDA.

Enghouse was quite a bit more aggressive than Constellation and Descartes, of the 16 acquisitions with disclosed financial metrics completed by Enghouse, five were of a size greater than 10% of the size of Enghouse.  The average size of the acquisitions was 12.7% of the size of Enghouse.  The median target acquisition price paid was 0.9 times revenues and we were not able to deduce a meaningful EBITDA multiple.

Finally, of the 21 acquisitions with disclosed financial metrics completed by OpenText, again, only two were of a size greater than 10% of the size of OpenText.  The average size of the acquisitions, taking out the two bigger ones, was 2.5% of the size of OpenText.  The median target acquisition price paid was 1.2 times revenues and the EBITDA multiple was not meaningful as a number of the targets were incurring losses at the time of the acquisition.

From the acquisitions with financial disclosure, we know that 82 acquisitions cost approximately $2.7 billion.  If we assume the acquisitions without financial disclosure were completed at each company’s average acquisition metrics, then this would add another $2.5 billion to the cost.   Based on these assumptions, a total of $5.2 billion was spent on acquisitions and $8.6 billion in value was created, suggesting the acquisition strategies created tremendous value.  While this is not perfect math, the simple truth is that when you look at the share price, each company has outperformed the TSX by a wide margin over the last 8 years.

There are many ways to study acquisition performance, from large worldwide/all industries studies to sector and geography specific studies.  While this data set is small, what we have observed is that the profiled companies have completed many small acquisitions.  There are a few bigger ones, but we would not call them transformational – those are the hard ones.  What we see here are a series of small, formulaic/cookie cutter acquisitions, rigorously held to reasonable valuation and payment terms.  Integrating acquisitions is hard but what this overview tells us is that if you establish strict parameters around size and value and you do enough of them, you get pretty good at it.

M&A Acronyms

The field of M&A is full of acronyms, appropriate I suppose as the descriptor of the field is one.  In actual fact, mergers are very rare (in order for a transaction to be recognized as a merger under GAAP it has to meet numerous accounting criteria) and the activity really consists of acquisitions and divestitures or A&D.  In any case, I thought it might be helpful to clarify some acronyms used in the M&A process.

One of the first documents used in the M&A process is a no-names summary description of the opportunity typically called a teaser.  If the teaser is of interest then parties will sign an NDA or CA (Non-Disclosure Agreement or Confidentiality Agreement) to receive more detailed information about the company.  The comprehensive information document is called a CIM or just IM or sometimes OM (Confidential Information Memorandum or Information Memorandum or Offering Memorandum).

In order to assess whether parties reviewing the CIM are worthy of moving forward they are typically be asked to issue a non-binding EOI or IOI (Expression of Interest or Indication of Interest) which will identify a valuation range, rationale and transaction structure parameters.

If the EOI is acceptable, potential purchasers are furnished with still more information typically in the form of monthly income statements, revenue and customer analyses and whatever else is important to the potential purchaser under the circumstances.  At this stage the potential purchaser and seller will meet in person and a Data Room is set up that will contain the actual contracts to allow the purchaser to verify that everything that has been represented to date is actually true (these days more and more data rooms are virtual data rooms in cyberspace).

Subsequent to this an LOI (Letter of Intent) is sought and upon signing the LOI, a period of exclusive due diligence is awarded to the single final successful party.  Once the potential purchaser is sufficiently comfortable, work will begin on the PSA (Purchase and Sale Agreement) and signature on this document and its many companions will consist of the closing.  The PSA will define the deal structure which may contain a hold-back and/or a VTB (Vendor Take Back).  A hold-back is typically for a period of less than one year and contingent on receivables being paid, customers being retained or any indemnity claims the purchaser may have a right to as defined in the PSA.  A VTB or vendor note is a purchase loan from the seller to the buyer.  This is typically subordinated to a senior lender (i.e. a bank) and is usually of a term longer than one year.

On the financial/valuation side there are acronyms such as EBT, EBIT and EBITDA (Earnings Before Tax, Earnings Before Interest and Tax, Earnings Before Interest, Taxes and Depreciation and Amortization (non-cash items), EV and TEV (Enterprise Value and Total Enterprise Value), FYE (Fiscal Year End), LTM (Last Twelve Months), and YOY (Year Over Year).

For further terms not mentioned here please see: http://www.divestopedia.com/dictionary.

Finding a Buyer: It is Rarely the One You Expect

When presenting your M&A advisory credentials to a prospective client, the part that typically has the most impact is illustrating that, either you already have a relationship with the perfect buyer, or that you can readily access the perfect buyer (i.e. you have done deals in the space which implies that you are familiar with the dynamics of the industry and the buyers in the space).  M&A shops also taut the fact that they have databases of many (for example, more than 5,000) active buyers.  My experience is that the highly anticipated buyer is rarely the actual buyer.

One reason for this is that the private M&A market is a highly illiquid market.  What does this mean?  It means that when you decide to sell your business, you initiate a process, and that process will approach many qualified buyers during a fairly short timeframe.  During this timeframe the highly anticipated buyer may:

  • be engaged in other acquisitions
  • be engaged in a financing
  • be engaged in a strategic review where acquisitions are put on hold
  • be on an extended business trip/holiday
  • not be interested or able to acquire
  • be engaged in being acquired themselves; or maybe
  • your business is no longer a strategic priority for them

There are many reasons why the highly anticipated buyer may not be interested or able to pursue an acquisition when you approach them.  Once you have started the process you can’t wait for the company that you thought would be your buyer to be ready.  You have to make the best of the universe you are addressing to bring to the table a number of capable and interested purchasers.

The other reason why the highly anticipated buyer is rarely the actual buyer is that it is sometimes impossible to predict the rationale for a buyer’s interest.  One type of buyer that can be a very good buyer is called a “platform buyer”.  A platform buyer will be interested in the business for one of three reasons, its customers, its personnel, or its technology.  As an example, we were engaged to sell a pattern recognition company in the field of product quality control.  This technology would scan a production line and “kick-out” products that did not meet certain criteria.  In this case, the ultimate buyer was the US defense department, who paid a strong premium and who then used the technology for facial recognition for national security purposes.  Who would have predicted that? … but having approached large technology companies that also served defense contractors ultimately led to this outcome.

Getting back to my first point…having done deals in the space or knowing more than 5,000 active buyers is of course a plus but other factors that are important (in choosing your advisor – more on this later) are getting the right team on the file, making sure they have the time to spend on it and that it is a priority for them.  What foremost an M&A advisor needs to do in any and all cases is run a thorough and diligent process.  As I have noted before, you might start by sending 200 teasers, then 20 CIMs, get 5 EOIs, have 3 management presentations and then go exclusive with one.  This experience is not unlike any other sales or business development funnel and as anyone in these fields knows, success comes from a thorough, diligent and tenacious approach.