Tag Archives: what makes a good buyer

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.

What Makes a Good Buyer?

Now that we have constructed the buyer list, what really went into the thinking of who to include?  What are the buyer list criteria?  I have outlined several considerations in my previous post but another way to look at it is as follows: identify companies with an ability to pay and an interest in paying a premium.

Assessing the ability to pay in the private market space is difficult.  While for public companies you can peruse their financial fillings, private company information is usually based on voluntary disclosure and may be out of date.  The other area where ability to pay is difficult to assess is if the company has a relationship with a private equity group.  The company may appear small and unable to acquire but the private equity group may have access to hundreds of millions of dollars.

With respect to paying a premium, the rationale for doing so may be:

  • Economies of scale
    The combined company can often reduce its fixed costs by removing duplicate departments or operations, lowering the costs of the company relative to the same revenue stream, thus increasing profit margins.
  • Economy of scope and cross-selling opportunities
    Economies of scope are attained when, for example, efficiencies are gained by increasing the scope of marketing and distribution to additional products (sometimes creating product bundles as seen in the Telecom sector).
  • Unlocking 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 these assets.
  • Access to proprietary technology
    In some cases start-up or R&D focused companies have developed technologies that can have an immediate and broad impact on the operations of leading incumbents and substantially improve their competitiveness.
  • Increased market power
    Acquiring a close competitor can increase market power (by capturing increased market share) to set prices.
  • Shoring up weaknesses in key business areas
    When talent is hard to attract, acquiring businesses that perform functions that are under performing can be an efficient way to fill gaps.
  • Synergy
    An example of synergy includes increased purchasing power as a result of bulk-buying discounts.
  • Geographical or other diversification
    Acquisitions can achieve immediate access to new geographic or product markets.  In some cases this can also serve to reduce earnings volatility.
  • Providing an opportunistic work environment for key talent
    Growth through acquisitions provides managers for new opportunities for career growth and advancement.
  • To reach critical mass for an IPO or achieve post IPO full value
    Larger companies typically have more financing options thereby reducing capital risk.  Once public, companies need sufficient trading in their shares to realize full value.
  • Vertical integration
    Vertical integration occurs when a company acquires its supplier and can result in significant savings if the supplier has substantial market power.

Determining beforehand whether a private company has these goals or can potentially achieve these results is nearly impossible.  The best way to find the company that will pay the most is to approach all possible buyers, talk to them and discuss the possible fit.