New Deals Are Moving from Scale to Strategic Value

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2 Companies historically have viewed mergers and acquisitions as a way to spur growth by bulking up : adding scale and market share by combining with another organization offering similar or complementary products or services. Such deals remain important in some industries and circumstances. But the focus of M&A increasingly is shifting. Digital disruption and industry convergence are forcing companies to adapt to a new ecosystem and pursue more strategic, smaller acquisitions that can serve as a platform for new business models that boost growth and innovation. New Deals Are Moving from Scale to Strategic Value When BBVA announced it was buying US-based online bank Simple in 2014, it turned a few heads. 1 It wasn t the kind of acquisition typical in the finance world, where big deals involving banks acquiring other financial services firms are more the norm. In fact, Simple only counted 100,000 customers at the time. But the $117 million deal perfectly fit BBVA s strategy to drive growth and competitiveness through entirely new businesses, and is emblematic of a new trend in M&A. Deals used to focus mainly on acquisitions that could help a company quickly bolster scale and market share while gaining cost synergies. Today, they increasingly involve small companies to gain access to IP, technology or skills that can help a company refine or create new business models or even generate additional growth in non-core areas. Monsanto had a similar rationale behind its $930 million acquisition of The Climate Corporation in The Climate Corporation applies its expertise in data science to turn a wide range of information into valuable insights and recommendations that can help farmers improve their crop yields and unlock additional value from their land. Monsanto believes data science represents a potential $20 billion revenue opportunity for the company beyond its main business of seeds and chemicals. 2 According to an Accenture survey, businesses are exploring market opportunities in other sectors of the economy and with a wider network of stakeholders. 3 These deals reflect an important shift in the value-creation equation behind acquisitions. Companies have always created or enhanced value by becoming leaders in their industry and traditionally, leadership has been defined by having more customers, a broader geographic presence, and an optimized cost base. Those drivers are still important, despite the fact that only 50 percent of such M&A deals typically lead to a positive impact on Total Return to Shareholders. 4 However, with the speed of change rendered by the digital revolution, leadership and resulting shareholder value increasingly hinges on building agile and adaptive new business models that unlock growth and innovation through new types of products and services. 2

3 New Targets Require a New M&A Approach As companies shift their M&A focus from scale and synergies to enablers and capabilities, they will need a new approach to both pre- and post-deal activities. Target Identification For starters, a company typically will look for different targets. A company has to broaden its horizons when considering an acquisition, casting its net across every industry in which the capability it seeks could be located. Conversely, in the search for new capabilities, targets often are small, nascent businesses plying their trade in an adjacent or, sometimes, a completely different industry. In fact, according to a recent Accenture survey, 80 percent of firms are planning to pursue non-traditional growth, in large part by venturing into or with other industries (60 percent). 5 These targets are attractive more for their considerable disruptive potential and less for their direct, immediate impact on revenue or margins. Daimler AG, for instance, became the first major car maker to enter the ride-sharing business with its combined $100 million acquisitions of technology companies RideScout LLC and Intelligent Apps GmbH, whose mobile apps connect users with transportation options. 6 Similarly, telecoms carrier Vodafone crossed industry lines with its $197 million purchase of Cobra Automotive Technologies, which specializes in car security and telematics for the insurance and automotive sectors. With this deal, Vodafone hopes to create a new source of revenue from the Internet of Things and connected vehicle services to make up for declining revenue in its traditional phone-call business. 7 Valuation In addition to seeking different targets, companies will have to assess the value of the targets differently. When valuing traditional targets, a company will rely on classic valuation techniques using tried-and-true criteria: the target s market share, number or location of factories, and revenue and cash flow; the ability to integrate and revamp the value chain; and the cost of capital. With smaller, less-established companies, such information may not be available (typically the case with privately held enterprises) or even be relevant (niche companies that have been around for only two years may not be revenue generating and can t provide a revenue projection). Proxies and new criteria often must be considered, including the target s R&D spend, disruptive potential, and magnitude of strategic impact. And these criteria could be different from deal to deal. Accenture research shows that selecting the right targets matters: Thirty-five percent of companies agree that identifying, screening and prioritizing the right targets is critical to M&A success, and more than 40 percent say getting due diligence right is a critical step. 8 Given the dearth of traditional market and financial-based information available, a company must make some major assumptions about where they believe the target is headed in the market and its chances for success as well as about how the company can effectively incorporate the acquired capabilities into its business to create value to determine the price it s willing to pay. And that means the margin for error is much higher and the risk of getting the valuation wrong and paying too high a price is greater. A venture capitalist can make a wide range of bets on promising companies knowing some may pay off and others may not. A company doing an acquisition can t take that risk it has to get it right. The amount of money 3

4 at risk with a niche, unproven company is much less than what s at stake when buying a major competitor while the potential upside can be immense. Integration Finally, the integration of a small entrepreneurial company is very different and has its unique challenges. The focus isn t on removing redundancies and maximizing operational and cost synergies. Rather, the prevailing concern is to not suffocate the acquisition and, consequently, diminish the value of the capability that was the basis for the deal in the first place. In other words, integration is innovation driven and often done concurrently with transformation activities needed to best leverage the new pool of talent and IP. When BBVA considered how it should handle the Simple integration, it was mindful of the risk of overwhelming Simple and diluting its impact. That s one of the reasons BBVA has chosen to allow Simple to continue to operate on its own within the context of the BBVA family. By building links between Simple and BBVA, BBVA can leverage Simple s online platform and other tools across the rest of the business. 9 Adapt Your M&A Strategy Given the rapid speed at which digital is driving industry convergence and creating greater opportunities for ecosystem collaboration, leading companies are redefining their business model to stay ahead of the business curve and create competitive advantage. And when they do, they will rely on those critical enablers and capabilities provided by niche companies. Without them, a company will lack what it needs to create a portfolio that ensures survival and drives growth and innovation through the next business cycle. To effectively identify, value and integrate these smaller strategic targets, companies need to develop an M&A vision that aligns with the dynamics of their industry, especially disruption and convergence. They also must adapt the criteria and decision frameworks for evaluating their portfolio and acquisition targets to fully understand a deal s impact on their entire portfolio and how it will enable them to meet market expectations. Perhaps most importantly, they have to accelerate their overall M&A decision making to move at the speed of the market and avoid missing out on key opportunities to acquire vital capabilities. Adopting a new M&A approach doesn t mean a company should completely eliminate its more traditional M&A strategy, which remains valuable in certain situations. But it does mean companies should recognize that while buying their competitors may lead to short-term dominance, the threat of business model disruption won t disappear. 4

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