Let’s use two
companies that are recognized as among the best at making successful
acquisitions, General Electric and Cisco Systems. As their stockholders
will happily tell you, these companies have been star performers in
growing shareholder value. General Electric is a giant conglomerate with
business lines such as GE Capital, GE Plastics, GE Power Systems, GE
Medical, and several others. Cisco Systems could be categorized as a
high tech growth company primarily focusing on voice and data
communications hardware, software, and services.
The first rule of strategic acquisition we learn from these two prolific
and successful companies is that they do it on purpose. They have a well
thought out defined approach. To quote GE, “We are allocating capital to
businesses that can increase growth with higher returns, businesses
requiring human capital as opposed to physical capital. We are
disciplined and integrators and we grow the businesses we acquire. Over
the past 10 years Cisco Systems has acquired 81 companies. If you track
their stock price over the same period, it is up a remarkable 1300% over
that same period. GE, starting with a much larger base, still
outperformed the S&P 500 index over the same period 3 to 1.
If you study the acquisitions of these two companies as well as good
middle market growth through acquisition companies, you find some common
strategic themes. The core principal that runs through almost every
example is INTEGRATION. With the exception of establishing the original
platform, GE expanding from their original roots and establishing a
presence in plastics, for example, all of these acquisitions focus on
integration.
An example that I use to summarize strategic acquisitions for Cisco
Systems is not a real acquisition, but a hypothetical company that
should demonstrate a point. I have been a very happy stockholder for
over a decade. It seems like every year they would announce an
acquisition that looked like this – Today Cisco announced the
acquisition of Optical Solutions Company for $30 million in stock.
Optical Solutions Company manufactures the OptiFast Switch, the fastest
optical networking switch on the market today. The Company was started
two years ago by two Stanford Electrical Engineering Professors. Current
sales are $1.5 million and last year they lost $700,000. My initial
reaction was, “What the heck are they doing?” What they were really
looking at was what this technology could become as it was integrated
into the Cisco family. First, Cisco has 5,000 sales reps, 12,000 value
added resellers and systems integrators that sell their solutions, and
600,000 customers that think Cisco walks on water. Cisco knows their
market, their customers, and the first mover advantage in their market.
With this backdrop, the OptiFast Switch achieves sales of $130 million
in its second year of Cisco sales. That’s what the heck they were doing
– a classic strategic acquisition.
There are several categories of strategic acquisition that can produce
some outstanding results with effective integration. Many acquisitions
actually have elements from several categories.
1. ACQUIRE CUSTOMERS – this is almost always a factor in strategic
acquisitions. Some companies buy another that is in the same business in
a different geography. They get to integrate market presence, brand
awareness, and market momentum. Another approach is to acquire a company
that can establish a presence for you in a different market segment. For
example, lets say that that Company A made fasteners for the automotive
industry and felt that their expertise could be applied to the aerospace
industry. A company that produced fasteners for the target industry
could help jump-start this strategic initiative.
2. OPERATING LEVERAGE – the major focus in this type of acquisition is
to improve profit margins through higher utilization rates for plant and
equipment. A manufacturer of cardboard containers that is operating at
65% of capacity buys a smaller similar manufacturer. The acquired
company’s plant is sold, all but two machines are sold, the G&A staff
are let go and the new customers are served more cost effectively.
Adding new customers without increasing fixed expenses results in higher
profit margins.
3. CAPITALIZE ON A COMPANY STRENGTH – this is why Cisco and GE have been
so successful with their acquisitions. They are so strong in so many
areas, that the acquired company gets the benefit of some, if not all of
those strengths. A very powerful business accelerator is to acquire a
company that has a complementary product that is used by your installed
customer base. It is ten times easier to sell an add-on product to an
installed account than to sell a product to a new account. Management
depth and skill, production efficiency/capacity, large base of installed
accounts, developed sales and distribution channels, and brand
recognition are examples of strengths that can power post acquisition
performance.
4. COVER A WEAKNESS – This requires a good deal of objectivity from the
acquiring company in recognizing and chinks in the corporate armor. Let
me help you with some suggestions – 1. Customer concentration: too much
of your business is concentrated on a small group of customers 2.
Product concentration: too much of your business is the result of one or
two products 3. Weak product pipeline – in a business environment that
is becoming more innovation focused, having a thin product pipeline
could be fatal. Many of the acquisitions in the pharmaceutical industry
are aimed at covering this weakness. 4. Management depth or technical
expertise and 5. Great technology and products – poor sales and
marketing.
5. BUY A LOW COST SUPPLIER – this integration strategy is typically
aimed at improving profit margins rather than growing revenues. If your
product is comprised of several manufactured components, one way to
improve corporate profitability is to acquire one of those suppliers.
You achieve greater control of overall costs, availability of supply,
and greater value-add to your end product. Another variation of this
theme some refer to as horizontal integration is to acquire a company
supplying you distribution.
6. IMPROVING OR COMPLETING A PRODUCT LINE – this approach has several
elements from other acquisition strategies. Successfully adding new
products to a line improves profitability and revenue growth. Giving a
sales force more “arrows in their quiver” is a powerful growth strategy.
You take advantage of your existing sales and distribution channel
(strength). You may be able to improve your competitive position by
simplifying the buying process - providing your customers one stop
shopping. You have already established momentum and credibility with
your installed accounts and it is far easier and cost effective to sell
them additional products than it is to win new customers.
7. TECHNOLOGY – BUILD OR BUY? This is a quandary for most companies, but
is especially acute for technology companies. Acquiring technology
through the acquisition of another company can be an excellent growth
strategy for several reasons. First, the R&D costs are generally lower
for these smaller, agile, more narrowly focused companies than their
larger, higher overhead acquirers. Secondly, time to market, window of
opportunity, first mover advantage can have a huge impact on the
ultimate success of a product. It has been said that Alexander Graham
Bell arrived four hours before another inventor at the patent office for
essentially the same invention. If there is a good idea or a market
opportunity, most likely it is being pursued independently and
simultaneously on several fronts. First one to establish their product
as the “standard” is the big winner. I sure would not want to try to
displace Microsoft Windows as the operating system for PC’s.
8. ACQUISITION TO PROVIDE SCALE AND ACCESS TO CAPITAL MARKETS – In this
area, bigger is better. Larger companies can generally weather a storm
better than smaller companies and are considered safer investments.
Larger companies command larger valuation multiples. Some companies make
acquisitions in order to get big enough to attract public capital in the
form of an IPO or investments from Private Equity Groups. Many smart
business owners have consolidated several smaller companies at lower
multiples to create a larger company that the investment community
valued at higher multiples. This can be a very effective grow to exit
strategy.
9. PROTECT AND EXPAND MATURE PRODUCT LINES - I recently came across an
outstanding example of the execution of this strategy. Johnson &
Johnson, the multi-billion dollar pharmaceutical company in 2000
acquired Alza Corporation, the maker of drug delivery systems and
devices for what appeared to be an unbelievably steep price of $13.7
billion, or 23 times year 2000 revenues. They are the inventors of the
transdermal patch used in products such as NicoDerm CQ. They have
developed time released pills that can, for example deliver Ritalin, the
drug for attention deficit disorder in children, at prescribed times
with one dose. They have developed an injectable titanium stint to
deliver cancer medication over the course of a year. Why would J&J pay
so much for this company? Here is the strategy. The latest price tag for
getting a major new drug through the FDA and to market is a whopping
$800 million. These delivery technologies can turn J&J’s old drugs into
new best sellers that are re-patentable at a far lower price than new
drug development. An added benefit is that they can do the same for off
patent drugs from other competitors.
10. PROTECT CUSTOMER BASE FROM COMPETITION – The telephone companies
have done studies that show that with each additional product or service
that a customer uses, the likelihood of the customer defecting to a
competitor drops exponentially. In other words, get your customers to
use local, long distance, cellular, cable, broadband, etc and you will
not lose them. Multiple products and services provided to the same
customer dramatically improve retention rates. At the risk of repeating
myself, it costs ten times more to get a new customer than it does to
keep one.
11. ACQUISITION TO REMOVE BARRIERS TO ENTRY – An example of execution of
this strategy is a large commercial information technology consulting
firm acquiring a technology consulting firm that specializes in the
Federal Government. The larger IT Consulting firm had valuable expertise
and best practices that were easily transferable to government business
if they could only break the code of the vendor approval process. After
many fits and starts to do it themselves, they simply acquired a firm
that had an established presence. They were able to then bring their
full capabilities from the commercial side to effectively increase their
newly acquired government business.
12. OPPORTUNISTIC ACQUISITION FOR WHEN THE MARKET TURNS – as they taught
me in business school: buy low and sell high. Well-run businesses often
will buy competitors that bring many of the benefits from above at very
favorable prices when times are tough. They buy customers, new
geographies, technology, management talent, etc. at less than strategic
prices because they have the staying power to last through a market
downturn. Buying a company that doesn’t fit at a bargain is ultimately
not a bargain if you are unable to integrate to make your core business
more powerful.
Larger firms with lots of resources have established business
development offices to execute corporate growth strategies through
acquisition. These experienced buyers search for companies that fit
their well-defined acquisition criteria. In most cases they are
attempting to buy companies that are not actively for sale. If a
strategic company is for sale and is being represented by an M&A firm,
the M&A firm’s job is to sell that strategic value to the marketplace.
If properly done, the buyers are competing with several other buyers
that recognize the strategic value and the price tends to be bid way up.
The win for the successful corporate acquirer is to target several
candidates that have many of the characteristics from above, buy them at
financial valuation multiples (traditional valuation techniques like
discounted cash flow or EBITDA multiples), integrate to strength and
achieve strategic performance.
David Kauppi is a Merger and Acquisition Advisor
with Mid Market Capital, Inc. MMC is a private investment banking and
business broker firm specializing in providing corporate finance and
business intermediary services to entrepreneurs and middle market
corporate clients in a variety of industries. The firm counsels clients
in the areas of M&A and divestiture, succession planning, valuations,
corporate growth and turnarounds. Dave is a Certified Business
Intermediary (CBI), a licensed business broker, and a member of IBBA
(International Business Brokers Association) and the MBBI (Midwest
Business Brokers and Intermediaries). For more information or a free
consultation please contact Dave Kauppi at (630) 325-0123, email
davekauppi@midmarkcap.com or visit our Web page
www.midmarkcap.com.
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