MERGERS AND ACQUISITIONS AND THE CRISIS

In the moments of crisis, it's worth thinking about how we are going to turn things around and make the most of our competitive advantages. If we don't have the ability to innovate, to focus on our clients and to think beyond, it's not likely we will survive a crisis!

For companies, not growing is not an option; growing is a constant need in the life of companies for them to keep up with all the technological innovation, the useful life of products, the unexpected crises, the increasingly aggressive competition brought by the globalization and by the easiness with which companies can nowadays be present all around the world, in a quick and cheap way.

Companies have two options to grow and strengthen their business:

  • internal growth, in other words, organic growth, attracting more clients, selling more, developping new products, etc;
  • or they can grow, or accelerate the internal growth, through the so-called external growth, through mergers, acquisitions, shares exchanges, joint ventures, etc.

We often hear the expression "better 10% of something, than 100% of nothing", but are businessmen/businesswomen really willing to give up the ownership of their businesses? Of most of their company? History has taught us that businessmen/businesswomen tend to focus on their business, on their property. Let's look at the example of agriculture in Portugal. We can find many producers for the same products, neighbors, but each with his/her own land, equipment, and they often compete against each other for the price! And if they got together, if they shared more powerful machinery, concerted marketing campaigns, the ability to add value to the product, transforming the primary product into an industrial product, for example fruit into dehydrated fruit, or vegetables into canned goods... They would have more competitive advantages, more ability to develop new products, to meet the consumers' needs... They would be focused on their clients and thinking beyond, as well as more prepared to face any crisis! We can adapt this example to any activity sector. In any business, the abilities acquired through external growth are great; there are many cases of success of mega mergers and acquisitions that created gigantic companies with great competitive advantages compared to their competitors. A few examples:

  • Merger of Exxon with Mobil (1998)
  • Purchase of Warner-Lambert by Pfizer (1999)
  • Purchase of Mannesman by Vodafone (1999)
  • Purchase of ABN Amro by RFS Holding (2007)
  • Merger of Heinz with Kraft (2015)
  • Purchase of Time Warner by AT&T (2016)...

When we talk about external growth, we almost always talk about Mergers and Acquisitions. It's, therefore, important to understand well the differences between both. A Merger implies two or more companies joining as one with everyone's participation, and it will be a joint vehicle for the development of a given economic activity, with a managing model developed by everyone and resulting in a model representing the union of all the entrepreneurs. An acquisition implies someone more powerful acquiring another previously existing entity and, from that point, detaining the decision ability of said other entity, so as to increase its critical mass. In many acquisition cases, there is a transition of management elements from the acquired entity to the acquiring entity. However, this doesn't mean that we are in the presence of a merger process, although in some cases it might be hard to establish where one process ends and where the other one begins.

Whenever a businessman/businesswoman is called upon making a decision related to this topic, it's important to understand if he/she's open to purchasing another business, selling his/her own, or simply joining another business, and what the consequences of that decision are. It's also important to understand that this external growth implies joining similar and/or competing businesses (horizontal growth) or joining businesses that complement each other in the value chain of the product (vertical growth). What often happens is a mixed model, where two similar businesses join to earn the ability to acquire a business in the value chain of the product, horizontal growth followed by vertical growth. Let's take for example a rump steak restaurant and a spareribs restaurant that join together to gain synergies and the ability to acquire a butcher's shop together; we have horizontal growth followed by vertical growth.

Normally, mergers and acquisitions are associated with transversal goals, such as the profitability of given investment activities, growth and the resizing of the business. Once these goals are achieved, it will be inevitable to obtain benefits like the increase of market shares and the reinforcement of financial and negotiation abilities. But to reach these goals and, as a result, these benefits, we must get around some constraints and difficulties. When we talk about merging two businesses, the hardest constraint to overcome might be ego management. Let's imagine that two neighboring restaurants decide to merge into one to gain more ability to negotiate with suppliers and to invest in a better equipped kitchen; it all makes sense. But what recipes and menus are they going to use? Who will be the head chef? What will the sales and cashier software be? Who will manage suppliers and purchases? We could keep asking unanswered questions, that are actually simple problems if every involved party is willing to make compromises and choose what is best for the business! Once the top management of the various entities is aligned and pursuing the same goals, we have to move on to the next, and just as arduous, phase: aligning the teams, (re) defining processes, choosing the best tools to define priority investments, defining forms of financing- creating a new culture! Only then will it be possible for the new entity to thrive, making the most of the entities that constitute it.

Just as important as overcoming all the constraints related to the culture and the business, is the need to find the fair value for the acquisition/sale or merger/exchange. If this point is not perfectly solved and agreed upon between the parties, there is no deal. Which leads us to the one million dollar question: How much is my business worth? What is, after all, the Fair Value? By definition, it's the value for which an entity is willing to sell something and another is willing to purchase said thing. The main point is not the negotiation that will lead to a transaction between both parties, but the assessment of how much a business is worth before the negotiations begin. We are not trying to detail too extensively the technical or methodological aspects that are required to carry out this assessment, since there are specialists who will be able to do it according to each individual case, but it's important to understand which aspects must be taken into account in as assessment: What is the ability to generate incomes in the future? What is the perpetual ability to generate said incomes? What are the expected growth rates? What are the investment needs to generate these incomes? What are the financing needs required to face these investments and the financial flux of operations? What additional activities assets are owned by the company? What are the contingencies associated with the business and the assets of the company? What is the specific risk of the business or of the markets where it carries out its activity?

We can't think about obtaining a correct assessment of our business value if we can't answer these questions. Once we have these answers, we can move on to establishing what changes a merger or acquisition/sale will bring in these matters. Only then will we be able to assess if, from a financial point of view, the business is interesting and fair, to define a reasonable interval for the negotiations. Once these phase is concluded, the price of the transaction (acquisition or sale) or of the trading relationship (merger) is determined. From the difference between the price and the fair value of the assets and liabilities of the business results the so-called goodwill, that can be either positive or negative. If it's negative, it means we purchased it for a value that is inferior to the Fair Value of those Assets and Liabilities, which can indicate the existance of some hidden contingency. If it's positive, it means we overvalued the business, maybe because the merger/acquisition will bring on gains that are not reflected in an individual analysis of the business.

The secret to a successful merger: defining in a correct and clear way the goals of the merger or acquisition, involving the management teams so as to create a new culture according to the defined goals, to which all the involved parties will be committed. Resorting to specialized professionals from various business areas, financial, legal and business development consultants, as well as auditors, among others, to ensure there are no "loose ends" to solve later on. What we manage to save today can end up costing a lot more when these "loose ends" become a problem that can cause friction between the various involved parties, and that can even put the whole merger and all its benefits in jeopardy!

But what is the best time to move on to a merger process? When the business is fine? When it's not? When the economy grows? When we are in crisis? There is no right answer, each case is different. But there is no wrong time either. Businessmen/businesswomen must be willing to ponder all the possibilities. Sometimes the opportunities to go into partnership with others, to sell or to purchase a business, appear when we least expect it. What we must do is always assess the various scenarios and the disadvantages of each scenario, making a decision based on this analysis. Make sure that the scenarios you draw are realistic and based on wise assumptions, that is, free of prejudice and preconceptions without any real ground.

We are nowadays experiencing moments of quick transformation in businesses, made possible by technological advances that involve quick decisions based on a relatively high degree of uncertainty. Not so long ago, the fax was still a dazzling novelty, and nowadays we don't even know how to use it anymore; we live in an increasingly global and almost border-less world, with no barriers to international trade. We live in a world where the possession of goods is gradually replaced by the right to use them, by the sharing of this use... Will we be able to look at our businesses like we always have? Do we stand a chance if we remain alone in our small businesses? and what about when big ones invade our business areas? What to do? It's worth thinking about... As an African saying goes: "If you want to go fast, go alone, if you want to go far, go together".

José FARINHA
CEO VISEEON PORTUGAL
jose.farinha@viseeon.com