Acquisitions are a strategic tool for companies to gain relevance in this everchanging market landscape. Playing safe is not an option. In longer-term, natural selection comes into play and there are only clear routes for businesses — Scale up or Scale down.
While these are tough times for business especially with COVID -19, maintaining relevance through organic and inorganic routes will always be fundamental to any business growth. ( For those who do not agree … please read “24 hours in hell with 2010 technology”).
In this long-form article, we will deep dive into the following:
1. Emphasize M&A as a strategic necessity
2. Understand two of the largest tech deals of the decade in hindsight, and justify aggressive multiples for LinkedIn and Whatsapp
3. Learnings from the winning strategies with a higher probability of success
I promise to keep the article simple enough with relevant links for deep thinkers
So, let’s start from the source. An HBR article is often quoted and misinterpreted in Board rooms and Chief Executives…
“M&A is a mug’s game: Typically, 70%–90% of acquisitions are abysmal failures”. (Source: HBR )
Let’s be clear, we do agree that acquisitions are a risky territory with a lot of unknowns. But I am also going to make the following assumptions on your behalf:
A) You believe that the future is optimistic with great opportunities
B) You as a company stand at the cusp of gaining relevance and influence in the marketplace
C) You are willing to make thoughtful and calculated bets
D) In short, you have a Growth mindset
If these assumptions are true, then acquisitions provide the natural way to maintain long term growth. The question that companies should be asking then — “Are you paying the right value” and “ Do you have the capability to integrate and realize the investment thesis”.
The HBR article also mentioned that as a philosophy M&A is all about “Give” as opposed to “Take” (Drawing parallels from Adam grant’s book Give and Take). Acquiring companies need to have a plan to make the acquired companies successful. This is a great philosophy and we will explore this further when we talk about winning strategies for acquisitions.
Backing up, how would you define the “right acquisition value”. In simple-speak, let us deconstruct the acquisition price :
A. “You pay a premium” to keep your current and future customers/ users and Employees/ Developers to migrate to other platforms
B. “You gain” new customers to grow your business, buy capabilities and talented teams (hard to grow that organically)
C. “You buy time” to gain access to critical markets, jumpstart new areas and gain relevance in the markets you play
Hard to accurately quantify A, B, and C by each transaction from outside. (There are various financial perspectives to arrive at intrinsic value). We can consider a few case studies and understand the growth performance of highly acquisitive companies.
As per a Mckinsey report, highly acquisitive companies grew revenues faster both organically and inorganically.
Highly acquisitive companies operate with a “Growth mindset”, learn from their failures and develop a strategic playbook to identify, engage, close, and integrate right acquisition targets.
During the scaling phase companies, need missing pieces of technology and talent to scale their products and services. Speed of operations is critical for aggressive go-to-market.
Acquisitions do not just bridge the technology gap, but also the necessary talent gap to lead new products and businesses. For ex. Apple acquired Fingerworks, a gesture recognition company to build capacitive touch screens. Wayne Westerman (founder) has developed carpal tunnel syndrome and created the technology for people with hand disabilities. His technology and expertise were critical to building what is now known as the iPhone.
Bill Gates was the pioneer in deal-making. Microsoft signed the first large contract with IBM for an operating system that they didn't have. Gates bought the rights to QDOS ( Quick and Dirty OS) for $75 000 and hired the key programmer from rival SCP to modify it into MS-DOS; which was then licensed to IBM for its PC as PC-DOS. This became a huge success for IBM and later the same technology was licensed to HP. Microsoft has done several strategic acquisitions in the 1980 and 1990 including buying PowerPoint for $14 M.
It is tough to kickstart an ecosystem of growth and innovation otherwise
M&A is a high-risk high reward game, you must stay long, and serial acquirers have figured out their own formula for success
In the Tech Space, FAMGA’s are serial deal makers and have been growing their way through acquisitions.
- Put together, they’ve done ~30, One Billion+ acquisitions from 2000 until 2020
- Microsoft (11), Google (8), Facebook (4), Amazon (4) and Apple (3)
- Overall, they’ve done 700 + acquisitions in this space with Microsoft and Google acquired ~ 225 companies each, Amazon, Apple, and Facebook 80–100 companies
- Built various competencies for growth through acquisitions, one of the most crucial being AI
- Acquired the prominent products and services over the last five years (e.g. Amazon’s Alexa, Apple’s Siri, or Google’s DeepMind)
It is simple… Growth and Relevance trump all metrics.
Let’s understand how analysts have various grossly misunderstood the value of two key “Headline Deals”:
Case study 1: LinkedIn Acquisition by Microsoft:
o Valuation: $ 26 B
o Consideration: All Cash
o Key Competitors: Salesforce, Facebook and Google
o Premium over the competition: 50%
Here is a quick back of the envelope analysis:
o The Deal was priced at ~12X of Sales; compared to 4.9X in the next year and 3.9 X after two years
o Other social media platforms like Facebook and Twitter are trading at 9.1X and 6.9X respectively
o Clearly, Microsoft paid the premium to jumpstart a social media platform by six months to a year … How is that a bad deal?
o As per the latest earning report for April 20, LinkedIn’s revenue was up 21% and is a growth driver for Microsoft
o LinkedIn continues to influence other key categories for Microsoft with Revenue growth in other segments — Dynamics 365 (CRM, ERP, HCM solutions) and even Bing (Integrate with LinkedIn data and targeted advertising)
Case Study 2: WhatsApp Acquisition by Facebook:
This is a 20 B question everyone asked in 2014 and it only takes a visionary like Mark Zuckerberg to think through a decade down the road
o Valuation: $ 19.6 B
o Consideration: $ 4 B Cash + $12 B FB Shares + $ 3.6 B employee retention package
o Competition: Google
o Premium over the competition: 50%
o The acquisition thesis was “Stay Relevant” and “Stay ahead of the game” and keep competition at Bay in social messaging services. Whatsapp has exceptional user growth and clearly would have given a great head start to Google
o Whatsapp is leading the chart of active users in any messaging app with 1.5 B users, followed up by 1.3 B users from Facebook messenger
o If you compare the two charts, you will notice that Gmail chat which used to be one of the fastest-growing messaging apps is nowhere close in 2019… In hindsight, that is what this acquisition was about
o A different take on Valuation — A detailed analysis by Aswath Damodaran during the acquisition explains that valuations for social media companies should be based on multiples of users, clearly WhatsApp has outgrown the number of users adding more than 1 million users per day. WhatsApp was acquired for $50 per user which has drastically reduced to $ 14–15 per user in 2019.
o 70% of WhatsApp users were active daily, compared to Facebook’s 62%. Additionally, WhatsApp users sent 500 million pictures back and forth per day, about 150 million more than Facebook users
o For Facebook, the monetization strategy for WhatsApp and Facebook messenger is user acquisition first followed by monetization. This is also evident from the recent FB-Jio deal.
o With a user base of 1.5 B, Facebook can monetize Whatsapp anytime especially when phone calls become obsolete and mobile message rein. More so it also provides FB the opportunity to merge messaging platforms for FB, Whatsapp, and Instagram … Possibilities are limitless.
So clearly, M&As are a probability game with a high-risk, high-reward proposition. The game is not recommended for the faint-hearted and like any competitive sport, there are different strategies for offense and defense applicable to each weight class.
Then the million-dollar question is what are the best integration approaches?
Winning strategies to pursue acquisitions with higher success probability:
1. Focus on creating value for target’s business:
One of the clear value-accretive strategies in acquisitions is to first focus on improving the target’s performance. One can accelerate the revenue growth by lending acquirer’s distribution engine or reduce/ redeploy redundancies to effective use and improve operating margins
It is very important to operate with the “Give” philosophy and overcommunicate the intent, otherwise critical employees from the target organization will feel stifled in the new set up. One of the most successful retention strategies is to keep a percentage of the consideration for key employees to stay motivated
2. Pay premium for the right asset vs buying cheap:
If the operating thesis is growth, it is very hard and largely unproven to buy distressed companies at a discount and turn them around. For obvious reasons, successful companies trade at a premium and it is worthwhile to buy the right asset which fits nicely into the inorganic strategy even if they come at a reasonable premium. This builds confidence overall and limits any excuses for growth
As established earlier, “Growth” and “Relevance” will trump all metrics.
3. Develop a Strategic Acquisition Playbook:
o Day one sets the tone: CEOs and senior management should communicate the clear vision, integration plan, and reasons for the deal with clarity and purpose. Outline the steps needed to help each functional team create its own work plan
o Overcommunicate: It is critical to communicate the strategic intent, long term continuity and value proposition to all customers, employees, and partners
o Succession planning: CEO’s and founders rarely tag along for a long time, Acquirers should identify the key employees in either organization to take a meaningful role
o There will be Skeletons in the closet: Quite often the integration phase is a bumpy ride with unknowns. While there are financial and contractual levers to take care of a few of them, one still finds them. It is important to not get overwhelmed and lose the “trust equity” built thus far
o Acknowledge the cultural differences: As they say … “Everybody talks about it, but nobody understands it “. It is important to sensitize with the target culture on all dimensions — Diversity, power distance, mindset, symbols, etc.
4. Skin in the Game:
The Due diligence team develops a lot of contexts which is difficult to transfer and therefore they should be accountable for the integration process.
Successful companies create leadership bench and identify executives who could lead the integration process, align cross-functional collaboration, and drive synergies
5. Keep it simple, stupid
You’ve would already visualize complicated spreadsheets and PowerPoint. However, integration is a marathon and it is always recommended to focus on key relevant long-term growth metrics, keep the two organizations isolated initially (if possible), retain key employees, link contingent earn-outs (if any) to simple trackable metrics. It is recommended to map out the key integration goals on one single sheet of paper.
- Growth and Relevance trump all metrics
- Highly acquisitive companies operate with a “Growth mindset”, learn from their failures, and develop a strategic playbook. They grow revenues at a much higher rate (organic and inorganic)
- There are clear winning strategies to pursue acquisitions with higher success probabilities
Comments and Notes :
This is a complicated topic and I’ve tried my best to keep it simple. There are various links provided in the article to dive into deep areas related to valuation, integration, etc.