Let’s Megadeal
Seven
strategies for managing the unique challenges of large technology acquisitions.
To the outside world, deal making in the
technology sector can often appear irrational, exuberant, and even insane. In
what other industry would a five-year-old startup with reported revenues of
US$10 million and fewer than 100 employees garner a $22 billion price tag?
That’s how much Facebook paid in February 2014 for WhatsApp, a messaging
service that allows users to exchange text messages without paying for SMS.
It’s
easy to disparage the extravagance of such a megadeal. Indeed, the tenor of the
discussion within the business community and in the media at the time of the
announcement veered from disbelief to dismay about tech valuation bubbles. “Facebook Buying WhatsApp Is a Desperate Move,”
screamed a headline at Fox Business News.
But for established technology firms, the
only thing worse than paying too much for a promising tech startup is failing
to pay enough to acquire it. Generations of innovation gurus and consultants
have lambasted IBM for missing the significance of the personal computer
operating system and thereby enabling Microsoft to grow from a junior partner
into a titan. Analysts have also criticized Microsoft for failing to purchase
Yahoo, dinged Yahoo for missing the opportunity to acquire Google in the late
1990s, and chastised Google for not pursuing Facebook. To be sure, not every
technology deal is like WhatsApp. But in technology, an industry unlike any
other, a handful of people working in a garage can transform a market in the
blink of an eye.
The unusual nature of deal making in the
technology sector, particularly deals involving headline-grabbing transactions
such as Facebook’s WhatsApp purchase and Microsoft’s $8.5 billion acquisition
of Skype in 2011, demands a closer look. How should company leaders consider
the value creation potential inherent in such deals? And how can they manage
integration to ensure success and avoid destroying value? To get a handle on the
megadeal universe, we examined 131 technology deals of at least $1 billion in
size made over the past five years, with a collective value of $388 billion.
The deals fell into four discrete categories.
Consolidation.
These
deals involve competitors, value chain participants, or companies with closely
adjacent products and overlapping customers. The motivation in these
transactions is focused less on growth and more on unlocking tremendous value
by cutting costs and improving efficiencies. These deals tend to be highly
successful because the companies know each other well and the synergy potential
is significant and obvious. According to our analysis, more than 60 percent (or
just over $25 billion) of the value of megadeals in the semiconductor subsector
was related to consolidation Notable examples include Texas Instruments’ $6.5
billion acquisition of National Semiconductor in 2011 and Avago Technologies’
$6.6 billion purchase of LSI in 2013. Google’s 2012 acquisition of the patent
portfolio of Motorola Mobility stands as an example of value chain
consolidation. Google held on to the patent assets after divesting the set-top
box and mobile device assets it received as part of the $12.4 billion deal.
Capabilities
extension.
Deals
that fall into this category — the biggest of the four by value — typically
involve two large, mature companies. In general, the buyer is seeking new
products, new talent, or new customers in a large, tangential market where it
doesn’t already possess the capabilities to compete. Capabilities extension
transactions accounted for 40 percent of the total value of tech megadeals over
the last five years (see Exhibit 2). Examples include SAP’s $8.3 billion
acquisition of travel-expense specialist Concur Technologies in 2014, Oracle’s $7.5
billion purchase of Sun Microsystems in 2010, and Microsoft’s 2014 $7.2 billion
acquisition of Nokia’s device and services business.
Technology-driven
market transformation.
Facebook’s
aggressive move to buy WhatsApp typifies this category. Although these
transactions constitute only 18 percent of tech megadeals, they tend to garner
significant headlines. Why? Because they involve a new technology that is
driving customer behavior in ways that could rapidly threaten established
business models and transform existing markets, or that represent the potential
for the convergence of existing markets. These deals tend to involve larger
companies dishing out huge sums to buy small upstarts whose technology has
great disruptive potential. Not surprisingly, these deals are most prevalent in
the Internet subsector, in which they accounted for more than half of the total
deal value from 2010 to 2014. Other examples include Google’s 2014 purchase of
smart home products maker Nest Labs ($3.2 billion), Facebook’s swoop for
virtual reality company Oculus ($2 billion), and Intel’s 2011 acquisition of
security software firm McAfee for $7.6 billion.
Going
private.
The
fourth technology deal category consists of transactions in which private
equity firms take companies private. In our analysis, these deals accounted for
23.5 percent of the total technology megadeals, and included the single biggest
transaction: the 2013 deal that took Dell private for $24.3 billion. Such deals
can occur for a variety of reasons. Because this article is addressing the
unique considerations for strategic acquirers evaluating megadeals, we will
discuss only the first three categories.
Avoiding
the Megadeal Pitfalls
Corporate leaders experienced in mergers and
acquisitions are well aware of the risks that come with transactions of all
sizes. Many have honed deal-related processes and playbooks that serve them
well when executing relatively small to midsized deals. However, we have
observed that megadeals in the technology sector pose a unique set of
challenges. They thus create barriers to success that are often unfamiliar even
to executives with significant acquisition and integration experience.
Indeed, many of the large spin-offs and
divestitures occurring in the technology sector today are the consequence of
past megadeals that either did not pan out or no longer fit strategically. From
the outset, these deals faced challenges in capturing expected synergies and moving
the parties seamlessly toward becoming a single company. Today, faced with the
need to focus on core capabilities or invest in new technologies — such as
cloud computing, social media, and mobile technologies — many leaders are
shedding prior investments.
Not all megadeals fail, of course. Indeed,
when executed correctly, these transactions can propel purchasers ahead of
their competition by creating formidable capability platforms, realizing
significant operational efficiencies, and opening up new avenues for growth. To
succeed, experienced leaders need to make adjustments and address certain
challenges.
We’ve identified seven critical challenges to
megadeals, and have developed strategies to cope with them. All seven apply to
the three technology deal types under consideration — consolidation,
capabilities extension, and technology-driven market transformation — although
the degree of the challenge varies by deal type.
1.
Assigning accountability.
In a
best-case acquisition scenario, a business unit (BU) leader is charged with
driving the transaction because the acquired operations fall within his or her
current scope. The BU leader evaluates the technology, the customers, the
marketplace, and core business functions. What’s more, the BU leader may take
ownership of the integration and the combined performance plan.
Consolidation-oriented deals tend naturally to include strong BU accountability
because of the high degree of operational overlap.
However, in capabilities extension megadeals,
almost by definition, BU accountability doesn’t exist. In this vacuum, the
chief executive officer often becomes solely accountable for the deal’s
business success. And that presents significant challenges to evaluating the
business logic and post-close execution.
We have seen CEOs take a number of approaches
to these deals and have generally observed that the more effective deals tend
to involve a combination of the following:
• Imposing
enhanced functional accountability. C-suite leaders in technology, sales
and marketing, manufacturing and distribution, and corporate functions are
empowered with acquisition ownership. And it is made clear that they are
accountable for the quantification, execution, and delivery of synergies.
• Increasing
board governance. Risks arise in transactions that are championed or led
directly by the CEO. That warrants greater involvement by the board. Either a
board member assumes a co-leadership role or the board more actively
participates throughout the acquisition process. This may also require a
greater use of external experts during the evaluation and execution phase.
In general, each of these approaches
distributes focus and accountability, augments capabilities, or provides for
greater objectivity and transparency to guard against deal biases.
2.
Relying on acquired management.
This
is particularly important for technology-driven market transformation deals in
which knowledge about the new technology is held by a small group of creative
or technology leaders. It’s also important for capabilities extension deals in
which the company is buying large operating units and needs experienced
managers in place from Day One to ensure that these operating units continue to
run smoothly.
This reliance on acquired management poses a
dilemma because most of the senior team from an acquired company can afford to
leave after the deal closes and will have other opportunities. They may also
simply dislike the idea of running a business unit in the new company after
having run the acquired company.
Given this reality, the acquiring company
needs to assess how much it will rely on these senior managers and for how
long. Retaining people contractually is often just a short-term solution; it’s
important to be mindful that retention does not always correlate with
performance. Leaders need to judge whether newly acquired talent will keep
their heads in the game, and put a succession plan in place for when they do
leave. This process will involve significant relationship building,
particularly with deputies and other sub-line leaders at the acquired company
who might be able to step in and run the business unit over a longer term.
3.
Valuing cost and revenue synergies.
A
strong conclusion that emerges from our study is that cost synergies are much
more achievable than revenue synergies. So when evaluating targets, it is
essential to assign more weight to cost opportunities and less weight to
revenue opportunities. This is particularly true for consolidation plays, in
which two mature companies come together and the cost synergies are apparent,
quantifiable, and attainable. For example, when NXP Semiconductors announced in
March 2015 its acquisition of Freescale Semiconductor, industry consolidation
was the rationale. NXP CEO Rick Clemmer stated that the company anticipated
$200 million in cost synergies in the first year, and $500 million to follow.
It is particularly difficult to achieve
revenue synergies tied to a big new strategic vision, or to long-term
assumptions that require integrating technology or changing customer behavior
over many months or years. Such assumptions, which many times are baked into
capabilities extension deals, don’t often materialize, or materialize more
slowly than expected, or materialize on a smaller scale than was envisioned. If
the acquisition thesis is dependent on revenue, leaders must push for truly
granular detail during due diligence, design a separate process within the
integration to carefully manage revenue goals, and focus intently on driving
revenue synergies as quickly as possible.
That said, revenue synergies cannot be
completely discounted, especially when it comes to technology-driven market
transformation deals. In 2006, when Google paid $1.7 billion in stock for
YouTube, the price seemed high. However, YouTube has delivered tremendous
growth. It posted revenues of about $4 billion in 2014, up from $3 billion in
2013. Buyers of today’s hottest startups, such as Instagram, must take revenue
synergies into account or they can never arrive at a competitive valuation. We
have observed companies failing to get the most from capabilities extension
transactions because they are reluctant to prioritize revenue synergies. And
that can prevent the product or solution transformation needed to address
converging technologies or shifting customer propositions.
4.
Tailoring the playbook.
Most
acquisitive technology companies have developed extensive M&A playbooks and
invested in internal capabilities to execute and integrate smaller “tuck-in”
deals. But these playbooks may not be useful for megadeals. In particular,
technology-driven market transformation deals, with their huge valuations,
narrow focus, tiny revenues, and entrepreneurial management, may force an
acquirer to toss out its playbook. Nothing in its recent corporate history would
have prepared Facebook to pencil out a $22 billion purchase of an app. Not
every deal will require such a leap of faith, but some will; it’s the nature of
the technology industry.
For consolidation and technology-driven
market transformation deals, companies need to put their standard M&A
playbook on steroids. Given the size and complexity of these deals, their
unpredictability, and the higher volume of requirements across the enterprise
necessary to execute them successfully, leaders need to step back, start with a
clean sheet of paper, and tailor the integration approach to the specifics of
the deal at hand. They must ensure that sufficient resources have been devoted
to the undertaking.
5.
Doing more diligence.
Despite
the size and complexity of megadeals, companies sometimes feel pressure to
skimp on due diligence. An attitude often prevails that big public companies,
with their sophisticated institutional investors, legions of regulators, and
audited books, have less to hide than small companies and thus require less due
diligence. Or senior leaders worry about losing momentum by digging too deeply.
Confidentiality issues are also cited as a reason to curtail due diligence, and
leaders can be uncertain about the depth of due diligence that is legally
permitted.
The net result is that companies involved in
megadeals may know surprisingly little about each other. A lack of due
diligence may not matter too much in the case of a technology-driven market
transformation deal, because the target company is small and the potential for
due diligence is limited. But a lack of due diligence can be quite damaging for
capabilities extension deals if cost and revenue assumptions are not properly
vetted.
Indeed, many of the megadeals completed over
the past several years are unraveling today for the simple reason that the
original due diligence did not uncover the barriers to success it should have.
As a result, the hoped-for synergies never materialized. Before signing on the
dotted line, CEOs and their teams should always consider what they didn’t
validate, and be sure they can live with the risk.
The adequacy of pre-acquisition due diligence
should naturally be a critical focus area for the board. In other surveys and
board seminars, we have noted a number of leading practices for boards
approving large transactions, such as approving diligence priorities and
“non-negotiables”; reviewing detailed (versus highly summarized) diligence
findings; interacting with third-party due diligence advisors on topics
including scope, access, and key findings; and reviewing pre-announcement
integration plans and budgets.
6.
Communicating effectively.
Good
communication is critical for all categories of tech deals from the moment a
deal is announced. Investors, employees, and customers must all understand the
goals, the integration activities necessary to achieve those goals, the metrics
used to measure whether those goals are being met, and who is responsible for
delivering on those goals.
However,
the emphasis of that communication may vary by type of deal. For example,
consolidation deals tend to create a lot of anxiety and dysfunction among
employees worried that cost synergies translates into lost
jobs. Since they’re not entirely wrong, the senior executives need to have
laid out the integration strategy for themselves in a detailed way so they can
communicate confidently to employees — especially key employees whose jobs are
secure. An inability to clearly communicate intentions inevitably creates
uncertainty. Instead of focusing on deal execution, people begin to focus on
personal survival.
By comparison, employees in technology-driven
market transformation deals are often less concerned about job security; after
all, they hold the critical intellectual capital the acquiring company needs to
retain. In these deals, a greater emphasis may be placed on communicating with
investors and Wall Street, which may be confused and upset by a very high price
tag. Facebook CEO Mark Zuckerberg used a statement to explain the Whats-App deal
to investors. “WhatsApp is a simple, fast, and reliable mobile messaging
service that is used by over 450 million people on every major mobile
platform,” he noted. “More than 1 million people sign up for WhatsApp every day
and it is on its way to connecting 1 billion people. More and more people rely
on WhatsApp to communicate with all of their contacts every day.”
7.
Managing the transaction as a business process.
The
larger the transaction, the more challenging the integration and the greater
the need for a well-defined business process to focus resources and capital on
the right activities at the right times and to capture cost and revenue
synergies as quickly as possible. This is especially true for both
consolidation and capabilities extension deals wherein two big companies are
coming together with a large number of employees and customers.
It’s helpful to remember that the deal
process has an inherent flaw that a fit-for-purpose business process can
mitigate. The original valuation is by necessity based on many assumptions.
After the deal is announced, those assumptions cannot be automatically accepted
as fact. Once the company gains access to people and additional information at
the target company, the acquirer must put a tailored business process in place
with the requisite accountability and transparency to get data and test
assumptions with fact-based analyses, and then make further decisions.
The business process for these types of deals
must include a clear set of guiding principles and goals connected to
sustaining everyday operations and capturing synergies, and relentlessly focus
on quantifying, reporting, and executing on value capture opportunities. What’s
more, the process must empower leaders to keep the integration on track by
giving them latitude to make quick decisions regarding organization, people,
customers, and priorities — and hold these leaders responsible for
communicating those decisions to customers, employees, shareholders, and
partners.
However, in the case of a technology-driven
market transformation deal, the integration should be handled more like a
relationship and less like a business process. That’s because the smaller, more
entrepreneurial team from the target company usually needs a more personal
touch to stay engaged post-close.
The challenges associated with technology
megadeals are significant and vary with the type of deal. Even so, we believe
that megadeals are worth doing as long as the acquirer acknowledges these
challenges and tackles them head-on. When executed correctly, these
transactions can boost efficiencies, increase revenues, and propel a company
ahead of competitors. They can even reshape an industry.
by Rob Fisher, Gregg Nahass, and J. Neely
http://www.strategy-business.com/article/00330?gko=08c08&utm_source=itw&utm_medium=20160616&utm_campaign=resp
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