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.
A New Megadeal Taxonomy
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. 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 (see Exhibit 1). 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=20160714&utm_campaign=resp
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