Tech Deals Bring New Challenges to M&A
For
established firms, acquiring a digital startup comes with promise and pitfalls.
General
Motors, which will be 110 years old in 2018, has made several acquisitions as
part of its move to develop a fleet of self-driving cars. In
March 2016, it purchased San Francisco–based
autonomous vehicle technology startup Cruise Automation, which now runs GM’s
self-driving unit. Then in October
2017, GM bought Strobe, a three-year-old startup
based in Pasadena, Calif., specializing in lidar sensors that can generate
high-definition images — a key component of autonomous vehicles’ navigation
systems. Walmart, founded in 1962, has also moved into the tech space to
facilitate its creation of a digital marketplace that goes beyond merely
selling its inventory online. During the last couple of years, the company has
acquired a number of digital
fashion retailers, including Jet.com, Bonobos, Modcloth, and
Moosejaw, to enhance its e-commerce presence.
Many
companies that existed decades before the Internet, and that did not have
technology at the center of their business model, are trying to lock in future
growth by relying more on the prowess of young tech firms. We reported two
years ago on the rise of acquisitions of digital
firms by companies not usually viewed as being in the tech sector, noting that such
deals had grown by 48 percent between 2011 and 2015. In 2016, tech
deals totaled more than US$125 billion — up from $20
billion in 2011 — and that momentum carried into 2017. Through August of that year, 51 percent of investments
in private tech companies came from non-tech corporations, according to CB
Insights.
But before jumping in, traditional firms need
to consider the unique characteristics and challenges of tech deals. This will
require them to think strategically about their own digital agenda and how best
to achieve it; to consider the various factors that can influence the terms of
a deal, including cyber-attacks; and to be mindful of the skills and mind-sets
that the digital firm’s technologists and leaders may bring to their new
organization.
Making the Right Purchase
Non-tech companies acquire tech startups for
different reasons. They may want to enhance their business or provide entirely
new digitally enabled services. They may also want to preempt disruption and
buy out a company they view as a potential competitor. The trouble is that deal
makers are evaluating technologies that have only begun to emerge; they thus
have limited history and information to go on. Moreover, even though
established firms may have created a blueprint for how new technologies could
enhance their business, most of these plans are relatively new and still
evolving.
In the
past, companies would factor such risks into the price or terms of the deal.
Although that continues to happen, one alternative that’s become increasingly
common in recent years is for firms to establish a partnership or joint venture
(JV) rather than make an outright acquisition. Such agreements can decrease the
risks involved in acquiring technologies that are relatively new. What’s more,
partnerships and JVs can address some of the common challenges of a traditional
M&A, including bearing financial debts or sharing sensitive data, and can
serve as a testing ground for companies that are intrigued by new technologies
but aren’t ready to commit. In fact, PwC’s
21st CEO Survey, which involved nearly 1,300 executives
around the world, revealed that the trend toward partnerships is occurring
across all types of M&A. About half of CEOs said they planned to pursue a
new strategic alliance or JV to drive corporate growth and profitability in
2018, compared with four out of 10 executives who said they planned to pursue
new M&A.
With partnerships, the two sides benefit in different ways: The non-tech
firm gains exposure to expertise and technology that it lacks; the tech target
keeps its independence and benefits from the vast resources that took the
non-tech acquirer years to build, including capital and decades’ worth of commercial
data. Those who see more to the partnership may eventually choose to strike an
M&A deal, which is not uncommon, as we saw in September 2017 when furniture
company IKEA
acquired tech startup TaskRabbit. The
deal emerged after the two companies piloted a furniture assembly partnership
in the United Kingdom.
It’s also worth noting that established
companies need to take a rigorous look at their digital strategies before
initiating tech deals. Many incumbents have developed such strategies,
outlining how they plan to grow by adopting new technologies, but one lingering
challenge is that many of these strategies are mostly experimental and need
time to evolve and mature. Potential acquirers need to ask themselves whether
buying this company makes sense for their business, and where they want to go
with the acquisition.
High-priced
acquisitions have been especially prevalent in tech deals, as more startups
reach “unicorn” valuations of $1 billion or more. Deal makers kicked off 2018
with a string of megadeals north of $5 billion. But not overpaying on deals
involving tech startups remains a challenge. A common refrain is that deal
makers should set a walk-away price early on and avoid bidding wars. Many
investors make the mistake of buying into the target’s growth story in ways
they wouldn’t for more traditional acquisitions. For instance, they may place a
bigger emphasis on the technological expertise of the target firm than on how
much revenue it expects to generate. This is especially true for early-stage
tech targets, which are often quick to put new technologies to use but have yet
to demonstrate profitability.
When evaluating early-stage tech companies,
it’s particularly important for the acquirer to question the assumptions
underlying the tech target’s projections for growth, including assumptions
involving user adoption and penetration rates among consumer-facing technology
companies. The acquiring company should also examine the target firm’s products
— including the scalability of its technology and how it plans to enhance and
improve its technological offerings. And because it’s not uncommon for
established firms (which typically have more to spend on R&D and other
investments) to pay more for a tech acquisition than a startup would, it’s important
to bear in mind that a target’s price varies depending on who the bidder is.
Another factor to consider is cybersecurity.
It’s still rare for a breach to kill a deal, but it could delay the transaction
or impact a target’s value. That was evident in 2017, when Verizon acquired
Yahoo. After Yahoo’s disclosure of two breaches in previous years, Verizon cut
its offer by $350 million, or 7 percent of the original price. To reduce such
challenges, acquirers should ask several key questions of the target when evaluating
a deal, including: Have there been breaches before? Is the intellectual
property secure or is it impaired? How mature are the cybersecurity controls
and countermeasures, and can they meet current and future needs?
Creating the Right Culture
Years
ago it might have made sense for an automaker to look within the auto industry
for its next acquisition target. That approach is no longer viable, because
emerging technologies have created new markets and spawned many more options
for the next generation of drivers. As a result, it becomes ever more important
for companies to look outside their immediate industry for expertise and new
opportunities, as we saw when Daimler acquired a majority stake in European
taxi hailing services MyTaxi in 2014 and Hailo in 2016, and
when Toyota
made investments in AI/machine learning specialist
Preferred Networks.
But integrating the distinct cultures of two
companies is easier said than done, especially when an incumbent acquires a
tech startup. A common problem is that, more often than not, acquirers forget
that they’re not just buying new technologies, but also acquiring the talent
and culture that made the startup groundbreaking in the first place. Some tech
companies have entrepreneurial and idiosyncratic cultures. They’ve operated as
digital companies from the start. They’re also more nimble, more agile, and
quicker to experiment and launch new products and services than the big
companies. These attributes have made them successful, and it is therefore
critical for non-tech acquirers to not only preserve them, but also embrace and
learn from them.
Companies
should establish an integration plan, setting objectives and milestones for
product development, continued innovation, and broader plans to collaborate in
the long term. A big part of this puzzle is retaining key talent, but this may
include more than just technologists. In some cases, it makes sense to retain
the tech target’s management. We saw that with PetSmart’s 2017 acquisition of
Chewy.com, in which the online retailer is expected to keep its CEO and operate largely as an independent subsidiary.
Unlike
other M&A cases, deals in which an incumbent acquires a tech startup are
less about cost cutting and more about leveraging the target’s technical
expertise and know-how. It is therefore critical to train employees on the
non-tech side with the necessary skills to succeed in the newly merged company.
Too often, executives change
everything upon acquisition, forcing employees to
adopt new ways of working that are antithetical to how they gained success in
the first place. This can hurt morale and drive employees to leave the company.
Thus, it’s critical for any newly integrated company to include not only
high-level executives but also employees firm-wide in its integration process —
whether it is creating a steering committee that gives employees a say about
changes at the company or scheduling time for them to shadow the tech target’s
key employees.
It’s clear that deals in which a non-tech
firm buys or partners with a tech startup are a different breed, and the ways
they’re negotiated and evaluated come with unique challenges. But the
established firms that get it right could well be positioned for high growth.
by Alastair Rimmer
https://www.strategy-business.com/article/Tech-Deals-Bring-New-Challenges-to-M-A?gko=90531&utm_source=itw&utm_medium=20180517&utm_campaign=resp
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