End-to-End M&A Process Design: Resilient Business Model Innovation [1st ed.] 9783658302887, 9783658302894

Table of contents :
Front Matter ....Pages i-xiv
End-to-End (E2E) M&A Process Design (Thorsten Feix)....Pages 1-30
Embedded M&A Strategy (Thorsten Feix)....Pages 31-107
Transaction Management (Thorsten Feix)....Pages 109-171
Integration Management (Thorsten Feix)....Pages 173-244
Synergy Management (Thorsten Feix)....Pages 245-281
M&A Project Management & Governance: The M&A Playbook (Thorsten Feix)....Pages 283-302

Citation preview

Thorsten Feix

End-to-End M&A Process Design Resilient Business Model Innovation

End-to-End M&A Process Design

Thorsten Feix

End-to-End M&A Process Design Resilient Business Model Innovation

Thorsten Feix Hochschule Augsburg Augsburg, Bayern, Germany

ISBN 978-3-658-30288-7 ISBN 978-3-658-30289-4  (eBook) https://doi.org/10.1007/978-3-658-30289-4 © Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 This work is subject to copyright. All rights are reserved by the Publisher, whether the whole or part of the material is concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting, reproduction on microfilms or in any other physical way, and transmission or information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed. The use of general descriptive names, registered names, trademarks, service marks, etc. in this publication does not imply, even in the absence of a specific statement, that such names are exempt from the relevant protective laws and regulations and therefore free for general use. The publisher, the authors and the editors are safe to assume that the advice and information in this book are believed to be true and accurate at the date of publication. Neither the publisher nor the authors or the editors give a warranty, express or implied, with respect to the material contained herein or for any errors or omissions that may have been made. The publisher remains neutral with regard to jurisdictional claims in published maps and institutional affiliations. Responsible Editor: Vivien Bender This Springer Gabler imprint is published by the registered company Springer Fachmedien Wiesbaden GmbH part of Springer Nature. The registered company address is: Abraham-Lincoln-Str. 46, 65189 Wiesbaden, Germany

Introduction

The M&A market is with a global transaction volume of USD 3–5 trillion per year, depending on the M&A cycle, an important segment of the global capital markets. Between 5–6% of the global market capitalization finds a new ownership driven by those M&A activities year by year. But more or less all recent studies and research focused on the global M&A market highlight that between 50–70% of those deals fail (NBER 2004; Kengelbach et al. 2005; Rudnicki et al. 2019). Failure rates within corporate financebased studies are typically defined as either destroying shareholder value in comparison to a defined peer-group measured by the cumulative abnormal return or underachieving on the intended and communicated synergy targets. Therefore, to find and understand the root causes of those failed acquisitions and mergers is of paramount interest. Several reasons, like the missing fit between the acquirer’s and the target’s business model, inconsistent due diligence, culture clashes, unsuccessful integration efforts or simply too high purchase prices within contested bidding processes might contribute. But in the end, the most severe drivers of M&A failures might be disruptions and missing links between the different parts of the underlying M&A process. Based on this assessment, this book, on the one side, develops an End-to-End (E2E) M&A Process Design which tries to overcome those failures. On the other side, it will challenge the robustness of such a design with the needs of twenty-first century digital business models and innovation strategies. The E2E M&A Process Design approach is based on in-depth scientific research and co-operations with leading universities. Besides, it was also stress-tested and verified in numerous international M&A consulting projects, discussions with corporate development and M&A teams, as well as M&A experts, like investment banks, Big 4 transaction managers and strategy consultants. The target group of this M&A book is manifold. On the scientific side, courses and lectures on advanced bachelor levels, intensive lectures focusing on corporate finance, M&A and related fields, as well as master and MBA programs with a touchpoint on M&A, corporate finance, corporate strategy or investment banking might find the book useful. On the practitioner side, advisors in investment banking, strategy consulting and M&A transaction management might be interested in the book. Last not least, corporate

v

vi

Introduction

decision makers and in-house M&A, corporate strategy, corporate finance, controlling and legal teams are typically highly interested groups. This book will develop an innovative End-to-End (E2E) design for M&A processes to address the following key questions, which are fundamental to improve M&A success rates: –  How to invent a robust E2E M&A Process Design which avoids the typical pitfalls of M&A projects? What should be the modules of such an integrated approach? How to take care of the crucial linkages and feedback mechanisms between the different parts of such a highly complex process model? –  How could twenty-first century digital tools and processes be applied within this given M&A Process Design framework to increase efficiency, quality, speed and robustness of M&A projects? –  How could transactions be designed to innovate business models, create or renew competitive advantage and lever enterprise, or more precisely, equity value? How to embed M&A in the wider toolset of corporate portfolio and business strategies? –  What are vice versa the challenges and impacts of digital business models for M&A as a strategy tool and for the M&A Process Design? These questions will lead us to a digital E2E M&A Process Design as a general framework for M&A projects. Such a design has to be adjusted with respect to the specific needs of a given corporate strategy, Business Design and M&A Strategy to provide a tailor-made approach. The storyline and flow of thoughts, including the topics of each of the following chapters of the M&A Process Design, are summarized in Fig. 1:

Seng the stage: An digital End-to-End M&A Process Design Chapter 1

• • • •

The seventh merger wave: The blended challenge of Innovaon versus resilience A first overview of an End-to-End M&A Process Design The use of digital processes and tools to improve M&A processes and success The challenges of resilient digital business models and the role model of M&A

Part II: The modules of the digital End-to-End M&A Process Design Chapter 2

Embedded M&A Strategy Chapter 5

Chapter 6

Chapter 4

Chapter 3

Transacon Management Synergy Management M&A-Project Management & Governance

Fig. 1   Structure of the book and flow of thoughts

Integraon Management

Introduction

vii

–  The first chapter of the book will start with the assessment of the long-term and the most recent developments on the global M&A market. Distinct market indicators highlight that we are in the later stage of the seventh global merger wave, which is driven on the one side by business model innovations, digital disruptions and thinking in new ecosystems instead of linear competitive environments. On the other side, the glut of liquidity on the global equity and debt markets supported in the years before the covid-19 crises financially the flow of mergers and acquisitions. To address the needs of this challenging environment a tailored M&A Process Design will be introduced. The E2E M&A Process Design is based upon five modules: the first three, the primary M&A process modules, are the Embedded M&A Strategy, the Transaction Management and the Integration Management. These primary M&A process modules will be supplemented by two support M&A processes, the Synergy Management and the M&A Project Management & Governance. Digital processes and tools, like artificial intelligence, analytics, big data, blockchains and others offer significant potential to improve M&A processes. Given the M&A Process Design, a whole new set of M&A tools are introduced to increase the effectiveness and efficiency of M&A projects in the 20s. Further more, the role of M&A for innovations in digital business models and, vice versa, how digital business models challenge M&A processes, will be assessed. Along the M&A Strategy digital business models demand a wider scan of potential targets within a given ecosystem. For example, an Ecosystem-Scan as a tool for the necessary 360-degree, in-depth view on and assessment of a company’s corporate environment might be applied. A second, more holistic tool for corporate development and value creation is the Business Model Innovation (BMI)-Matrix. By comparing and evaluating acquisitions, mergers, joint ventures, incubators, accelerators and business model innovation approaches, the best option could be chosen. Another digital business model challenge is the valuation of digital targets and platform strategies within the Transaction Management. A Reversed Discounted Cashflow Model (DCF) might offer here new insights. Chapters two through six present the specific modules of the M&A Process Design in detail and will highlight the importance of an integrated approach in the sense of an E2E process. Especially at the interfaces of the different M&A modules, for example at the hand-over between the modules Transaction and Integration Management, many M&A projects fail. These interphase problems of M&A projects are also to be found between individual processes within a given module, for example within the Transaction Management between the Due Diligence, the valuation and the negotiation part. Besides, a dedicated focus will be on selected, newer topics with lasting impact on the success of

viii

Introduction

M&A projects, like the Due Diligence for digital targets and intangible assets, cultural integration issues, the tracking and controlling of the integration progress, the management of synergies or the design of a professional M&A project house and lasting tacit M&A-capabilities: –  In Chap. 2 the Embedded M&A Strategy module sets the stage for a M&A project: The first critical milestone is here the review of the corporate and the business unit strategies. Any M&A project should pay in double-sided: On the one-side, M&A projects have to contribute to the corporate and business strategy of the acquirer and, on the other side, it has to be financially assured that any transaction will lever shareholder value. Based on these guidelines the key pillars of such an Embedded M&A Strategy will be defined. Besides, a special emphasis will be on the Frontloading of Integration issues, like the Standalone Business Design Diagnostics of the target company and the acquirer, the drafting of a Joint Business Design, as well as on the Standalone Culture Diagnostics and the Joint Culture Design Blue Print. The E2E M&A Process Design proposes that already within the M&A Strategy such a sketch of the key pillars of a potential Integration Approach should be developed. –  The second module, the Transactions Management, will be discussed in Chap. 3. Core elements within the Transaction Management module are the Due Diligence, the valuation of the target company or merger with and without synergies, the acquisition financing, the negotiation as well as the drafting of a share purchase, asset purchase or merger agreement and the Purchase Price Allocation (PPA). Last not least the Blue Print of the Joint Business and Culture Design must be stress-tested along the Transaction Management phase. This book will focus foremost on the latter issues, as well as valuation and Due Diligence topics.1 –  Chap. 4 provides a detailed framework for the Integration Management. The Integration Approach Blue Print has to be detailed in an Integration Strategy. Additionally, the freezing of the Joint Business and Culture Design has to be assured. Thereafter, the dedicated Integration Masterplan will be designed and executed in four waves, short-, mid- and long-term as well as post-transaction to lever strategic and value upsides beyond the first-hand integration process. In parallel, the integration success has to be tracked and controlled, as well as learning-loops initiated. –   M&A projects only generate value, if the realised synergies overcompensate the agreed upon and finally paid acquisition premium. Therefore, the Synergy Management, which will be described in Chap. 5, is especially important for the value creation of an M&A project. The M&A Process Design understands the Synergy Management, in line with Michael Porter’s value chain idea, as a supplementary process, which runs in parallel, meaning End-to-End, to the three

1The

second edition intends to cover all parts of the Transaction Management.

Introduction

ix

primary M&A processes, the M&A Strategy, the Transaction and the Integration Management. –  In the end, any M&A process has project characteristics, having a defined starting— latest at the signing of the nondisclosure agreement—and end point—the closing of the Integration or post-mortem report-. In this sense, a professional M&A Project Management & Governance is, as a second supplementary process, mandatory for a seamless E2E M&A Process Design. An M&A and Integration Project House might serve as a capability and knowledge platform throughout the whole acquisition process and might scale M&A Project Management and Governance tools, as well as M&A specific, often tacit knowledge. This will be covered in Chap. 6. The entire book stresses the idea that an M&A Process Design has to be tailored according to the needs of a specific M&A Strategy, Business Design and ecosystem. The chosen pattern will be defined as a tailor-made E2E M&A Process Design: A M&A Process Design of a multiple acquirer, for example in the sense of a “pearls-of-string” acquisition strategy, is obviously quite different as one for a company which realizes only from time to time a dedicated M&A project or from one of a Private Equity (PE) player. Accordingly, the M&A Process Design needs to be tailor-made.

Contents

1 End-to-End (E2E) M&A Process Design . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 1.1 The 7th Merger Wave: The Age of Digital Disruption and Business Model Innovation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2 1.2 End-to-End M&A Process Design for Digital Times . . . . . . . . . . . . . . . . . 7 1.2.1 Overview of the End-to-End M&A Process Design . . . . . . . . . . . . 7 1.2.2 Modules of the End-to-End M&A Process Design. . . . . . . . . . . . . 9 1.2.3 Interrelations between the M&A Modules: An End-to-End View . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 1.3 Digital Touch Points of the End-to-End M&A Process Design. . . . . . . . . . 20 1.3.1 Digital M&A Processes and Tools. . . . . . . . . . . . . . . . . . . . . . . . . . 22 1.3.2 The Impact of Digital Business Models on M&A and Vice Versa. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29 2 Embedded M&A Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 31 2.1 Reframing of Corporate Portfolio and Strategic Business Unit Strategies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 2.2 M&A for Strategy Development on Corporate Portfolio and Strategic Business Unit Level . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2.2.1 M&A for Corporate Strategy and Portfolio Management. . . . . . . . 36 2.2.2 M&A for Business Unit Strategies and Competitive Advantage . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52 2.3 Purchase Price, Synergies and Shareholder Value. . . . . . . . . . . . . . . . . . . . 58 2.3.1 M&A Value Added Versus Dilution. . . . . . . . . . . . . . . . . . . . . . . . . 58 2.3.2 Synergies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 2.3.3 The Tao of Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2.4 Embedded M&A Strategy Design. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62

xi

xii

Contents

2.5 M&A Target Profiling and Pipeline. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2.5.1 Criteria for Target Profiling and Target Scorecards. . . . . . . . . . . . . 65 2.5.2 Assessment of the Fit Diamond. . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 2.5.3 The Process of Screening and Target Pipelining. . . . . . . . . . . . . . . 72 2.6 Frontloading of Integration Approach Blueprint. . . . . . . . . . . . . . . . . . . . . 73 2.6.1 Standalone Business Design Diagnostics and Joint Business Design Blueprint . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 2.6.2 Standalone Culture Design Diagnostics and Joint Culture Design Blueprint . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 2.7 Embedded M&A Strategy for Digital Targets. . . . . . . . . . . . . . . . . . . . . . . 99 2.8 Summary of Embedded M&A Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 2.8.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . 102 2.8.2 Key Success Factors and Takeaways. . . . . . . . . . . . . . . . . . . . . . . . 103 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 3 Transaction Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109 3.1 Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 117 3.1.1 M&A Valuation Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 118 3.1.2 M&A Valuation Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120 3.1.3 Valuation Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 3.1.4 Valuation Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141 3.2 Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142 3.2.1 Due Diligence Targets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 143 3.2.2 Due Diligence Management and Process. . . . . . . . . . . . . . . . . . . . . 144 3.2.3 Due Diligence Tools. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 149 3.2.4 Core Parts of the Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . 152 3.3 Blending of SCDs and SBDs and Redrafting of JCD and JBD. . . . . . . . . . 159 3.3.1 Business Design Due Diligence: Blending of SBDs and Redrafting of JBD Blue Print. . . . . . . . . . . . . . . . . . . 159 3.3.2 Culture Design Due Diligence: Blending of SCDs and Redrafting of JCD Blue Print. . . . . . . . . . . . . . . . . . . 162 3.3.3 Due Diligence and Verification of Integration Approach. . . . . . . . . 162 3.4 Valuation and Due Diligence of Digital Business Designs. . . . . . . . . . . . . 163 3.5 Summary of Transaction Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 3.5.1 Critical Cross-Checks and Questions of Transaction Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 168 3.5.2 Key Success Factors of Transaction Management. . . . . . . . . . . . . . 169 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 170 4 Integration Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173 4.1 Integration Strategy and Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179 4.1.1 Integration Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 179 4.1.2 Integration Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 185

Contents

xiii

4.2 Integration Masterplan: Planning the Transition. . . . . . . . . . . . . . . . . . . . . 197 4.2.1 Integration Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 198 4.2.2 Integration Masterplan Modules: Planning the Transition to the JBD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 203 4.2.3 Culture Transition Program: Planning the Transition to the JCD. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 4.3 Transition Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 4.3.1 Integration Principles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 225 4.3.2 Implementing the Integration Masterplan. . . . . . . . . . . . . . . . . . . . 228 4.4 Integration Monitoring, Controlling and Learning . . . . . . . . . . . . . . . . . . . 232 4.4.1 Integration Tracking and Scorecards. . . . . . . . . . . . . . . . . . . . . . . . 233 4.4.2 Integration Controlling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 4.4.3 Integrational Learning: Post Mortem Report and Learning Platform. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 236 4.5 Integration Management for Digital Targets and Business Designs . . . . . . 237 4.6 Summary of Integration Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238 4.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . 238 4.6.2 Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 239 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 242 5 Synergy Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 245 5.1 Transaction Value Added (TVA) and the Role of Synergies. . . . . . . . . . . . 250 5.2 Synergy Diagnostics and Patterns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 5.2.1 Demystifying Synergies—I: Financial Diagnostics of Synergy Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 253 5.2.2 Demystifying Synergies—II: Joint Business Design Diagnostics of Synergy Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . 258 5.2.3 Valuation and Prioritization of Synergies . . . . . . . . . . . . . . . . . . . . 262 5.3 End-to-End Synergy Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264 5.3.1 Synergy Management & Embedded M&A Strategy: Synergy Diagnostics & Scaling Approach. . . . . . . . . . . . . . . . . . . . 265 5.3.2 Synergy & Transaction Management: Proof-of-Concept of Synergy Value and Scaling . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 5.3.3 Synergy & Integration Management: Synergy Capture—Implementation & Tracking . . . . . . . . . . . . . . . . . . . . . . 269 5.4 Synergy Management Toolbox and Synergy Capture Assessment. . . . . . . 272 5.4.1 Synergy Toolbox . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 272 5.4.2 Evaluating Synergy Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276 5.5 Synergy Management of Digital Targets and Business Designs. . . . . . . . . 277 5.6 Summary of Synergy Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279 5.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . 279 5.6.2 Summary and Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . 280 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

xiv

Contents

6 M&A Project Management & Governance: The M&A Playbook. . . . . . . . . 283 6.1 Purpose of the M&A Playbook: End-to-End M&A Project Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 6.1.1 End-to-End M&A Process Map. . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 6.1.2 End-to-End M&A Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288 6.2 M&A Playbook and End-to-End M&A Process Design. . . . . . . . . . . . . . . 289 6.2.1 Development of an Embedded M&A Strategy . . . . . . . . . . . . . . . . 289 6.2.2 Execution of the Transaction Management. . . . . . . . . . . . . . . . . . . 290 6.2.3 Managing the Integration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 6.3 M&A in the 20s: Management of M&A Capabilities. . . . . . . . . . . . . . . . . 294 6.3.1 M&A Capabilities in the 20s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 6.3.2 M&A Departments 2020+. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296 6.4 M&A in the 20s: Digital Tools of the M&A Playbook. . . . . . . . . . . . . . . . 297 6.5 M&A Project Management of Digital Targets and Business Design. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 299 6.6 Summary M&A Project Management & Governance. . . . . . . . . . . . . . . . . 301 6.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . 301 6.6.2 Summary and Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . 301 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302

1

End-to-End (E2E) M&A Process Design

Contents 1.1 The 7th Merger Wave: The Age of Digital Disruption and Business Model Innovation. . . 2 1.2 End-to-End M&A Process Design for Digital Times . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 1.2.1 Overview of the End-to-End M&A Process Design. . . . . . . . . . . . . . . . . . . . . . . . 7 1.2.2 Modules of the End-to-End M&A Process Design. . . . . . . . . . . . . . . . . . . . . . . . . 9 1.2.3 Interrelations between the M&A Modules: An End-to-End View. . . . . . . . . . . . . . 18 1.3 Digital Touch Points of the End-to-End M&A Process Design. . . . . . . . . . . . . . . . . . . . . . 20 1.3.1 Digital M&A Processes and Tools. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21 1.3.2 The Impact of Digital Business Models on M&A and Vice Versa. . . . . . . . . . . . . . 26 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 29

Abstract

The long-term development of the global M&A market is characterized by a highly volatile pattern and was challenged by six merger waves. Multiple financial market assessments indicate that the global M&A market is in the midst of a new, the seventh merger wave, which is driven by business model innovations within technology as well as traditional industries. Besides, a glut of global liquidity due to ultra-loose monetary policies of multiple developed market central banks supports M&A financing potentials. Given this highly dynamic macro-view, a robust E2E M&A Process Design is mandatory to assure successful mergers and acquisitions. This M&A Process Design is built upon 5 modules, the Embedded M&A Strategy, the Transaction Management, the Integration Management, the Synergy Management and the M&A Project Management & Governance. The E2E M&A Process Design not only addresses these five modules, but also takes care of the crucial linkages within and between those modules. This mission-critical © Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_1

1

2

1  End-to-End (E2E) M&A Process Design

interdependencies of modules demand an E2E architecture. The M&A Process Design integrates also digital challenges and opportunities: Digital tools and processes might be used to increase the efficiency, speed, quality and robustness of M&A processes. Additionally, M&A could be used as a corporate development tool to design robust digital business models, resilient innovation strategies and to reshape corporate portfolios for the needs of the 20s.

1.1 The 7th Merger Wave: The Age of Digital Disruption and Business Model Innovation The global M&A market is with a yearly transaction volume between USD 3–5 trillion not only a significant, but also a volatile part of the global capital market. Within the M&A community, a common understanding exists, that these ups and downs of the global M&A market were shaped by six merger waves. Merger waves are thereby defined as multi-year clusters of extraordinary high global merger and acquisition activity (DePamphilis 2015, pp. 18–20; Maksimovic et al. 2013; Gugler et al. 2012) (Fig. 1.1).

Macro view: Development and paerns of the global M&A market •

Brief summary of the six tradional merger waves and their drivers

•

The 7th merger wave: its drivers and challenges

Resilient business model innovaon

Global glut of liquidity

Micro view: The E2E -M&A Process Design

Embedded M&A Strategy

Transacon Management Synergy Management M&A Project Management & Governance

Integraon Management -

E2E M&A Process Design, digitalizaon and business model innovaon

Efficiency

Quality

Robustness

Fig. 1.1   Structure and flow of thoughts of Chap. 1

Business Incubaon / Accelerators

BMI distance from core

E2E M&A Process Design

Venturing (CVC)

+

Speed

M&A

Alliances & Partnerships

Joint Ventures

Minority & Cross Shareholdings -

Short term

Inhouse Business Model Innovaon

Implementa on me

Long term

1.1  The 7th Merger Wave: The Age of Digital Disruption …

3

Background Information There are two competing schools of thought on the phenomenon of merger waves: The theory of “external shocks” argues that merger waves occur due to significant changes in the wider ecosystem of companies. The drivers of those changes might be redesigns of the regulatory environment, tectonic shifts in the macroeconomic environment like significant commodity price increases, disruptions due to new technologies1 or the sudden appearance of new distribution channels like the Internet. These macro-shifts in the external environment challenge corporations to overhaul their corporate strategies and portfolios and therefore foster mergers and acquisitions as important corporate strategy tools. The second argumentation line is based on the theory of the “merger mania phenomenon” and temporary corporate mis-valuations. Here the line of thought is that managers use shares of their own company believed to be temporarily overvalued to buy perceived lower-valued firms and assets. Further, the argument goes, management confidence is high during merger waves due to booming capital markets, and therefore managers might use a significant proportion of debt to finance their acquisitions.2 All in all, the external shock theory might explain the phenomenon of merger waves better than the temporary mis-valuation theory (Garcia-Feijoo et al. 2012). Nevertheless, high liquidity on the global debt and equity markets seems to have fueled merger activity in recent times, as the development in the aftermath of the Global Financial Crisis (GFC) of 2008 proved.3

The Six “Traditional” Merger Waves – The first merger wave (1897–1904)—Horizontal consolidation: Around the turn of the last century merger and acquisition activity kicked-off. The underlying ­route-causes were new anti-trust regulations like the moderate enforcement of the Sherman Anti-Trust Act in the US and new technology developments. This led to mergers between and acquisitions of competitors and enforced a significant consolidation process, especially in the raw material and transportation industries. Financial turbulences due to the stock market crash in 1904 put a halt to this first merger wave.

1Carlota Perez (2018) describes from an e ­ conomic-historical point of view, that revolutionary technologies first go through a “gilded age” in line with an investment hubble that pops after a couple of years, before entering a “golden age” of widespread development. 2For this theory to be valid two assumptions have to be met. First, that capital markets might behave from time to time irrational. This is in line with the explanation of irrationalities by behavioral economics, but is in contradiction to the traditional theory of corporate finance. The latter proposes the efficient market hypothesis. Secondly, that the method of payment within merger waves is more share- than cash-based, which was in contradiction to the empirical findings within the first six merger waves. 3Another interesting fact about merger waves was highlighted by Netter et al. (2011). The correlation between merger waves and external shocks is more obvious in studies which use smaller data samples than those which use larger ones. It seems therefore, that M&A activity that includes smaller deals and private acquirers is less sensitive and wavelike then M&A patterns observed with only public acquires and larger deals.

4

1  End-to-End (E2E) M&A Process Design

– The second merger wave (1916–1929)—Increasing concentration: The interim period between World War I and II and its economic boom have been the foundation for the second merger wave which resulted in a further concentration within several industries. Once more, a stock-market crash, this time in 1929, and the introduction of the Clayton Act in the US to limit monopolistic behavior stopped this second merger wave. – The third merger wave (1965–1969)—The diversification and conglomerate era: New management theories and portfolio techniques, as introduced by management consultants of the likes as the Boston Consulting Group and McKinsey, have been the intellectual backbone of the third merger wave. Corporate managers used M&A to diversify their business activities and to create a balanced portfolio of strategic business units concerning their cash flow, growth and risk patterns. The third M&A boom was tapered off by the stock market underperformance of most of those new conglomerates. – The fourth merger wave (1981–1989)—The LBO and core competency era: Starting in the 1980s, corporate raiders enforced the breakup of, foremost underperforming, major conglomerates by using hostile takeovers and leveraged buyouts (LBOs), meaning significantly leveraged acquisitions of the target companies. After closing the acquisition, the target companies have been restructured by the new owners and resold as secondary buyouts or in public markets. Driven by this takeover threat conglomerates began by themselves divestment strategies of non-core businesses and refocused their corporate portfolios on their core competencies. This wave collapsed by massive LBO bankruptcies and a slowing global economy. – The fifth merger wave (1992–1999)—Global plays and TMT: A stock and bond market boom, the transformative power of innovations in the technology, media and telecommunication (TMT) industries combined with the trend to establish a global footprint on the corporate side drove the global M&A marking to new records. At the millennium, the bust of the TMT bubble also crashed global M&A activity. – The sixth merger wave (2003–2008)—World awash in money, PE and financial engineering: The global capital markets, on the debt side with low interest rates and driven by aggressive monetary policies of the leading global central banks, on the equity side with high stock market valuations, fueled more or less unlimited growth and financing possibilities before the Global Financial Crisis in 2008 took off. A significant portion of this exuberance in liquidity was used to finance acquisitions with global ambitions and high risk. This contributed to highly leveraged acquisitions and encouraged acquirers to overpay for attractive target companies within competitive bid environments. In the end, the Global Financial Crisis in 2007/2008, with the crash of Lehman Brothers and massive asset write-offs, forced the global banking industry to stop excessive lending activities and to rebuild their capital structure. In addition, the European sovereign debt crisis triggered additional capital market shocks. No surprise, that M&A activity collapsed and recovered unusual slow in the aftermath of the Global Financial Crises.

1.1  The 7th Merger Wave: The Age of Digital Disruption …

5

A 7th Merger Wave? Having discussed the historical six merger waves the question is obvious if we are in the midst of a new merger wave. The significant volume of the global M&A market in the last years might indeed indicate a 7th merger wave. The latter could serve as a showcase of the before mentioned theories: On the one side the glut of global liquidity due to the still ultraloose monetary policy, especially by the US-Fed, the ECB and the Japanese central bank, to combat the long-term effects of the GFC. On the other side technology disruptions of and business model innovations within multiple global industries and ecosystems. New Heights From a disruptive and strategic point of view, four trends stand out driving the global M&A markets nowadays: – New regulatory initiatives, especially in the energy & power and in the financial industry, led strategists to reshuffle corporate portfolios by divestments and M&As. The triggering event for the energy and power distribution industry was the environmental disaster in Fukushima. This enforced a massive investment in renewable energy sources and energy storage as well as energy distribution systems. The restructuring of the global banking industry was driven by the need to rebuild capital structures due to new global regulatory frameworks like Basel III as well as national regulatory initiatives, like the Dodd Frank Act in the US, in the aftermath of the GFC. Besides, also technology disruption played out in the banking industry driven by the new business models of FinTechs, meaning startups and unicorns who enter the banking industry with technology-driven value propositions and business models (Fig. 1.2). – A second driver are M&As within the technology ecosystem. Especially globally leading technology and platform companies like Apple, Google, Amazon, Tencent, IBM, SAP as well as social media companies like Facebook and Alibaba, apply external growth initiatives to extend their service and product portfolios beyond their cores. Additionally, technology companies leverage the newest digital developments like the Internet of Things (IoT), industry 4.0 applications, big data and augmented reality to enter more and more traditional industries using their tech capabilities, thereby shifting industry boundaries in an unprecedented way. To scale and speed up their market entry in these more traditional industries they also use mergers and acquisitions. – Closely linked to this development are business model innovation driven M&As of incumbent companies and newcomers within traditional industries, like automotive, pharma & healthcare or the media, telco and entertainment industry. This trend will be discussed in more detail within Chap. 2 on Embedded M&A Strategy. The “new technology alphabet” of the automotive industry, for example, describes how the disruptive power of multiple technology innovations at the same time shake up the traditional mobility industry: Autonomous driving using a camera, radar and lidar systems, the electrification of the powertrain by hybrid and pure electric solutions, the

6

1  End-to-End (E2E) M&A Process Design

M&A volume

4

2

Being amazoned M&A

High Tech

Retail

1

Media, TelCo, Entertainment

„Tradional“ or regulatory driven M&A

Power & Energy Distribuon

Fashion & Luxury Goods Industry Raw Materials

Technology ecosystem driven M&A

FinTechs & Banking

Pharma & Health Care

Automove

3

Business model innovaon driven M&A Indicave deal premia

Fig. 1.2   Drivers of the 7th merger wave: Digitalization and disruptive business model innovations

development of car-to-car communication and fleet learning, or business model innovations like shared mobility, ride-hailing or robo-taxis. As incumbents have in most of those activities limited capabilities, they use M&As to get access to those decisive technologies of tomorrows automotive markets. – By combining the second and third force an ultimate lever for the global M&A market emerged: Driven by the threat of the market entry of digital natives, like Amazon or Netflix, incumbents of traditional industries initiated early-stage M&A activities. Examples are here the media industry, where the streaming revolution of Netflix and the likes initiated a deal-making frenzy, with AT&T buying Time Warner and Disney the 21st Century franchise from Rupert Murdoch. Amazon, the e-commerce leviathan, rattled the entire retail industries with one swift move to acquire Whole Foods for close to USD 14 billion. Amazon’s move prompted bricks-and-mortar retailers to acquire other global shopping centres. Faced with the threat of Amazon’s entry into the pharmacy business, the US drugstore chain CVS Health acquired the healthcare insurer Aetna in a consolidation play for about USD 69 billion. Taken these trends together, it indeed seems that the global M&A market is in the midst of a 7th merger wave. But how to cope with those trends in the global M&A markets? An E2E M&A approach, which starts with a detailed understanding of the strategy, that supports an efficient and fast Transaction Management, as well as a high-class integration, is therefore mandatory.

1.2  End-to-End M&A Process Design for Digital Times

7

1.2 End-to-End M&A Process Design for Digital Times Section 1.2 will introduce an E2E M&A Process Design to improve M&A performance and to cope with highly dynamic markets and ecosystems. This E2E M&A Process Design is the reference model4 and framework for this entire book. It could be defined as the design of a holistic M&A process which covers all essential parts of an M&A project. Therefore, it is an E2E process approach.5 This approach is based on two important assumptions: The quality and success of an M&A project is on the one side defined by the application of a structured, result driven M&A process and best-in-class performance within the individual M&A modules of such a process design (Nikandrou and Papalexandris 2007, p. 155; Singh and Zollo 2004). On the other side, the interrelations between the M&A modules are of essence. This is the reason why this approach is called an E2E M&A Process Design. The latter point is also in so far important as the missing linkages between the different modules of M&A processes are one of the route-causes for M&A failures. A standardized, but still tailored transaction process should offer a fast and robust process with low transaction costs and a clear focus on the transaction specific strategic rationale and synergy capture.

1.2.1 Overview of the End-to-End M&A Process Design  5 modules build the cornerstones of the E2E M&A Process Design: 1. Embedded M&A Strategy 2. Transaction Management 3. Integration Management 4. Synergy Management 5. M&A Project Management & Governance These modules have different characteristics, but as well multiple overlaps, iterations, and feedback loops. For the design of a holistic M&A process approach, the idea of Michael Porter’s value chain theory (Porter 1985, pp. 33–61) was applied. The first three

4The

first journal description of the E2E M&A Process Design may be found in Feix, T. (2017a, pp. 153–159) and Feix, T. (2017b). 5The need to view M&A as an E2E business process is also underlined by Galpin and Herndon (2014, pp. foreword xix, 25). Their understanding of an E2E view is as well based on the entire M&A life-cycle from strategy through Due Diligence to integration. Nevertheless, their deal flow model is based on substantially different modules, like formulate, locate, investigate and negotiate for the pre-deal phase, and integrate, motivate, innovate, and evaluate in the post-deal-phase (Galpin and Herndon 2014, pp. 28–30). Also, their primary research focus is on the integration part.

8

1  End-to-End (E2E) M&A Process Design

modules, the Embedded M&A Strategy, the Transaction Management and the Integration Management, are the primary M&A processes (Müller-Stewens 2010, pp. 9–10). These modules are also milestones and are for the ease of discussion presented as a ­step-by-step process. Nevertheless, later the linkages and the overlaps between these primary M&A processes will be assessed and highlighted. The M&A modules four and five, the Synergy Management and the M&A Process Management & Governance are supplementary processes, which run in parallel to the three primary ones (Feix 2017b) and is a unique pattern of this E2E M&A Process Design (Fig. 1.3). Historically, the scientific view on M&A started with the valuation of target companies. The valuation issue was derived from the then already established corporate finance literature and developed throughout the years to a separate corporate valuation practice. Nowadays, corporate valuation focuses foremost on the different valuation techniques, like Discounted Cash Flow (DCF) based valuations, and pricing techniques, like ­transaction- or trading-multiples (Koller et al. 2015; Damodaran 2006). The M&A Strategy idea, that any M&A project has not only to create value but also should contribute to the corporate and business strategy of the acquiring company, was more an outcome of the corporate strategy literature and discussions (Müller-Stewens 2010, pp. 5–6). Integration issues became a primary field of scientific interest in the mid of the 1990s, as many acquisitions and mergers failed or underdelivered with respect to intended synergy targets and integration success. Besides, within the corporate world, the different parts of an M&A project have been often loosely knit. Jeffries highlights this briefly: “As recently as 15 years ago, most acquirers did very little if any, integration planning until after legal close. This happened for a variety of reasons. Many organizations focused almost exclusively on the transaction until it was complete, then merely threw the integration “over the transom”

#1

Embedded M&A Strategy

• • • • •

Embedded M&A Strategy: BMI Matrix Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond Assessment Integraon Approach Blue Print Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach SBD Blending and JBD Proof-of-Concept SCD Blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

Synergy Diagnoscs and Blue Print of Synergy Scaling Approach

Synergy Paern and Scaling Approach Proof-of-Concept

#2

Transacon Management

#3

Integraon Management

• Integraon Strategy • Integraon Approach Freeze JBD Freeze JCD Freeze • Integraon Masterplan (IM) • Transional Change: Implement JBD • Culture Transion • Integraon Tracking & Controlling • Integraonal Learning & Best Pracce

Synergy Management

#4

Synergy Capture: Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and digital M&A Tool Plaorm M&A playbook

Fig. 1.3   The E2E M&A Process Design and its 5 M&A modules

M&A Knowledge Management

1.2  End-to-End M&A Process Design for Digital Times

9

to unsuspected and previously uninvolved functional leaders. Other organizations viewed Due Diligence and integration is distinctively different processes that, at best, were loosely aligned but not effectively coordinated. Still, other organizations interpreted anti-trust and anti-competition laws as that literally no information could be exchanged prior to closing and no amount of pre-closing integration planning could take place. Regardless of the reasons, the results were the same. Most integrations were commenced when it was already too late, organizations have become galvanized by ambiguity, uncertainty, and a delay between the announcement and close, performance has declined, and talent and customers left stranded. The result was a startling statistic from countless studies that 70% of deals underperform or became outright failures (Jeffries 2014, p. xvii).” The corporate finance view on M&A is on the other side straight forward: M&A projects increase only shareholder value if the realized synergies outperform the paid acquisition premium. Therefore, surprisingly, the topic of Synergy Management, despite being of utmost importance for M&A success, is only slightly covered in the existing M&A literature. Limited research exist on the classification and valuation of synergies (Damodaran 2006, p. 563). The same is more or less true for the Management and Governance of M&A processes. Most ideas of the M&A Project Management have been therefore derived from the traditional Project Management research. Only in the last years a couple of authors and researchers tried to establish an entire process view on M&A (DePamphilis 2015, p. 142; Davis 2012, p. 11; Müller-Stewens 2010, pp. 9–10). The E2E M&A Process Design follows these latter approaches. This has the advantage that mission-critical success factors of the Transaction or even more the Integration Management, like the definition of a tailored Integration Approach or the Blue Print of the Joint Business and Culture Design, could be addressed at an early stage. This Frontloading of integration intends also a higher speed of integration and will support Day One readiness.

1.2.2 Modules of the End-to-End M&A Process Design To stress the End-to-End idea of the M&A Process Design, a brief overview of its five specific M&A modules and their linkages will be provided before the details of each M&A module are analyzed throughout the following chapters. Embedded M&A Strategy In the first step, the framework in which the M&A Strategy plays out has to be defined. A holistic, well-thought M&A approach starts with a recapitulation of the corporate portfolio strategy and the underlying business unit strategies of the acquiring company. Such an Embedded M&A Strategy approach is mandatory as M&A is an important, but just one of multiple potential levers for the design of corporate portfolio strategies or initiatives on strategic business unit level to lever shareholder value and growth. Additionally, the corporate strategy has to provide guidance, targets and the playground for such an

10

1  End-to-End (E2E) M&A Process Design

Embedded M&A Strategy. The integration of the M&A Strategy within the wider setting of the corporate strategy is, therefore, a precondition for a successful transaction execution.6  The Embedded M&A Strategy frames the cornerstones of the design of merger and acquisition initiatives, like: – The detailed strategic targets which should be achieved by M&A initiatives. These targets serve as the transaction rational of a specific acquisition. Examples might be to get access to untouched regional markets or customer segments, acquiring innovative products or services, gaining new core capabilities and skills, or to create cost advantages by economies of scale or scope. – The corporate finance framework in the sense of how the M&A projects might be financed. This incorporates the definition of the financial headroom and bridge finance possibilities, as well as the top-down value creation targets, including the rough synergy deliverables of the M&A projects. Besides, the likely impact of the intended deals on the consolidated financial statements of the acquirer has to be broadly forecasted. Best- and worst-case scenarios could be used to define and stress-test the bandwidths of likely outcomes. – The preferred external growth design, like mergers, acquisitions, joint ventures, corporate venturing, incubation or acceleration within a holistic, strategic framework. A newer tool, the Business Model Innovation (BMI)-Matrix, describes how to evaluate and select the best fitting approach. – The criteria for the definition of the profile of the ideal target company and the potential fit assessment, the Fit Diamond. – The targeted Integration Approach, based on a first Diagnostic of the Standalone Business and Culture Designs, but as well including a first Blue Print of the target Joint Business Design and Culture Design. The latter are intertwined with the strategic rationale of the transaction (Chatterjee 2009) (Fig. 1.4). Based on this detailed and consistent framework a first assessment of potential target companies in the sense of a long-list of attractive targets could be defied. Especially in the case of highly dynamic markets and digital business model innovations, it might make sense to apply an Ecosystem-Scan of different potential scenarios with respect to the future environment of the company, technology and market trends. Based on this assessment, a detailed research of potential target companies is initiated. Given this scan as a reference framework, the contribution of potential target companies regarding the defined strategy and financial targets could be defined.

6The

M&A Strategy phase might be roughly comparable with the phases formulate and locate in the model of Galpin and Herndon (2014, pp. 28–30).

1.2  End-to-End M&A Process Design for Digital Times Rethinking Corporate and SBU Strategies

 



WHERE TO COMPETE (PORTFOLIO STRATEGY) Assess Corporate Porolio Compeve & Parent Advantage Market aracveness HOW TO COMPETE (SBU STRATEGY)

 

 

 

Compeve Advantage - SBU Business Design, VP, core competencies and culture STRATEGIC INITIATIVES Product/service strategy Market strategy: Customers, regional, channel strategies Technology strategy Valuaon & financial targets

  

Design of Embedded M&A Strategy

Fit assessment & M&A porolio

SBD & SCD diagnoscs, JBD & JCD blue print

STRATEGIC RATIONAL REDESIGN CORPORATE PORTFOLIO

FIT DIAMOND ASSESSMENT

SBD DIAGNOSTICS & JBD BLUE PRINT

Build new Business Design Growth in adjacent markets Divestment

LEVER SBU COMPETITIVE ADVANTAGE   

 

  

11

New region, product, service New Capabilies Cost advantages ACQUISITION DESIGN HOW TO ACQUIRE Alternave growth opons Intended advantages and synergies Valuaon & financing Integraon approach JBD and JCD blue print

Standalone aracveness Risk profile BD and CD Fit

Fit Diamond

#1 CS Financial (synergec) fit

CA #6 CC #7

#8 CP

Strategic Fit (raonal)

CV #3 #9 CF

CR #4 CH #5

#2 C M

#10CO

M&A PORTFOLIO & PIPELINE

SCD DIAGNOSTICS & JCD BLUE PRINT 1

Corporate value footprint

Centricity 1 2 3 4 5 6 7

2

Regional culture Embeddedness

Power distance 1 2 3 4 5 6 7

3

Management style Leadership atude 1 2 3 4 5 6 7

Spirit 1 2 3 4 5 6

Group 1 2 3 4 5 6 7

Decision making 1 2 3 4 5 6 7

Midset 1 2 3 4 5 6 7

Uncertainty 1 2avoidance 3 4 5 6 7

Corporate Spirit 1 2 3 4 5 6 7

Diversity 1 2 3 4 5 6

Gender 1 2 3 4 5 6 7

Working principle 1 2 3 4 5 6 7

Group values 1 2 3 4 5 6 7

Orientaon 1 2 3 4 5 6 7

Risk tolerance 1 2 3 4 5 6 7 Driver for decisions

Communicaon 1 2 3 4 5 6 7

1 2 3 4 5 6 7

Fig. 1.4   Embedded M&A Strategy: Sub-modules

In a follow-on step, the long-list of target companies has to be reduced by predefined strategic, financial and business model fit criteria, the Fit Diamond, to a s­ hort-list of highly attractive targets. This short-list serves as the starting point of an M&A project. Additionally, for a specific transaction target, the Business and Culture Design must be diagnosed and the targeted Joint Designs defined. Transaction Management The Transaction Management is the second module of an M&A project.  Core parts of the Transaction Management are the valuation of the target company, the Due Diligence, the negotiation of a share purchase, asset purchase or merger agreement, the acquisition financing, the Purchase Price Allocation (PPA) and last not least the preparation of the integration by stress testing the Blue Print of the Joint Business Design7 and Culture Design. Core parts of the Transaction Management are highlighted in Fig. 1.5: A specific M&A project typically kicks off with the first contacts and preliminary discussions between the management teams of the target company and the potential acquirer or, more formally, with the signing of a non-disclosure agreement (NDA). The NDA serves as a bridge to close the gap between the information interest of the acquiring company and the protection of confidential and highly sensitive data, like financials, 7Zott

et al. (2010) provide an in-depth overview on the historical roots and research with respect to business model theories.

12

1  End-to-End (E2E) M&A Process Design

Valuaon • Rough • Outside-in perspecve

Negoaons • First contacts • Outside-in perspecve

Due Diligence • Back-tesng investment thesis • Gathering detailed informaon for further valuaon • Searching for „hidden“ risks • Synergy proof • Gaining insights for integraon & negoaons

Valuaon • Thorough • Informaon from inside

Deal Closure • Aer detailed negoaons • Based on final valuaon & DD

Fig. 1.5   Transaction Management: Sub-modules

business plans, IP rights or customer information, on the seller’s side. An alternative starting point in sell-side auctions might be the establishment of a virtual data room (VDD) by the seller and the preparation of a teaser document, followed by the signature of a NDA on buy and sell side. Based on a joint understanding of the potential transaction interest on both sides the target company’s management team prepares an information memorandum. The latter covers the most important cornerstones of the target company, like key financials, organizational structure, a rough strategy outlay, core products and services, management information, IP, mission-critical know-how, management information, and others. Based on this document and further information made available by the sell side, the potential acquirer prepares a non-binding indicative offer that might be embedded in a Letter of Intent (LoI). An LoI includes, besides the indicative valuation of the target company, the assumptions on which the indicative offer rests and how the further steps of the acquisition process could look like. If this indicative offer and the proposed futher process is roughly in line with the expectations on the sell side, both parties might commit themselves to a Due Diligence process. The Due Diligence is especially important for the buy side, as the potential acquirer has to back-test within a very limited timeframe of a couple of weeks if the assumed synergies and standalone financials of the target company justify the indicative purchase price and proposed premium. A crucial point is here the linkage between the Due Diligence and the valuation of the target company, as pinpointed by Fig. 1.6: The valuation and indicative offer, as well as the assumed synergies, are the starting point. As they are based on the value drivers of to target company they also define the to be assessed financials and deliverables of the Due Diligence. Vice versa, the Due Diligence serves as a crosscheck of the stand-alone valuation thesis and assumed synergies. Therefore, the outcomes of the Due Diligence have to be integrated into the update of the stand-alone and synergy valuation. In so far, the Due

1.2  End-to-End M&A Process Design for Digital Times

13

Valuaon • Indicave valuaon parally defines deliverables for DD • Detailed valuaon based on DD informaon

Due Diligence • To idenfy strategic, financial, legal, operaonal and cultural risks as well as potenal Integraon needs • To verify strategic, organizaonal & cultural fit between acquirer and target company • To detail financial and operaonal synergies • To gather informaon for both valuaon and deal negoaon

Purchase agreement Definion of: • Purchase price • Adjustment mechanisms • Deal structure • Reps & warranes to protect acquirer from idenfied risks • …

Fig. 1.6   Transaction Management: The linkages between valuation, synergies and negotiation

Diligence could be thought of as a process of verification or falsification of the original investment thesis and indicative purchase price offer. Valuation and Due Diligence are linked as well to the negotiations, especially at the later stage of the Transaction Management. The purchase agreement includes much more than just the final and agreed upon purchase price. It has also to describe, based on the valuation and Due Diligence outcomes, the intended deal structure (share deal vs asset deal, a precise definition of the potentially carved out business or assets of the target company, …) and the representations and warranties to protect the acquirer from potentials risks. Also, purchase price adjustments based on a locked-box principle or closing accounts have to be defined. The final financial part of the Transaction Management is the Purchase Price Allocation (PPA). The PPA gained in the last couple of years in importance due to the fact that, not only for digital acquisitions, the competitive advantage of target companies is nowadays foremost based on intangible assets like brands, IP rights or customer contact. A detailed PPA reduces the risk of potential impairments after closing as the valuation of intangible assets reduces the goodwill which is exposed to a yearly impairment test according to US-GAPP and IFRS accounting principles. Integration Management  The Integration Management complements the Embedded M&A Strategy and the Transaction Management as the primary processes of a holistic E2E M&A Process Design. Key parts of the Integration Management are the definition of the Integration Strategy which includes the Freeze of the Joint Business and Culture Design, the design of an

14

1  End-to-End (E2E) M&A Process Design

Integration Masterplan (IM) covering a dedicated and tailor-made integration program, the preparation of Day 1 readiness, the implementation of the IM short- and longterm, the monitoring and controlling of the integration progress as well as the definition of the lessons learned. Fig. 1.7 summarizes the mission-critical sub-processes of the Integration Management: Applying an E2E approach, the definition of the Integration Approach and priorities should be driven and framed by the outcomes of the Due Diligence and the valuation. The key target for the Integration Strategy is the refinement and freeze of the intended Joint Business and Culture Design as a post-acquisition vision for the joint company. Besides, the Integration Strategy has to define in detail the depth, intensity, and speed of the integration as well as the time horizon. The Integration Strategy also has to assure that the parenting and competitive advantages are preserved. The integration is fundamental for the realization of the synergies and intertwined with the Synergy Management. Synergies justify in the end the purchase price and assure the long-term value creation of an acquisition. Therefore, within an E2E M&A Process Design, the Integration and Synergy Management, especially the levers, the time horizon and the value of the synergies, have to be coordinated with the integration initiatives. Based on the targets of the Integration Strategy the Integration Masterplan (IM) for the short-, mid- and long-term integration could be defined. Within most integration projects typical modules of the IM are the strategic, the financial, the process, the organizational, the management, and the cultural integration. The holistic M&A Process Design uses the 10C Business Design from the strategy phase to structure the IM. This enables

Integraon Strategy (JBD & JCD Freeze) 



Integraon needs and priories defined on  Strategic raonal  Valuaon & synergies  Due Diligence blending  Integraon risk analysis Integraon Strategy Design Integraon vision & mission  Integraon Approach  Integraon model  Integraon targets  Integraon intensity  Alignment with Synergy Management  Speed and ming

Integraon Masterplan (IM) 

JBD & JCD refinement and freeze



#8 CP

CA #6 CC #7

CV #3 #9 CF

CR #4 CH #5

#2 CM

#10 CO 

Culture Change Program



Design of IntegraonProject House and built up of necessary integraon capabilies



Design of and training on integraon toolkit



Coordinaon with Synergy Management

Fig. 1.7   Integration Management: Sub-modules

Integraon guidelines Definion of responsibilies  High degree of transparency  Focused, aligned communicaon 

#1 CS





Design of IM modules , workstreams, -scorecards

Transformaonal Management



Culture Transion Management



Implementaon of Integraon-Masterplan  Day one readiness  100 days plan  Mid term plan  Full potenal leverage plan

Integraon Monitoring  

Integraon tracking Integraon controlling Gap assessment  Definion of counter acons 



Integraonal learning Lessons learned and Post Mortem Report  Integrao BestPracce Plaorm (IBPP) 



Redefine core areas of Integraon for longterm full-potenal value leverage

1.2  End-to-End M&A Process Design for Digital Times

15

a consistent and efficient integration pattern. The integration modules have to be framed by a transparent and in time integration communication strategy. To orchestrate and navigate these complex tasks, especially for highly complex and international M&A projects, an Integration Project House (IPH) with the necessary resources and responsibilities has to be defined. The head of the IPH should be an experienced manager who is on the one side responsible for the management of the integration, but on the other side has also to communicate and discuss mission-critical integration questions with the top management and decision-makers. Additional key targets for the IPH team are the project management of the integration, the coordination of the different integration modules and the design of the necessary integration tools and reporting standards which are aligned with compliance and governance principles. Based on the Integration Strategy the integration has to be executed. Most companies use a multiple-step approach, a short-, mid- and long-term implementation framework. A clear definition of the responsibilities of the individual modules and sub-modules, transparency as well as open and fast communication is mandatory for integration success. To safeguard that all integration targets will be achieved, a permanent tracking, monitoring and controlling of the integration projects and modules has to be assured. Digital tools, as in other processes of the M&A Process Design, offer substantial improvements in comparison to traditional approaches and will be discussed in the follow-on subchapter. The top management and the IPH manage the integration process and take counter actions in case of deviations, based on an integration pre-warning system with Degree of Implementation (DoI) indicators. Synergy-Management Synergies and valuation are intertwined: The stand-alone value of the target company— in most instances defined either by a Discounted Cash Flow (DCF) valuation or in case of a stock listed company simply by its market capitalization—plus the net present value of all synergies define the upper limit of the purchase price of the target for the potential acquirer. For the owner of the target company, on the other side, the potential sale of the company is only attractive if an additional premium on top of the fair value of the target company is offered. According to the latest assessment of the strategy consulting company McKinsey the average premium in acquisition processes is round about 33% of the stand-alone value of the target company (Ferrer and West 2017, p. 4), not neglecting that there is a significant spread between and within industries. Nevertheless, to assure a value increase by an acquisition, the buyer has to realize a net present value of synergies which overcompensates the paid premium. Many studies show that more than half of the global M&A deals destroy value. This means in the end that typically the realized synergies undershoot the paid premium in acquisition processes. To stress this importance of the synergies for the value creation of mergers and acquisitions the E2E M&A Process Design uses as a supplementary process a tailored Synergy Management along the three primary M&A modules, as described by Fig. 1.8:

16

1  End-to-End (E2E) M&A Process Design

Top-Down Synergy Mapping & Scaling 

Synergy concept in line with strategic fit: Idea about qualita ve synergy levers



Defini on of underlying strategic and financial assumpons

Synergy proof of concept & Synergy-Valuaon Blending 

Validaon & proof of top-down synergy concept and values within DD



Detailed and reframed priories with Synergy Matrix (por‚olio): Timing & value Design of Synergy Master Program between signing & closing with detailed Synergy Scorecards:





First rough financial top-down esmate (quan ta ve) of synergy values (with benchmark)

o

Using informa on from DD & Synergy-Matrix



First priorizaon of synergies: value contribu on, likelihood & ming

o

Synergy business case with valua on impact

o

Implementa on plan and milestones ( ming)

First dra of synergy cases and framing of requirements

o

Defini on of teams, tasks and responsibili es

o

Necessary investments, resources & capabili es



Combining synergy concept with valuaon

o

Dra of milestone and DOI repor ng



Es mate integraon costs (dyssynergies)





Update combined value with latest synergy esmates

Synergy implementaon, tracking and controlling 

Final validaon and sign-off of Synergy Master Program and Synergy Scorecards o

Goals and value targets

o

Timing & milestones

o

Responsibili es (project owner)

o

Resources needed



Synergy implementaon



Synergy tracking o

By DoI

o

Project repor ng and loops



Synergy controlling and connuous synergy update



Synergy learning loop: Develop synergy database

Fig. 1.8   Synergy Management: Modules and sub-processes

 A holistic Synergy Management starts within an early top-down assessment of the most likely synergies as well as the definition of the time horizon to achieve them and their volume, runs a proof-of-concept of the assumed synergies within the Due Diligence and ensures a fast and focused realization of the intended synergies, including real-time tracking and controlling of the synergy implementation. Along with the Embedded M&A Strategy in a first step the likely synergies have to be defined and roughly top-down quantified. This is mission-critical as from a valuation point of view it has to be assessed if the value of likely synergies might justify the necessary premium. Therefore, an early identification and quantification of the synergies are mandatory. For a first estimate of the potential synergies, the financial statements and information of the target company, benchmarks and, in case of an intra-industry acquisition, the buyer’s in-house data might be used as an input for a first-hand synergy estimate. Also, the likely time horizon of the synergies should be assessed. The combination of the potential value of the synergies and their time horizon defines in an early stage the priorities for the later synergy implementation and capture. For a net perspective, also the present value of integration costs has to be taken into account. Within the Transaction Management, especially within the Due Diligence, the synergies have to be verified concerning their value contribution, their robustness, and their timing. Based on this proof-of-concept the synergies could be classified in a synergy portfolio in short-term versus long-term and low versus high value contributors. For the most important synergies, detailed Synergy Scorecards with respect to the target values,

1.2  End-to-End M&A Process Design for Digital Times

17

the milestones for their capture, the timing and the responsibilities have to be designed. Transparent responsibilities and open communication are prerequisites for a successful synergy realization. For the long-term integration success, a permanent monitoring and controlling of the synergies along the integration process is proposed. Based on early warning indicators and digitalized Degree of Implementation (DoI) measures any deviation from the Synergy Masterplan could be detected and countermeasures initiated. M&A Project Management & Governance M&A processes have in the end project characteristics. They possess defined starting and endpoints. The specifics of M&A projects are their complexity and foremost international exposure. The complexity is partially driven by the fact that besides employees of the acquirer and target company external advisers, like M&A consultants, investment bankers, strategy consultants, and lawyers might have to be involved in the transaction. An E2E M&A Project Management is, therefore, a must for a professional transition process. At least for larger and transformational transactions an M&A or Integration Project Houses (IPH) and M&A Playbook contribute to the success of an M&A project by offering foremost standardized Project Management processes, capabilities, and tools along the primary M&A steps.  A canvas of the M&A Project Management & Governance is the backbone of an M&A Playbook. Crucial parts are: – – – –

The M&A Capability Map The M&A and Integration Project House (IPH) The digital M&A tool platform The M&A knowledge management

Especially for multiple acquirers and string-of-pearls M&A strategies with recurring M&A projects the establishment of M&A core competencies already in the M&A Strategy phase may make sense. The core competencies of the company, specifically for M&A, are a complex bundle of often tacit capabilities like valuation and Due Diligence competencies, project and intercultural management skills as well as a detailed knowledge about the company’s strategies and Business Design. Another task of the M&A core competencies is the design of a standardized tool platform for M&A projects (Feix 2013). In the following sub-chapter will be analyzed how digitalization offers new and powerful tools to improve the M&A Playbook (Feix 2018) and to support the primary M&A processes. For the Transaction and Integration Management the knowledge of how to handle complex projects is a mission-critical capability. Besides, the design of tailor-made M&A tools and processes is another important task. Within the Due ­ Diligence, the M&A teams have to deliver under severe time pressure high-quality

18

1  End-to-End (E2E) M&A Process Design

results. The M&A Project House has to guide through the process of the Due Diligence, orchestrate the necessary resources from within the company and the consulting side, and coordinate the different sub-teams. Additionally, specialized Due Diligence tools, like digital templates and scorecards, data room tools as well as Due Diligence interview guidelines are nowadays used within transaction processes. Successful M&A projects avoid the common pitfall of a breakup between the Transaction Management, more specifically the closing of the deal, and the integration and synergy realization phase, which start officially at Day One. Typical tools are Degree of Implementation (DoI) measures, Integration and Synergy Scorecards or culture pulse checks. Especially serial acquirers run a post-mortem project report after each M&A deal to summarize the lessons learned of each transaction and improve their best practice M&A database and knowledge within the company.

1.2.3 Interrelations between the M&A Modules: An End-to-End View The M&A Process Design underlines the importance of an E2E approach. Such a holistic approach has the advantage that it takes care of the sensitive interrelations within and between the different modules of an M&A process. Besides, also contents, tasks and assignments within M&A projects are often intertwined: Interrelations on Content Level The interrelations on the content level start already within the inner workings of the strategy phase: An Embedded M&A Strategy is derived from the targets and intent of the corporate and business unit strategies. The early discussion of the transactional rational may ensure a consistent transaction process by serving as the “northern star” throughout the transaction. Such a rational may lever the engagement for the transaction throughout the joint organization if it is understood as top-management priority. A holistic strategy approach also has to view M&A as an important, but alternative option of a wider corporate development tool-set. M&A strategies should always be evaluated and benchmarked in comparison with internal growth options, like business model innovations, and alternative external growth options, like strategic alliances, joint ventures, incubators or accelerators. Also, the definition of the long- and shortlist of attractive M&A targets must be framed by the boundary conditions of the M&A Strategy. Last not least, the selection of the best fitting M&A targets is of utmost importance as it determines the likelihood to capture intended synergies and the success rate of the follow-up M&A processes, especially the Integration Management. The importance of the interrelations within the Transaction Management, especially between the valuation, the Due Diligence and the negotiation of the purchase agreement,

1.2  End-to-End M&A Process Design for Digital Times

19

has been underlined already before. Another crucial link exists between the valuation part and the synergy part. The maximum purchase price for the buyer is defined by the fair stand-alone value plus the net present value of the synergies. Therefore, a permanent update of the verified synergy estimates must be feed into the valuation during the Due Diligence process. Multiple linkages also exist between the Transaction and Integration Management. To assure proper preparation of the integration the proof-of-concept of the Integration Strategy, especially the Joint Business and Culture Design, should be based on the Due Diligence assessment. In many transactions a time-delay between the end of the Due Diligence phase and the Day One of the integration exists, due to mandatory, but outstanding board approvals, antitrust approvals or final negotiation issues. This time frame may be efficiently used for the set-up of a proper Integration Strategy and Masterplan. Another important overlap between the Transaction and Integration Management is driven by legal considerations and needs: The share purchase, asset purchase, merger or Joint-Venture agreement is signed subject to certain closing conditions, like anti-trust approvals, which have to be fulfilled before the integration could be kicked-off. The contracts of the target company might additionally include certain liabilities and responsibilities on the buy and sell side after closing and therefore have to be tracked and realized within the integration phase. In case of volatile cash flows of the target company or significant purchase prices, the parties might additionally agree an earnout-clause as an incentive for the target management to contribute to a successful integration. A consistent evaluation of the defined and audited financials8 within the time horizon, as defined by the earn-out clause, is in such cases mandatory. Final interrelations between the modules of the M&A Process Design exists on the Synergy Management side: The top-down synergy estimates of the Embedded M&A Strategy have to be verified within the Transaction Management, especially the Due Diligence. This proof-of-concept of the synergies is further on the reference point for the integration where the synergy capture has to be tracked, controlled and managed. Interrelations on Task and Assignment Level Within the M&A Process Design, the M&A Project Management & Governance takes care of the interrelations on the tool, task and assignment level. A highly capable M&A Management, especially for multiple acquirers, requests that the tools used in the different phases of the M&A process are provided by one single source, the M&A Project House, to assure quality and consistency. It is also the task of the M&A Project House to redesign and optimize this M&A tool-set in the sense of a continuous improvement process. A standardized tool-set is as well mandatory for the

8In

most transactions earn-outs are based on the EBITDA or turnover performance of the target company for 3–5 years post-closing.

20

1  End-to-End (E2E) M&A Process Design

governance of M&A projects. M&A tools which may be provided by the M&A Project House are, for example: – For the M&A Strategy: Strategy assessments, strategic fit assessments and top-down valuation models. Newer tools, especially for disruptive and highly innovative markets, are Ecosystem-Scans, the Business Model Innovation (BMI)-Matrix and the Fit Diamond assessment. All of the latter will be discussed in the second chapter. – For the Transaction Management: Due Diligence (DD) tools like DD and virtual data room request lists, DD questioners, DD interview guidelines, DD reporting guidelines, layouts for mandatory management summaries and risk assessment guidelines. Besides, the typical valuation tools like Discounted Cash Flow based valuation models and multiple assessments should be standardized tools. – For the Integration Management: Integration and Synergy Scorecards, DoI assessment and synergy tracking tools or pulse checks for the culture integration. As M&A projects have highly complex and often international patterns, the linkages on the task and assignment level have to be addressed by the top management level. The M&A Process Design fosters top management engagement and proposes an empowered M&A and Integration Project House which takes care of the E2E process handling from the early start of an M&A project onwards up to the final closing of the integration by the post-mortem integration report. Still, most companies use different and independent teams or departments, especially for the Transaction Management and the Integration. So, no wonder, that many M&A transactions fail exactly due to the missing handover of crucial Due Diligence or valuation information onto the Integration Management.9

1.3 Digital Touch Points of the End-to-End M&A Process Design For a thorough view on the impact of digitalization and business model innovation on M&A two perspectives have to be distinguished, the content perspective versus the process and tool perspective: – The process and tool perspective assess digital tools and approaches for the design of high-quality M&A processes. The latter will be the main discussion point in this subchapter. Digital tools and processes will offer manifold potentials for the improvement of M&A processes in the 2020s as most M&A activities are still manually, non-automatized. Additionally, the complexity of transactions and involved business models continually increases. 9Details

of a professional M&A Project and Integration House which takes care about the E2E approach will be discussed in Chap. 6 on M&A Project Management & Governance.

1.3  Digital Touch Points of the End-to-End M&A Process Design

21

– The content perspective describes the impact of digital business models and innovations on the M&A process. It also covers vice versa how M&A could be used as a strategic tool for corporate development and business model innovations. This part will be discussed in more detail in the later part of this subchapter and Chap. 2 on the Embedded M&A Strategy. Based on the five M&A modules a digital version of the E2E M&A Process Design integrates breakthrough digital tools and approaches to lever highest efficiency, speed, robustness and quality within transaction processes.10 Therefore this sub-chapter will provide an overview on the impact of digitalization of M&A processes and the assessment of what kind of design possibilities digitalization offers for the primary M&A modules, the Embedded M&A Strategy, the Transaction and Integration Management, as well as for the support processes, the Synergy Management and the M&A Project Management & Governance.

1.3.1 Digital M&A Processes and Tools A digitalized E2E M&A Process Design is an approach which supports all three primary and both support M&A processes by scaling digital applications and processes, as described by Fig. 1.9: Embedded M&A Strategy

#1

Ecosystem & Digital IP Scan by big data, analycs and AI Business Model Innovaon (BMI)-Matrix and Fit Diamond Digital target search (engines) #4

Transacon Management

#2

Financial & Legal DD automaon by ediscovery, big data analycs, NLP, AI (machine learning)

Virtual Dataroom Predicve M&A market assessment

Tech & Cyber Due Diligence (incl. AI, VR)

Integraon Management

#3

Digital closing condion monitor Digitalized DoI monitor & Integraon Scorecards Integraon (mobile) app

Synergy Management Digital synergy library

Synergy Scorecards

Synergy priority matrix

Synergy DoI tracking

Digitalized synergy verificaon, tracking and controlling #5

M&A Project Management & Governance

Double sided consulng plaorm

Cloud based M&A project map

Online M&A best pracce plaorm

Online M&A educaon

Fig. 1.9   Digital process and tool canvas of the E2E M&A Process Design

10More

information might be found from Spring 2020 onwards on the web-page www.tfX-advisory.de.

22

1  End-to-End (E2E) M&A Process Design

Embedded M&A Strategy and Digitalization Many industries are in the midst of a technology and innovation driven shakeup mode, which will be discussed in more detail in Chap. 2. Therefore, most acquirers have to start their target search program within a much wider competitive setting than in former times. This setting must be derived from the forecasted ecosystem, especially the technology and the market-based trends which have a lasting impact on the acquirer’s Business Design. The Intellectual Property (IP) Scan applies digital patent and IP datamining. It assesses in how far targeted market segments and technology fields are untouched and offer a market entrance and which target companies might have the most attractive value propositions within those segments. Additionally, Digital Trend-Scouting by using the combination of machine learning algorithms and big-data assessments could be used to find new customer use cases and trends. An example of those new approaches are ­partial-automatized predictions of the success of target companies in defined technology fields by so-called hybrid intelligence approaches (Dellermann and Popp 2017). Further potentials of the digitalization for the M&A Strategy are based on the ­early-stage assessment of the strategic fit between the target company and the buyer by applying a Fit Diamond assessment, as also discussed in detail in Chap. 2, and the design of a shortlist of attractive target companies. Additionally, to the typical early-stage assessments and information of financial reports and official presentations search engines like, for example, Google MetaSearch or LinkedIn Sales Navigator could be used to get sensitive employer and employment information of the target company. These additional data might be especially interesting for the early-stage evaluation of high-tech or start-up acquisitions, as the employees and intangible assets are often the decisive factors for the competitive advantage of this kind of target companies. Based on those assessments intelligent matching algorithms strolling databases might suggest first companies with a potential strategic fit, based on predetermined strategic filters. Transactions Management and Digitalization Within the Transaction Management—which covers, as discussed, the valuation, the Due Diligence, the negotiation, the acquisition financing, the Purchase Price Allocation and the proof-of-concept of the Joint Business and Culture Design—especially the Due Diligence is exposed to digital technology revolutions. Within the Due Diligence an enormous amount of structured, e.g. ERP-System based information, financial and tax accounts, as well as unstructured sets of data have to be analyzed in a very short timeframe. The automatization of Due Diligence tasks by using big data and NLP assessments, search engines (e-discovery) and machine learning approaches offers efficiency and time gains, especially within the Legal (LDD) and Financial Due Diligence (FDD). Especially within competitive bidding scenarios, this might offer a competitive advantage. E.g. in the LDD the digital extraction of contract contents and their assessment might define a new M&A standard. Specified contract clauses like reps & warranties, exclusivity agreements, change-of-control clauses,

1.3  Digital Touch Points of the End-to-End M&A Process Design

23

IP-rights, and others could be scanned fully autonomous in a wide range of contracts. Especially semantic assessments with the support of machine learning algorithms fit well for the analysis of huge data sets. Given these assessments, the evaluation of the legal risks of a transaction could be assessed with high precision. In a second step digital proposals for optimized solutions could be developed. Besides, the digital data search and assessment could be used for the digital support within Virtual Data Room (VDR) assessments. This is, for example, applicable in case of forensic assessments within the compliance Due Diligence and for the Financial Due Diligence. A newer tool is the Technology Due Diligence, which was developed in the last years as a separate field within the overall Due Diligence process. It involves a detailed assessment of the technology platforms in use within the target company and its IT- and ­ERP-Systems based on standardized digital assessment and checklists. Cornerstones of such a Technology Due Diligence are the evaluation of the system architecture and platforms, the functional user characteristics and the inbound and outbound interfaces (APIs). As an addition, the compatibility assessment with the buyer’s technology architecture may be used to initiate an early-stage migration planning of the target’s technology platforms. This Frontloading of issues with respect to the matching technology platforms between the buyer and the target company from the Integration Management into the Due Diligence is another example of the multiple linkages between the different parts of the M&A Process Design. It is also important for the success of an overall ­M&A-Project, as many integration projects fail exactly due to a missing integration of technology platforms and outdated technologies might drive significant legacy costs, as, for example, in the banking industry. As the assessment of the system architecture, platforms and application software becomes more and more a standard procedure, the systematic assessment of the end-user workplaces as well as mobile applications are still missing in most Due Diligence processes. Without an analysis of the end-user related hard- and software, especially midand large-sized transactions might be exposed to overshooting integration costs, to an underperformance of the technology system post-acquisition and to compliance issues. In the mean-time, established tools are Virtual Data Rooms (VDRs), which substituted physical data-rooms as they offer multiple advantages. On the buy side, they allow more efficient and structured assessments of the documents within the data room. Besides, they offer significant cost advantages, especially for international M&A projects. By using VDDs the seller could integrate multiple parties within the transaction process and increase the competitive pressure of the bidding process. The seller has also much better possibilities when and where to release sensitive and confidential information. Additionally, digital assistance could be used for the autonomous detection of missing documents and data loopholes and for the support of the Due Diligence teams in their daily routines. Last not least, risks could be digitally assessed and proposals for their solutions developed. A newer development by leading data-room providers are predictive M&A market models based on big data assessments of M&A transactions.

24

1  End-to-End (E2E) M&A Process Design

Finally, digitalization could be used to intensify the interlocking between the Due Diligence, evaluation and the verification of the synergies in the sense of a true E2E approach. Integration Management and Digitalization An efficient and effective Integration Management is essential for solving the complexities of integration projects. Using the M&A Process Design approach, the Integration Management covers the definition of the Integration Strategy, the transition to the Joint Business and Culture Design, as well as the implementation of the Integration Masterplan. After the closing, the buyer has access to a much wider set of data of the target company in comparison to the Due Diligence. Therefore, the digital tools, like e-discovery approaches, used in the Due Diligence could be used and leveraged as well in the integration. Use cases within the integration are, for example, the assessment and tracking of legal responsibilities which have to be addressed post-closing of the acquisition. Digital M&A project management tools are of significant value for the Integration Project House (IPH) as the IPH team has to orchestrate the overall integration project. To safeguard the integration success, permanent monitoring and controlling of the integration is mandatory. Based on digitalized DoI assessments and Integration Scorecards the management could track early deviations from the intended integration progress and initiate countermeasures to avoid project delays and under-performance. Synergy Management and Digitalization The financial value of the transaction is defined by the difference between the paid premium and the realized synergies. The application of digitalized synergy tools for an E2E tracking, controlling and management of the synergies offers the same potential as the digital integration tools. Digital DoI measurements, milestone concepts, Synergy Scorecards and Synergy Maps are just a couple of examples for a digitally empowered Synergy Management. The lessons learned of the synergy implementation might be used to establish, independently from an individual transaction, a lasting lessons-learned database. This database could be used to improve the synergy performance of M&A projects s­ tep-by-step and might additionally provide benchmark synergy estimates in an early stage for ­follow-on transactions. M&A Project Management & Governance and Digitalization The vision of a truly digital E2E M&A Process Design is to exploit the potential of digitalization in the M&A Project Management and Governance along with all primary and secondary modules of the M&A process. From the viewpoint of partially or fully digitalized tasks the following tools seem to be especially promising:

1.3  Digital Touch Points of the End-to-End M&A Process Design

25

– Cloud-based M&A project maps visualize the portfolio of M&A projects already from the starting point of the M&A Strategy, including the fulfilled and next mandatory governance and approval stages of each transaction. Besides, they enable ­real-time project reports, linking project tasks, documents, responsibilities and access rights of teams and team members to assure a consistent M&A project governance. – Cloud-based documentations and assessments of M&A best practice approaches, as well as digital learning programs and loops, are used to professionalize the in-house M&A teams.11 Additionally, the information on past projects and best practices offers a rich data source for machine learning algorithms and guidance of specific transactions. – Digitalized best practice templates and checklists, a digitalized project steering and a centralized data management are especially for the Due Diligence and the Integration Management applicable. They offer a seamless and transparent Project Management, even for projects exposed to time pressure, and include all stakeholders throughout the M&A process. – The digitalization of an E2E M&A Process Design fosters also the interrelations between the Due Diligence and the Integration Management. Within the latter the digitalization offers further quality improvements: – a digitalized and consistent mapping of the integration project structure, of the individual integration workstreams, teams and the task assignments – the mapping of cross-functional dependencies and interrelations – a transparent and digital status tracking and reporting of integration projects and modules with Integration Scorecards – as well as an early stage, autonomous risk reporting and forecasting A newer approach are B2B M&A consulting platforms. On the corporate side, they should enable the selection of transaction or management consultancies for the needs of a specific M&A project. On the consulting side, they offer investment banks, strategy consultants and transaction advisors a platform on which they could present their M&A competencies, service portfolios and reference projects in a digitalized, standardized and transparent way. As with all platform strategies, the intend is a perfect matching for both sides. The platform enables the selection of consultancies based on objective criteria like real-world customer reference projects with respect to quality, cost and time performance indicators.

11A

2020/2021 scientific research project will analyze if the insourcing of best practice M&A business cases and data-sources could offer further improvements with respect to the M&A success rate, by linking a specific inhouse M&A project to already realized M&A projects with the same characteristics by applying algorithms and analytics.

26

1  End-to-End (E2E) M&A Process Design

In case of revolving M&A projects, an online competency management and learning platform with an integrated digital toolset may be tailored along the separate steps of the M&A Process Design. In most of the M&A projects a high number of employees on the buy and sell side. In such circumstances, digitalized lessons-learned and best-practice approaches allow a rapid scaling of the necessary internal M&A know-how.

1.3.2 The Impact of Digital Business Models on M&A and Vice Versa As more or less any industry is nowadays exposed to disruptive technologies and business model innovations a second, more content-driven perspective of digitalization addresses how far M&A could be used to design breakthrough digital business models. Vice versa, a second question is how to adjust the M&A Process Design for the needs and characteristics of digital business models and platform strategies (Fig. 1.10). It is the nature of digital and technology disruptions that they change rapidly industries and markets. Therefore, in the Embedded M&A Strategy phase, the potential attractive target companies of digital-driven businesses could only be understood by taking a wider view on the acquirer’s environment, as an Ecosystem Scan does.12

#1

Embedded M&A Strategy

Ecosystem-Scan: Digital industry assessment BMI Matrix Diamond Fit evaluaon #4

#2

Transacon Management

Valuaon of digital assets with dynamic, volale and risky cashflow paerns and exponenal growth potenal Valuaon of scenarios and businesses (“blue oceans”)

#3

Due Diligence of startup businesses

Integraon Management Detailed definion of integraon model

Earn-outs and other contract clauses for digital assets Corporate culture assessment

Joint Culture and Business Design

M&A Synergy Management

Synergy esmates for digital & disrupve business models Synergy scaling blue print #5

Verificaon of synergy scaling approach Dra of organisaonal alignment needs at parent and target

Rapid synergy scaling and dominant design footprint Parenng advantage leverage

M&A Project Management & Governance

New capability modelling Trend- & Ecosystem analycs

Target capability scan Insourcing of missing capabilies

Mentorship program Orga. Design and culture tools

Fig. 1.10   The impact of digital transactions and business models on the M&A Process Designs

12The

Ecosystem-Scan will be discussed in detail in Chap. 2 and 6.

1.3  Digital Touch Points of the End-to-End M&A Process Design

27

The Ecosystem-Scan assesses newest technology developments, use cases, trends, shifts in the competitive environment and other industry specific drivers. For example, applying this Ecosystem Scan for the developments within the global automotive industry for the 2020s, it is not enough for automotive OEMs just to follow up with an assessment of their core competitors. It is much more important to get a thorough understanding of: – new technologies, like battery technology, car-to-car communication, electric and hybrid powertrains or autonomous drive approaches – the wider set of new entrants in the industry, like a Tesla, Google and others – the chances and risks of alternative business models, like ride-hailing services as offered by Uber, Lyft, Ola or Didi and the likes or car sharing concepts Only based on this in-depth understanding of an industry and the underlying technology disruptions a tailor-made M&A Strategy and shortlist of attractive M&A targets, which could shape the competitive advantage in the years to come, may be derived. To analyze the full potential of M&A strategies and to compare those with alternative strategic approaches the Business Model Innovation (BMI)-Matrix tool, was developed. The BMI-Matrix embeds M&As in a context of alternative external growth options, like Joint Ventures (JVs), inhouse Corporate Venture Capital (CVC) concepts, incubator and accelerator models, strategic alliances as well as in-house business model innovations. The BMI-Matrix concept will be explained in detail within Chap. 2. Below a canvas of selective automotive strategies within such a BMI-Matrix are shown in Fig. 1.11:

BMI-Distance from Core

(touch points with respect to value proposions, technologies and markets)

New corporate “touch points”

Uber / Oo Uber / Careem

Daimler / MyTaxi

GM / Cruise:

BMW iVentures

PE / Scout

BMW startup Garage

GM / Ly

Adjacent “touch points”

Intel / Mobileye

ZF / Wabco

Minority & cross shareholdings Short term

Osram & Con Lighning JV

BMW & Briliance JV

PSA Group (Opel) & Fiat Chrysler

Renault/Nissan/ Mitsubishi

BMW & Vissmann JV

BMW & Great Wall Motors R&D JV + Electro Mini

Valeo / FTE

Core Business

BMW & Daimler Share Now (Car2go & DriveNow)

Alliances & Partnerships

ZF / TRW

M&A

Daimler Startup Autobahn (incubator)

Business Incubaon

ZF Ventures

BMW & Daimler & Audi: Acquision of Here

Venturing (Inhouse VC)

Geely / Daimler

Joint Ventures Google / Waymo

Tesla BMW i-series BMW Designworks

Inhouse Business Model Innovaon

Time Needs for Implementaon

Fig. 1.11   The BMI-Matrix for the global automotive industry

Long term

28

1  End-to-End (E2E) M&A Process Design

These alternative strategy approaches have to be evaluated within a consistent framework to choose the best fitting alternative and for fulfilling the ultimate strategic targets of the corporate strategy. This could be achieved by a consistent evaluation of the alternative growth paths as will be discussed as well in more detail within Chap. 2. For the Transaction Management multiple specifics of digital business models will be highlighted here in brief, whereas details could be found within Chap. 3: – Digital targets are typically based on complex, young and often unique Business Designs. Their valuation might be therefore challenging. Target companies within a digital disruptive framework have foremost on the one side dynamic and fast-growing, but on the other side also highly volatile and risky cashflow patterns. As acquirers nevertheless pay still significant purchase prices for attractive digital targets a sensitive valuation is of paramount interest mirroring these cashflow patterns by using scenario approaches and statistical financial tools like Monte-Carlo simulations or option-pricing models, where applicable. In Chap. 3 also a new tool for the valuation of digital and platform businesses, the Reversed DCF Model, will be introduced. – Secondly, the Due Diligence of digital targets it is often demanding. As they have typically start-up business characteristics their corporate history offers only a limited amount of sound legal, financial or business data and also their business model might not yet be proven to be successful. Accordingly, the Due Diligence of digital targets is closer to a venture capital approach then to the typical in-depth assessments of incumbent targets. – To limit the risk exposure on the buy side concerning the target performance post-closing, earn-outs or milestone payments and other contract clauses are nowadays a crucial part of the purchase agreement of digital targets. The intent of such clauses is to stabilize the cashflow pattern of the target company post-closing by keeping the existing management of the target with their entrepreneurial approach on-board and by sharing the upside potential and risks post-closing. – Especially in the case of multiple-billion incumbent acquirers buying small, but highly successful start-up businesses with disruptive technologies, often culture clashes derail the later integration. Therefore, an early Culture Design Diagnostic is recommended. The target of the Culture Diagnostics is to maintain the start-up characteristics and culture of an acquired digital target post-closing. It has therefore to addresses the sensitive trade-off between integration needs and organizational alignment to realize the intended synergies, but also to provide the necessary autonomy for the target company. A crucial part plays here the Joint Culture Design independently from the targeted Joint Business Design. Like the cashflow pattern of digital targets, the synergies have specific characteristics which have to be addressed within the Synergy Management. As the nature of innovative business models implies that new markets are approached and traditional markets disrupted, the major part of the synergies is typically revenue-based. Therefore, the buyer

References

29

has to run an early assessment of how successful and fast the business of the target company could be scaled within the acquirer’s context post-closing. An early, first draft of this Synergy Scaling Approach is recommended. Also, in the Due Diligence, the verification of the synergy scaling approach is a crucial topic. Besides, the buyer has to draft the Business Design alignment needs on the parent and target side based on the Due Diligence outcomes and intended synergies. A rapid scaling of the synergies post-closing to create a dominant industry design and the leverage of the parenting advantages for the target company are the priorities within the integration phase for digital targets. The M&A Project Management for the acquisition of innovation-driven targets might be challenged by missing capabilities on the acquirer’s side for a sensitive assessment of the target’s Business Design. Additionally, new tools like trend assessments or Ecosystem-Scans and analytics have to be defined to get a detailed understanding of the target’s strengths and weaknesses. Benchmark acquirers in-source the missing capabilities for the evaluation of digital targets latest in the Due Diligence. Within the integration, the focus of the Project House is on specific management and cultural integration tools, like mentorship programs and organizational design tools. In the follow on chapters the five modules of the E2E M&A Process Design will be discussed in detail.

References Chatterjee, S. (2009). Why is synergy so difficult in mergers of related businesses? Strategy & Leadership, 35(2), 46–52. Damodaran, A. (2006). Damodaran on valuation – Security analysis for investment and corporate finance (2nd ed.). New Jersey: Wiley. Davis, A. A. (2012). M&A integration: How to do it – Planning and delivering M&A integration for business success. West Sussex: Wiley. Dellermann, D., Popp, K. M, et al. (2017). Finding the unicorn: Predicting early stage startup success through a hybrid intelligence method. Proceedings of the International Conference on Information Systems. DePamphilis, D. M. (2015). Mergers, acquisitions, and other restructuring activities (8th ed.). Oxford: Elsevier. Feix, T. (2013). Der Bewertungsprozess bei einem Strategen. In K. Lucks (Ed.), M&A Projekte erfolgreich führen – Instrumente und Best Practice (pp. 216–226). Stuttgart: Schäffer-Poeschel. Feix, T. (2017a). Nichts geht ohne den Firmengründer – ein M&A-Prozessmodell für den Mittelstand mit fünf Bausteinen. M&A Review, 05(2017), 153–159. Feix, T. (2017b). M&A-Management: Das M&A-Prozessmodell für den Mittelstand. In T. Feix, J.-P. Büchler, & T. Straub (Eds.), M&A – Erfolgsfaktoren im Mittestand. München: Haufe. Feix, T. (2018). Die Digitalisierung von M&A-Prozessen – ein Manifesto für ein digitales ­End-to-End Prozessmodell. M&A Review, 09(2018), 280–284. Ferrer, C., & West, A. (2017). M&A 2016: Deal makers catch their breath. McKinsey Corporate Finance March 2017. Galpin, T. J., & Herndon, M. (2014). The complete guide to Mergers & Acquisitions – Process tools to support M&A integration at every level. San Francisco: Jossey-Bass/Wiley.

30

1  End-to-End (E2E) M&A Process Design

Garcia-Feijoo, L., Madura, J., & Ngo, T. (2012). Impact of industry characteristics on the method of payment in mergers. Journal of Economics and Business, 64, 261–274. Gugler, K., Mueller, D., & Weichselbaumer, M. (2012). The determinants of merger waves: An international perspective. International Journal of Industrial Organization, 30, 1–15. Jeffries, J. (2014). Foreword: Building M&A integration capabilities as a competitive advantage. In T. J. Galpin & M. Herndon (Eds.), The complete guide to Mergers & Acquisitions – Process tools to support M&A integration at every level. San Francisco: Jossey-Bass/Wiley. Koller, T., Goedhardt, M., & Wessels, D. (2015). Valuation – Measuring and managing the value of companies (6th ed.). New Jersey: Wiley. Maksimovic, V., Philips, G., & Yang, L. (2013). Private and public merger waves. Journal of Finance, 68, 2177–2217. Müller-Stewens, G. (2010). Mergers & Acquisitions: Eine Einführung. In G. Müller-Stewens, S. Kunisch, & A. Binder (Eds.), Mergers & acquisitions – Analysen, trends und best practices. Stuttgart: Schäffer-Poeschel. Netter, J., Stegemoller, M., & Wintonki, M. (2011). Implications of data screens on merger and acquisition analysis: A large sample study of mergers and acquisitions. Review of Financial Studies, 24, 2316–2357. Nikandrou, L., & Papalexandris, N. (2007). The impact of M&A experience on strategic HRM practices and organizational effectiveness: Evidence from Greek firms. Human Resource Management Journal, 17(2), 155–177. Perez, C. (2018). Economist August 18th 2018, 50. – Economic historian. Porter, M. E. (1985). Competitive advantage – Creating and sustaining superior performance. New York: Free. Singh, H., & Zollo, M. (2004). Deliberate learning in corporate acquisitions: post acquisition strategies and integration capability in U.S. bank mergers. Strategic Management Journal, 25, 1233–1256. Zott, C., Amit, R., & Massa, L. (2010). The business model: Theoretical roots, recent developments, and future research. IESE Business School. Working Paper WP-862. June 2010.

2

Embedded M&A Strategy

Contents 2.1 Reframing of Corporate Portfolio and Strategic Business Unit Strategies. . . . . . . . . . . . . 34 2.2 M&A for Strategy Development on Corporate Portfolio and Strategic Business Unit Level. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 2.2.1 M&A for Corporate Strategy and Portfolio Management. . . . . . . . . . . . . . . . . . . . 36 2.2.2 M&A for Business Unit Strategies and Competitive Advantage. . . . . . . . . . . . . . . 52 2.3 Purchase Price, Synergies and Shareholder Value. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 2.3.1 M&A Value Added Versus Dilution. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 58 2.3.2 Synergies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 2.3.3 The Tao of  Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2.4 Embedded M&A Strategy Design. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 62 2.5 M&A Target Profiling and Pipeline. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65 2.5.1 Criteria for Target Profiling and Target Scorecards. . . . . . . . . . . . . . . . . . . . . . . . . 65 2.5.2 Assessment of the Fit Diamond. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 2.5.3 The Process of Screening and Target Pipelining. . . . . . . . . . . . . . . . . . . . . . . . . . . 72 2.6 Frontloading of Integration Approach Blueprint. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73 2.6.1 Standalone Business Design Diagnostics and Joint Business Design Blueprint. . . 75 2.6.2 Standalone Culture Design Diagnostics and Joint Culture Design Blueprint. . . . . 83 2.7 Embedded M&A Strategy for Digital Targets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 99 2.8 Summary of Embedded M&A Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 2.8.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 102 2.8.2 Key Success Factors and Takeaways. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

Abstract

Taking a holistic view, an Embedded M&A Strategy is an integral part of the corporate strategy and the business unit strategies of the acquiring company: On the level of corporate strategy, M&A is a tool to innovate or restructure corporate portfolios and © Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_2

31

32

2  Embedded M&A Strategy

to increase shareholder value. On the level of business unit strategies, M&A may be used as a strategy tool to get access to new products, services, markets or capabilities and to realize value potentials. Corporate and strategic business unit strategies should frame the M&A approach, as M&A is an important but just one of a set of alternative growth and value creation options for a company. Additionally, the corporate strategy is the reference point for the definition of the Transaction Rational of a potential acquisition or merger and the intended M&A targets. Based on a comprehensive strategy review, an Embedded M&A Strategy defines the detailed strategic targets to be achieved by transaction initiatives, frames the corporate finance part of potential acquisitions, sketches value creation targets, including the intended synergies, decides on the preferred external growth design, selects the assessment criteria for the profiling of the ideal target company and the Fit Diamond assessment. The E2E M&A Process Design also intends to Frontload two mission-critical integration issues into the M&A-Strategy: On the one side by Diagnostics of the Standalone Business Designs of the target company and the acquirer and by drafting of a Blue Print of the intended Joint Business Design, on the other side by Diagnostics of the Standalone Culture Designs of the target company and the acquirer and by drafting of a Blue Print of the intended Joint Culture Design. This Frontloading of Business and Culture Design issues intends to increase the likelihood of integration success. Once such a consistent and detailed M&A Strategy is defined, potential target companies could be evaluated, selected and integrated into a long-list of potentially attractive targets. Based on the Fit Diamond, meaning a more detailed strategic, financial, synergistic, Business Design and Cultural Gap assessment, the long-list of target companies will be boiled down to a short-list of highly attractive potential transactions, which serve as a starting point for a dedicated M&A initiative. Chapter 2 will stress the importance of a holistic and consistent corporate and business strategy framework for an Embedded M&A Strategy. A comprehensive strategy review provides the strategic rationale for a transaction (Galpin and Herndon 2014, p. 31). Especially within nowadays markets, which are characterized by technology disruptions, innovative business models and dynamic ecosystems with blurred boundaries, this alignment between M&A and corporate as well as business unit strategies is a necessary ingredient for any successful transaction (Figs. 2.1 and 2.2). This will be highlighted throughout the book by several case studies for a manifold of global industries, like the automotive, the financial services, the media or the pharmaceutical industry. Besides, a set of new M&A tools will be discussed to cope with the strategic challenges of vibrant industries, like the Eco-System Scan, the Business Model Innovation (BMI)-Matrix, the Fit Diamond assessment, the Standalone Business and Culture Design Diagnostics and the Joint Business and Culture Design Blue Print.

2  Embedded M&A Strategy

#1

• • • • •

Embedded M&A Strategy

33

#2

Embedded M&A Strategy Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

Transacon Management

Integraon Management

#3

• Integraon Strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan (IM) • Transional Change: Implement JBD • Culture Transion • Integraon Tracking and Controlling • Integraonal Learning & Best Pracce

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − JBD Blending and JBD Proof-of-Concept − Culture Blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

Synergy Management

#4 Synergy Diagnoscs and Blue Print of Synergy Scaling Approach

Synergy Paern and Scaling Approach Proof-of-Concept

Synergy Capture: Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and M&A Tool-Plaorm

M&A Knowledge Management

M&A playbook

Fig. 2.1   The E2E M&A Process Design: Embedded M&A Strategy

Rethinking Corporate and SBU Strategies

 



WHERE TO COMPETE (PORTFOLIO STRATEGY) Assess Corporate Porolio Compeve & Parent Advantage Market Aracveness HOW TO COMPETE (SBU STRATEGY)

 

 

 

Compeve Advantage - SBU Business Design, VP, Core Competencies and Culture STRATEGIC INITIATIVES Product/Service Strategy Market strategy: Customers, Regional, Channel Strategies Technology Strategy Valuaon & Financial Targets

  

Design of Embedded M&A Strategy

Fit Assessment & M&A Porolio

SBD & SCD Diagnoscs, JBD & JCD Blue Print

STRATEGIC RATIONAL REDESIGN CORPORATE PORTFOLIO

FIT DIAMOND ASSESSMENT

SBD DIAGNOSTICS & JBD BLUE PRINT

Build new Business Design Growth in Adjacent Markets Divestment

LEVER SBU COMPETITIVE ADVANTAGE   

 

  

New Region, Product, Service New Capabilies Cost Advantages ACQUISITION DESIGN HOW TO ACQUIRE Alternave Growth Opons Intended Advantages and Synergies Valuaon & Financing Integraon Approach JBD and JCD Blue Print

Standalone Aracveness Risk Profile BD and CD Fit

Fit Diamond

#1 CS Financial (Synergec) Fit

CA #6 CC #7

#8 CP

Strategic Fit (Raonal)

CV #3 #9 CF

CR #4 CH #5

#2 C M

#10CO

M&A PORTFOLIO & PIPELINE

SCD DIAGNOSTICS & JCD BLUE PRINT 1

Corporate value footprint

Centricity 1 2 3 4 5 6 7

2

Regional culture Embeddedness

Power distance 1 2 3 4 5 6 7

3

Management style Leadership atude 1 2 3 4 5 6 7

Spirit 1 2 3 4 5 6

Group 1 2 3 4 5 6 7

Decision making 1 2 3 4 5 6 7

Midset 1 2 3 4 5 6 7

Uncertainty 1 2avoidance 3 4 5 6 7

Corporate Spirit 1 2 3 4 5 6 7

Diversity 1 2 3 4 5 6

Gender 1 2 3 4 5 6 7

Working principle 1 2 3 4 5 6 7

Group values 1 2 3 4 5 6 7

Orientaon 1 2 3 4 5 6 7

Risk tolerance 1 2 3 4 5 6 7 Driver for decisions

Communicaon 1 2 3 4 5 6 7

1 2 3 4 5 6 7

Fig. 2.2   Embedded M&A Strategy: Structure and flow of thoughts of Chap. 2

The strategy context also serves as a backbone for the assessment of the Transaction Rational. Besides its strategic contribution, any M&A deal has also to assure that it creates value for the buyer and the seller. For the latter, it may be easier to create value with a transaction, as the buyer has to offer a premium on top of the stand-alone value to convince the owners of the target company to sell their assets. More challenging is the position of the buy side. The latter value is only created in case that the intended synergies overcompensate the paid premium. Therefore, a systematic Synergy Management

34

2  Embedded M&A Strategy

Value & synergy creaon

Lever for strategic advantages

Fig. 2.3   Embedded M&A Strategy targets: Value creation and strategic advantage

is of utmost importance for the buyer for setting the price and to avoid to overpay (Davis 2012, p. 9). This is one of the crucial reasons why the E2E M&A Process Design includes the Synergy-Management as a detailed and separate E2E workstream which is interwoven with the valuation. This double-sided justification of a transaction’s strategic and financial advantage, as expressed by Fig. 2.3, within the M&A Strategy makes the early-stage assessment of a transaction so demanding. The precise definition of the intended achievements of a merger or an acquisition, as defined by the Transaction Rational, also serves as a yardstick for the post-acquisition measurement of M&A success and as the “northern star” throughout the whole M&A process. The latter argument is of high importance within the Integration Management for not getting lost within the complexity of integration workstreams.

2.1 Reframing of Corporate Portfolio and Strategic Business Unit Strategies Corporate versus business strategies1 There are clear distinctions between corporate and business strategies, which may be summarized as follows: – Corporate strategy: Corporate strategy is the transformation of a corporation. It defines where a company competes and therefore implicitly also the playground but as well the boundaries of a company. The scope of activities spans three different dimensions: 1. the portfolio of products and services which mirrors the degree of diversification, 2. the inter- or multinational scope, meaning the geographical footprint, and 3. the vertical scope which is defined by the Business Design activities of the company and its degree of vertical integration. The vertical scope is closely linked to the core competencies and co-operative ecosystem. It decides how vertically specialized a company is.

1Compare,

for example, Grant (2013), Müller-Stewens (2010).

2.1  Reframing of Corporate Portfolio and Strategic …

35

These boundaries of a company my shift during the cause of time due to technological innovation or new management techniques. Since the turn of the millennium, the trend in corporate strategy were more focused corporate portfolios. Besides, multinational companies expanded their activities at a slower pace internationally. Corporate strategies have been driven foremost on the one side by a refocusing on core competencies and limiting the vertical scope using divestments and outsourcing strategies and on the other hand by a renewed focus on core activities limiting the product scope. – Business strategy: Business strategy defines how a firm competes within a particular product or service market and ecosystem. The core of business strategies is the quest for a competitive advantage. The two main drivers for competitive advantage have been since the late 1980’s cost advantage and differentiation advantage (Porter 1985). Cost advantage causes a company’s unit costs to differ from those of its core competitors (“cost drivers”) and may rest on skills like economies of scale or scope. Differentiation advantage is based on innovation, customer insight, and the exploitation of uniqueness. Differentiation advantages tend to be longer lasting. They request that the demand pattern of customers’ preferences for product or service go ­hand-in-hand with the differentiation capabilities of a company by creating unique attributes on the supply side. Differentiation advantages are embedded in outpacing Business Designs, especially by exceptional core capabilities of a company. Nowadays, competitive advantage is often based on strategic or business model innovations, meaning new approaches in doing business, e.g. creating value for customers by introducing new products, services, use cases, or modes of product delivery (Hamel 2006; Kim and Mauborgne 1999; Kim and Mauborgne 2004).

As Fig. 2.4 describes, M&A activities have the advantage that they could be used as a corporate strategy initiative for the redesign of the company’s portfolio, but as well for

Investment

Value creaon

Market a racveness

high

M&Astrategy Porolio strategy: Where to compete

middle

Business strategies: How to compete low

Divestment weak

Cash Cow = Equity value (MVA) of strategic business unit

middle

Relave compeve posioning

Fig. 2.4   M&A Strategy as a lever for corporate and business strategy

strong

36

2  Embedded M&A Strategy

business unit initiatives to lever competitive advantage by acquiring new products or services, getting access to new markets or customers, gaining new capabilities or realizing economies of scale and efficiency gains.

2.2 M&A for Strategy Development on Corporate Portfolio and Strategic Business Unit Level Twenty-first century portfolio management applies at the same time divestment and investment strategies. The strategic intent of such portfolio reconfigurations and renewals is on the one side to adjust the corporate strategy exposed to new trends in the ecosystem and on the other side to lever shareholder value by: – Acquiring targets which offer access to highly attractive—meaning high-return, fast-growing—new markets or customer segments where the buyer has a synergetic fit and may exploit and lever parenting advantages – Selectively diversifying the portfolio by acquiring attractive businesses in adjacent markets or technologies. The latter are often driven by start-up activities which may have just a loose touchpoint to the company’s existing business. Nevertheless, they might impact the buyer’s core business due to technology disruptions or megatrends on the consumer side mid- to long-term. Therefore, they might be mandatory to build and protect the future competitive advantage of a company – Divesting businesses in slow growth, mature and low profitable markets, or which are only loosely knit businesses to the core activities and competencies of the company – to shape shareholder return and competitive advantage in existing business segments and core capabilities by a string-of-pearl M&A strategy or consolidation play In so far, the capital market approach goes hand in hand with corporate strategy. The first three strategies are corporate portfolio strategies, the latter is part of business level strategies:

2.2.1 M&A for Corporate Strategy and Portfolio Management As the shareholder value approach gained ground in the 1990s (Müller-Stewens 2010, pp. 9, 10), the management of the corporate portfolio became a core task of corporate boards, especially for listed corporations. The drivers for shareholder value are the Free Cash Flows (FCFs) generated by the portfolio of the company’s businesses. The FCFs, by themselves, depend on the two ultimate value drivers, growth and Return on Invested Capital (RoIC) (Koller et al. 2015, pp. 29–33; Gaughan 2013, pp. 21–24). Both drivers could be achieved by entering fast-growing, highly profitable markets with a strong

2.2  M&A for Strategy Development on Corporate Portfolio …

37

strategic fit and synergy potentials, by divesting mature, price-sensitive and low profitable business units, or by building a dominant market position with economies of scale. Therefore, the strategic rational of portfolio-based M&As is to permanently re-invent the corporate portfolio and business model by orchestrated investment and divestment strategies: – Built the corporate portfolio by investments and growth strategies – Acquiring new business models and core competencies with a strong strategic and synergetic fit to the businesses of the existing portfolio – Growing in attractive adjacent market segments, which have today just minor touch-points to the existing core business, but might shape the future of those existing businesses – A very selective diversification by entering unrelated, but highly attractive businesses where still parenting advantages might develop long term – Streamlining and restructuring the corporate portfolio by targeted divestments Portfolio Investment and Growth Strategies Portfolio investment and growth strategies might apply M&As to acquire businesses or core competencies which are very close to the existing business activities of the acquirer. This tight knit, to be acquired businesses will have per definition a strong strategic fit to the core business. Nevertheless, the acquirer has to prove that the strategic fit could be captured by financial synergies and related FCFs beyond the standalone value of the target to justify any purchase premium. The second portfolio investment approach is the acquisition of businesses in attractive, but more adjacent market segments, which are outside of the existing core business, but might shape the future of those existing businesses. Examples might be a global automotive company with a focus on the traditional combustion engine powertrain technology acquiring an electric-drive powertrain company or a media incumbent acquiring a streaming technology company. A further justification of portfolio investment strategies might be a very selective, focused diversification approach. In such cases, a diversification is understood as the acquisitions of targets which go far beyond the current line of businesses and markets of the acquirer. Diversification approaches often go in line with the shift of the corporate product-market mix into higher growth, megatrend segments, even if those segments are unrelated today to the company’s current line of business activities. Therefore, by definition, operational cost synergies might not exist or be at least limited. The justification of this approach could rest only on financial synergies2, long-term strategic parenting advantages and megatrends. This is understood as focused diversification.

2Financial

synergies will be defined and discussed in detail in the next sub-chapter and Chap. 6.

38

2  Embedded M&A Strategy

Examples might be the latest acquisitions by the global software giant Microsoft of the professional social media network LinkedIn and the web-based communication network Skype. Both acquisitions enabled Microsoft to shift its portfolio from its highly profitable, but slower growing software business with its flagship Microsoft office package into newer, fast-growing web-based and social media businesses. The parenting advantage of Microsoft are its management capabilities in scaling software and internet businesses. These serve as a glue between the own core and the acquired, quite adjacent businesses. In this sense, a focused diversification could also be described as a related diversification (DePamphilis 2015, pp. 12, 13). This approach has to be separated from the pure financial portfolio diversification strategies of the late 1980s with their acquisition spree into unrelated businesses. The latter has been the foundation of global conglomerates. Examples of such strategy approaches might have been General Electric, Siemens or emerging economy conglomerates, like Tata in the late 1990s. Those conglomerate strategies proofed to be in the majority of cases unsuccessful as synergies, strategic alignments of existing and acquired businesses, as well as parenting advantages, were missing. Also, the governance and management of multiple business companies proofed to be challenging (Hoechle et al. 2012). Furthermore, management teams of conglomerates bear the risk to underinvest in attractive growth options of their strategic business units (Seru 2014). No wonder that conglomerates often trade at a discount on the global equity markets in comparison with the sum-of-the-parts value of their strategic business units or in comparison to more focused peers (pure plays). This markdown is called conglomerate discount. Besides these strategic reasons, a couple of capital market and investor arguments try to explain the markdown of conglomerates. Conglomerates might be perceived as higher risk investments, as management teams might be limited to understand and run multiple unrelated businesses at the same time. On top of these management limitations, investors might also be afraid that management teams of conglomerates are more interested in diversification strategies to build their empires, rather than to improve the performance of the stand-alone businesses (Andreau et al. 2010). Also, equity investors might find it difficult to evaluate the different business units of a conglomerate from an outside-in perspective due to missing transparency and details with respect to the separate businesses in financial reports or due to missing peers with the same portfolio of activities (Best and Hodges 2004). All in all, there is a common understanding and significant evidence that truly diversified businesses underperform (Backer et al. 2019).3 In line with this finding, acquisitions in unrelated, diversified businesses financially underperform more focused acquisitions on announcement (Akbulut and Matsusaka 2010) and generate also lower financial

3E.g.

Backer, Manley and Todd show in a latest study from McKinsey and Goldman & Sachs that multiple-business segment companies underperform in comparison to pure-plays with respect to P/E-ratios and E ­ V/EBITDA-multiples (Backer et al. 2019).

Value creaon potenal of market

2.2  M&A for Strategy Development on Corporate Portfolio …

high

Investment

Parent stars

• Business model innovaon • Acquisions • Partnering

Built ownership in core “must haves” by • Business model innovaon • Acquisions • Partnering

middle

Porolio diagnoscs

Cashflow opmizaon

Non-cores low

39

• Sell • Equity carve out • Spin off weak

• Cashflow focus • Sensive redeployment in core middle

strong

Relave parenng advantage

Fig. 2.5   Portfolio Diagnostics: Value creation potential-relative parenting advantage matrix

returns (Megginson et al. 2003; Singh and Montgomery 2008). Therefore, proven financial synergies and strong parenting advantages are mandatory to justify acquisitions into adjacent markets. The latter means that the acquirer has to make a “best owner”—internal view—assessment, besides the traditional market attractiveness analysis—external view—for portfolio realignments (Backer et al. 2019). A matrix for portfolio strategies might align the corporate finance with the strategy perspective: • the relative parenting advantage, as internal perspective • and the value creation potential of the market, as external perspective These two criteria4 could be used to design a value-parenting advantage matrix, as described by Fig. 2.5: The diagnostics for the corporate portfolio renewal could be tailored around four steps: • Portfolio diagnostics: Evaluation of the as-is corporate portfolio in terms of the short- as well as the long-term value creation potential of the company’s businesses and markets and its relative parenting advantage in those specific market segments.

4The

Backer, Manley, & Todd (McKinsey) approach uses the relative ability to extract value and the value creation potential as the two decisive criteria for their portfolio approach (Backer et al. 2019).

40

2  Embedded M&A Strategy

• Design a recalibrated future corporate portfolio and “broad-brush” portfolio strategy: Definition of future corporate portfolio design and balanced corporate portfolio investment, divestment and development strategies. • Tailored corporate portfolio strategies and map of strategic moves: The comparison of the as-is with the intended corporate portfolio will implicitly define the redesign moves: This might include on the one side alternative growth strategies, like business model innovations and external growth approaches, like mergers and acquisitions, joint ventures, alliances, Corporate Venture Capital (CVC) or incubator and accelerator models. On the other side, divestment strategies might be scaled for noncore activities within the as-is portfolio • Prioritization of the different strategic portfolio moves as well as definition of their timing and resource needs are part of step four. Within this portfolio context, M&As are one of an alternative set of strategic tools for portfolio renewal by targeted investment and divestment strategies. Therefore, transactions have to be evaluated in comparison with alternative growth options. These options have different characteristics and specific patterns of advantages and disadvantages:  Definition A brief description of the different growth options for corporate portfolio renewal: – Acquisition: Acquisitions are transactions in which the acquirer, takes a controlling interest in another, the target company or acquires the assets of the target company. Acquisitions always lead to a change of control, in the sense of a transition of ownership rights concerning the acquired firm from the seller to the acquirer. The target company might continue to exist as a legally owned subsidiary of the acquirer but loses its economic and financial autonomy, even if its legal structure is retained. The acquisition of the target company leads to an integration into the acquirer’s Business Design. – Merger: In a merger, two or more companies fully combine and integrate their activities from a business and financial point of view. From a legal perspective, one of the partners or both cease to exist. The latter case is a statutory consolidation where both parties create a new corporation, a so-called NewCo. Shareholders of the consolidated entity exchange their existing shares for shares in the new company. The two partners of a merger are often of similar size. Mergers are also often described by the interrelationships of the markets and businesses of the merging companies: Horizontal merger means that the two partners are in the same industry, vertical merger that the partners come from up- or downstream markets and are linked by their value chain (backward integration of suppliers or forward integration of distributors), or conglomerates, where the partners play in different industries.

2.2  M&A for Strategy Development on Corporate Portfolio …

41

– Joint-Venture (JV): JV are selective business combinations formed by two or more independent companies with a distinct intent, as defined in the JV contract. A JV involves the establishment of a separate legal entity, the NewCo, whereby the JV parties are the shareholders. None of the shareholders does cease to exist. The shareholders integrate selected activities of their own company, assets or cash, depending on their core competencies and the intended scope of the JV. The JV has its independent management, as well as own reporting and compliance standards. – Strategic alliances: Strategic alliances are loose-knit tie-ups without any ownership transitions. They may or may not result in an independent legal entity with joint management and organization. In the latter case, an alliance agreement might frame the co-operation between the involved parties. Strategic alliances involve, coordinate or integrate only selective parts of the alliance partners. The rational is foremost the combination of complementary core capabilities, products, services or technologies. Further arguments to foster alliances might be the leverage of market access or the realization of economies of scale within the alliance. E.g. the strategic alliances of global airlines integrate their route-offerings by code sharing programs within the alliance and reduce costs by joint ground-handling operations, despite being still independently operated companies. Alliances could involve new businesses in defined ecosystems or align more mature businesses. – Minority-investment and cross-shareholdings: In case of a minority investment one party acquires a non-controlling interest in another party, in case of a cross-shareholding both companies acquire such a minority interest in the other party. The intend of such minority investments is an alignment of strategic targets. This alignment is achieved by board representations and veto rights with respect to strategic initiatives, significant capital expenditures like M&As, equity and debt capital raisings, or the amount of dividend payments and share repurchasing programs. The advantage of minority- and cross-shareholding is that they offer partial access to the partners’ capabilities and align interests while limiting the necessary financial and management investment as well as potential transaction and integration risks. The disadvantage is the limited control of the partner and the missing participation on the partners’ FCFs and performance. – Incubator: To get access to complementary or unique capabilities an early-stage corporation with start-ups might be a more promising strategy than a straight forward acquisition. Business incubation is more than a loose corporation as the parent corporation might support the start-up business with a bundle of activities, like management capabilities, market access, research and development labs, office space or access to professional networks. A financial investment of the parent corporation is not mandatory, but a minority equity investment between 10–25% is likely. – Accelerator: Acceleration, in contrast to incubation, does focus more on the early ramp up process of a start-up’s business. In most instances, accelerators offer a well-structured program for the scaling of the start-up business along a given business plan and apply a tight schedule with detailed milestone reports. The support

42

2  Embedded M&A Strategy

of the parent cooperation might be in the form of skilled mentorship or coaching, in providing access to the relevant community and networks for scaling the business, in digital or technological capabilities, or simply providing office space. Equity investments are in most instances very limited up to 10%. Due to their more structured approach accelerator strategies might be faster to ramp up, in most instances 3–6 months, but less tailor-made than incubator strategies. – Corporate Venture Capital (CVC): CVC units are majority owned VC units by large corporations. The units act as holding for all VC investments of a company. In comparison to incubators and accelerators, the intent is more on an early-stage investment, typically a minority-stake, in new and adjacent technologies. CVC offers the possibility to get insights in more distant markets, technologies and ecosystems without having to commit to a full investment already at the beginning. After five to seven years the CVC might decide to sell off or fully acquire and integrate the venture. CVC is applicable for seed as well as for late-stage investments. – Internal growth options, like innovation and R&D strategies, market access or distribution strategies: The before mentioned external growth options and c­ o-operations have always to be mirrored, back-tested and benchmarked against internal growth options with respect to their applicability, advantages and likely value added. Based on this brief definition of the different growth and value leverage strategies their detailed patterns can be described and compared by Fig. 2.6.

Characteriscs of external growth opons

Operaonal

Strategy

Finance

Criteria

Acquision

Merger

JV

Alliance

Incubator

Accelerator

Parally

Only for JV assets

No

Yes (parally)

Yes (parally)

Change of control

Yes

Investment need

High

No

Limited

No

Limited

Limited

Risk

High

High

Middle

Limited

Limited

Limited

Limited to JV

Limited to alliance

Synergy potenal

High

Middle

Limited by size Limited by size

Ownership (legal set up)

Ownership transfer

NewCo

NewCo

Independence

Shareholding

Shareholding

Management style

Leadership

Joint Mgt.

Partnership

Partnership

Mentoring

Mentoring

Limited to JV acvies Defined by JV agreement

Fully

Fully

Defined by alliance

Access to partners capabilies & assets

Fully

Time horizon

Long

Long

Short-Middle

Short

Middle

Middle

Middle

Middle

Very high

High

Limited

No

Limited

Limited

Set up me Integraon needs Core challenge

Integraon

Fully

Selecve

Decision a„er 5- Decision a„er 57 years 7 years

Joint alliance Joint Smart parenng Smart parenng Joint JV strategy interest Management

Fig. 2.6   The patterns of external growth strategies

BMI distance from core

(touch points with respect to value proposions, technologies and markets)

2.2  M&A for Strategy Development on Corporate Portfolio …

43

Corporate Venturing Capital (CVC)

New corporate “touch points”

Accelerators

Business Incubaon

Adjacent “touch points”

Alliances & Partnerships

M&A

Joint Ventures

Core business

Minority & Cross Shareholdings

Inhouse business model innovaon

Divestments Short term

Implementaon Time

Long term

Fig. 2.7   Business Model Innovation (BMI)-Matrix

The concept of the Business Model Innovation (BMI)-Matrix5 describes the corporate portfolio playground by integrating those corporate strategy options within one portfolio. The different options are clustered by their pattern using two dimensions: – The business model innovation distance of the business potentially entered by the specific strategy approach to the existing core business of the company. The distance from the core could be measured with respect to the intended value proposition, core technologies and capabilities, the targeted markets and the intended customer use case – The time horizon and need to implement the specific strategic option, from short-term meaning half a year up to very long-term of 5–7 years (Fig. 2.7) Mergers and acquisitions could be used for growth and value strategies close to the core business of the acquirer, but also for adjacent markets or for riding blue oceans. M&As offer a timing advantage, as the acquirer or merged company gets immediately after the closing of the transaction access to the markets and capabilities of the target or partner.

5Roberts

and Wenyun (Roberts and Wenyun 2001, p. 29) published one of the first articles on the linkages between the technology-life-cycle, alliances and acquisition types. This idea is embedded implicitly within the vertical axis of the BMI-Matrix on the “distance to the core”.

44

2  Embedded M&A Strategy

The negative side of M&As is, that they bear significant financial and business risks, especially concerning integration needs. JVs are a suitable option if the combination of the capabilities of the partners allows them to enter new or exploit existing market segments or to leverage economies of scale and scope. Especially in the first case, JVs have a more distant touchpoint, by getting access via the partner to missing capabilities. In most instances, JVs are more time-consuming than M&As, as they request, besides the traditional M&A process, a strong alignment of the interests of the JV partners. Business incubating and venturing approaches are foremost used to get access to totally new capabilities, technologies and markets by acquiring or building start-up businesses. The time horizon to implement those strategies is long-term, as the scaling of the acquired business needs time and support by the parent company. All of those external growth options have to be mirrored with the alternative of a pure internal growth strategy, e.g. an inhouse business model innovation approach. The latter bears significantly less risk as it is based purely on a company’s own resources and capabilities. But it may need a long time horizon to build the new business and might bear the risk of not being capable to enter in the end successfully the intended market. To select the best fitting alternative, the different growth options have to be evaluated and compared by a consistent set of criteria. Decisive criteria for the selection of the preferred portfolio strategy are: – on the financial level the likely and targeted synergies, their pattern—meaning if they are more cost or revenue-driven -, existing financing potentials by internal cashflows or equity and debt capital market access on the acquirer’s side, as well as the acquirer’s risk tolerance – on the strategic level the available resources, including management and capabilities at the acquirer to integrate the targeted business, the intended time horizon to enter new markets or technologies, the potential access of the acquirer to the core market capabilities to enter these new markets or to build up the intended customer use cases and last not least the technological and digital capabilities of the acquirer. The pattern of a specific growth strategy along these financial and strategic criteria indicates the best fitting strategic option. The best-fitting external growth option must be finally compared with the alternative of a pure standalone internal growth path by inhouse innovation or business model innovation approaches. In some circumstances, there might exist not only one viable growth alternative (Fig. 2.8).

2.2  M&A for Strategy Development on Corporate Portfolio … Growth opon:

M&As

JVs

45

Incubators/Accelerators

Financial criteria

Intended level of synergies? Strong

7

6

5

4

3

2

1

Weak

3

2

1

Growth driven

Synergy paerns? Cost driven

7

High

7

6

5

4

Financing potenals (cashflow, equity and debt market access) ?

6

5

4

3

2

1

Low

3

2

1

Low

2

1

Low

2

1

Low

Risk tolerance? High

7

High

7

6

5

4

Strategic criteria

Available resources and capabilies of acquirer for integraon?

6

5

4

3

Time to market needs, constraints? High

7

6

5

4

3

Acquirers resources and capabi lies to enter new market? Strong High

7 7

6

5

4

3

2

1

Weak

6

5

4

3

2

1

Low

Acquirers access to technologi cal and digital capabilies?

Fig. 2.8   Financial and strategic evaluation of BMI and portfolio strategies

Combining BMI Approaches with Generic M&A Strategies The matching of the transaction rational with the pattern of the different growth options identifies suitable BMI-portfolio strategy pairings: Portfolio transforming M&As are applied for bold M&A moves to enter white spots or for riding blue oceans. An example might be if a biotech company enters completely new segments of healthcare treatments. Adjacent M&As might have their strongest applicability in case of capability driven transactions or string-of-pearl strategies. A global media champion entering the streaming market by acquiring a target company with streaming capabilities might be here a showcase. Core M&As are typically used for consolidation plays or the scaling of a distinct competitive advantage within an industry the acquirer is already in. Alliances and JV strategies are foremost built upon capability or regulatory driven partnering strategies or consolidation needs, whereas venturing and incubating strategies are used to build the next unicorn, to enable early-stage investments in adjacent markets and technologies or to get access to attractive distinct capabilities (Fig. 2.9).

2  Embedded M&A Strategy

BMI distance from core

(touch points with respect to value proposions, technologies and markets)

46

New corporate “touch points”

Porolio transforming M&As • Bold M&A moves to enter white spots / riding blue ocens • Strategic foresight M&As

Adjacent M&As Adjacent “touch points”

• Capability driven M&As • String-of-pearl M&As

M&A

• Consolidaon plays • Compeve scaling Minority,edge cross

Value unlocking & shareholdings divestments divestments • IPOs • Spin-offs • Carve-outs

Short term

(Inhouse VC) • Build the unicorn • Early stage adjacent capability investment Business Incubaon

Alliances & partnerships Partnering strategies • Capability driven partnering • Regulatory driven partnering • Alliance building

Core M&As

Core business

Venturing

Venturing & incubang

Joint Ventures

Inhouse business model innovaon

Implementaon Time

Long term

Fig. 2.9   BMI and generic M&A Strategies

Case Study on the Application of the Business Model Innovation (BMI)-Matrix “Strategic options to shape the future of the global automotive industry 2020+”

The new “technology alphabet” of the global automotive industry describes the multiple challenges and technology disruptions which unsettle the global automotive OEMs and the mobility ecosystem. It is also a perfect example, how the focus in M&A and business model innovation shifts step-by-step from a product and cost leadership approach to technology, data and relationship enabling strategies: – “A” like autonomous drive: Partial and even fully autonomous drive technology is already in test mode of leading global automotive OEMs like BMW, Mercedes, GM, Ford or Tesla. Also, technology companies like Alphabet, with its Waymo car enter the market of driverless cars, side-passing 100 years of automotive development. Autonomous drive solutions request the technology integration of camera, radar and lidar based in car systems with real-time mapping and traffic information, therefore, breaking traditional car industry boundaries and shaping a new mobility ecosystem. – “B” like new Business Designs: Multiple new Business Designs like ride-hailing as offered by Uber, Lift, Didi-Chuxing, Grab, Ola and the likes shake up the

2.2  M&A for Strategy Development on Corporate Portfolio …

47

traditional car ownership model of the last decades. A couple of leading OEMs try to establish also fully integrated multiple transportation mode solutions by offering, besides their classical sale, finance and leasing businesses and solutions, also shared-mobility, raid-hailing or even rent-a-bike concepts. An example of an OEM based shared mobility approach is the new Share Now JV of Daimler and BMW, which integrates the former BMW DriveNow and Daimler car2go concept of those fierce high-end car competitors. – “C” like connectivity and car-to-car communication: Advanced driver assist and infotainment solutions are built upon car-to-car communication and fleet learning algorithms. – “D” like digitalization: Digitalization and virtual reality concepts reinvent nearly any part of the automotive Business Design, from R&D and manufacturing to marketing, customer experience, sales, aftermarket services and repair. Additionally, digitalized services will define new customer use cases like automated hotel search or safety solutions. – “E” like electric and hybrid powertrains: The revolution in the drivetrain started with the first hybrid concept of the Toyota Prius, but really took off with the market entree of Tesla and the latter’s pure electric powertrain solutions. It is obvious that such a dynamic market, competitive, and technology ecosystem requests highly flexible and dynamic strategy approaches. One-fits-all concepts like the former consolidation play driven acquisitions of automotive incumbents to gain size and a brand portfolio seem outdated. The BMI Matrix may be applied to get a detailed picture of the different options within the global automotive industry: Automotive OEM still run multibillion investments for their inhouse R&D and business model innovation programs. But at the same time, they anticipate that in a couple of critical needs and capabilities for the future automotive markets, like battery and electric powertrain technologies, navigation systems, or platform-based raid-hailing concepts the inhouse capabilities are missing or, at least, are limited. JVs are used to get access to critical capabilities or to gain enough volume. For the first argument, the JVs between automotive OEMs and battery suppliers might be a good example. Batteries, based on lithium-ion solutions, are the most expensive subsystem within hybrid and fully electric powertrains. Automotive OEMs, having an engineering focus with mechanical and electromechanical capabilities, are traditionally missing the chemical capabilities for the development of advanced battery solutions. A second problem is that the applied lithium-ion based battery technologies are used within multiple industries, like mobile phones, household appliances and others. A pure automotive focus would limit economies of scope. As a consequence, global automotive OEMs formed multiple JVs with leading battery ­suppliers as the ­best-fit solution to gain access to those critical capabilities. Another JV approach is the before mentioned new partnership between BMW and Daimler

48

2  Embedded M&A Strategy

for car-sharing and m ­ obile-app solutions by merging their standalone platforms car2go (Daimler) and drive now (BMW). Both companies intend to enlarge the scope of this JV beyond raid-hailing and sharing by including also multimodal services, on-demand mobility concepts, as well as parking and charging concepts. The key reason for this JV is to gain enough volume and traction to be competitive against global raid-hailing competitors like Uber, Lift or Didi. Besides, OEMs established inhouse incubating and venturing concepts for co-operations with startups in different kinds of advanced technology systems. Nevertheless, M&A plays an even more important role than in the past for the automotive industry: M&As are still applied for consolidation purposes, like the acquisition of the Opel brand and business by the French PSA Group or the latest merger between Fiat-Chrysler and PSA Group. Within the automotive supplier industry, a core argument for M&As is nowadays the access to mission-critical capabilities to become a leading tier-1 supplier for the future automotive market. Examples might be here the USD 10 billion acquisition of the US-supplier TRW by the German ZF-Group and the multibillion follow-on acquisition of Wabco or the Valeo acquisition of FTE. A third rational for automotive M&As are more adjacent markets entrees. The acquisition of the high-tech startup Mobileye by Intel allows the latter to enter the market of advanced camera and software solutions for the automotive industry, which will be mandatory systems for autonomous drive applications. Another interesting example is the buy-out of the Nokia mapping technology by the leading German automotive OEMs BMW, Daimler and Audi. At the same time, a couple of automotive OEMs establish new business models besides their core business. E.g. Daimler supplemented its raid-hailing business and acquired the necessary technology capabilities with the purchase of Intelligent Apps, the parent company of the leading European raid-hailing company mytaxi, and RideScout. These external growth options, as pinpointed in Fig. 2.10, compete with pure inhouse approaches, as the Waymo driverless-car concept of Alphabet or the electric and autonomous drive concepts of Tesla show. ◄ Value Creating Divestment Strategies Mergers and acquisitions are a suitable instrument for an active portfolio management as they can be used for investments as well as for divestments. Divestments could be attractive strategies for unlocking value in cases where the company is, in comparison to its core business, an owner of assets and activities which are exposed to different eco-systems, meaning significantly diverging trends in markets or use-cases, a different set of competitors, differences within their investor patterns, or discrepancies in growth trajectories, RoIC performance and investment needs. Divestment strategies could be private market based, like a direct sale for cash or stock either to another company or a private equity investor. An alternative are public market exit strategies, as an equity carve-out by a public offering for the to be

2.2  M&A for Strategy Development on Corporate Portfolio … Uber /

BMI-Distance from Core

(touch points with respect to value proposions, technologies and markets)

New corporate “touch points”

Uber / Careem

Daimler / MyTaxi

GM / Cruise:

BMW iVentures

PE / Scout

BMW startup Garage

GM / LyŠ

Adjacent “touch points”

Intel / Mobileye

Minority & cross shareholdings

Geely / Daimler

Joint Ventures Google / Waymo

BMW & Vissmann JV Osram & Con Lighning JV

BMW & Briliance JV

PSA Group (Opel) & Fiat Chrysler

Short term

BMW & Daimler Share Now (Car2go & DriveNow)

BMW & Great Wall Motors R&D JV + Electro Mini

ZF / Wabco

Renault/Nissan/ Mitsubishi

Daimler Startup Autobahn (incubator)

Alliances & Partnerships

ZF / TRW

Valeo / FTE

Core Business

Venturing (Inhouse VC)

Business Incubaon

ZF Ventures

BMW & Daimler & Audi: Acquision of Here

M&A

49

Tesla BMW i-series BMW Designworks

Inhouse Business Model Innovaon

Implementaon Time

Long term

Fig. 2.10   The BMI-Matrix and the design of strategic options in the future global automotive ecosystem

separated business, a spin-off, a split-off or a combination of different divesture options in a dual-track: – Direct sale: A direct sale is the sale of a company, one of its strategic business units (SBU) or substantial assets to another company, private equity player or investor. A direct sale of a company or SBU incorporates a full transfer of ownership rights from the seller’s shareholders to the acquirer, meaning a complete change of control for the defined and carved out business. The means of payments on the buy side could be cash or shares of the acquirer. In the former case the seller has the advantage of a cash inflow, in the latter of becoming a shareholder of the buyer and therefore participating on the intended synergies, but bearing the risk to be dependent on the buyer’s future stock-market performance. Direct sales have the advantage to be foremost fast processes with a clear-cut exit strategy and minor impacts on the day-to-day operations of the remaining business. – Equity carve-outs: An equity carve-out is a partial divestiture of an SBU. Within an equity carve-out, the parent company issues and sells a part of the shares of the carved-out subsidiary on the stock market. In contradiction to a direct sale,  in an equity carve-out a company does not sell all shares of the carved-out business, but just a defined equity proportion, the parent retains a major, in many cases, at least at the beginning, even a majority shareholding position. A company may prefer a carve-out instead of a direct sale especially in cases where the SBU is deeply embedded in the business model of the parent or where synergies might still exist on parent level.

50

2  Embedded M&A Strategy

– IPOs: In case of an IPO the parent company separates the assets and liabilities of the to be listed strategic business unit and transfers them into a NewCo. The NewCo is listed on the stock-exchange and shares are sold to “new” investors for cash. In difference to an equity carve-out, the IPO is a full divesture of the NewCo. The difference of a direct sale and an IPO is, that in the first the NewCo is sold to one new owner, either a strategic or private equity investor and therefore is a private market divestment strategy, whereas in the latter the NewCo is sold on the public market. But in both strategies cash is generated by the divestment for the parent company, which is not the case in spin-offs and split-offs. – Spin-offs: A spin-off is a form of divestiture, where the parent company inaugurates a newly listed company, the NewCo, transfers the assets and liabilities of the to be spun-off strategic business unit into this NewCo and then distributes the new shares to the current shareholders via a stock dividend. The shares of the spun-off division trade in the chosen stock market just like shares of the parent company. The spun-off SBU must be therefore listed and set up for an IPO on the public market. The newly created entity operates as a complete independently legal company with its own management team and Board of Directors. The original shareholders own post-listing and post-stock transfer shares of the parent company and a proportional number of shares of the new standalone company. The spin-off might be partial, meaning that a reminder of the spin-off shares is retained by the parent, or a 100% spin-off, where all shares are distributed to existing shareholders. A spin-off could also be combined with an equity-carve out in case that NewCo shares are distributed partially to new shareholders, but the remainder is kept by existing shareholders. – Split-off: A Split-off involves the same first steps as a spin-off, creating a NewCo, transferring and integrating the assets and liabilities of a defined SBU and to list the new entity. The only difference is technically, that it involves an exchange of parent stocks for the stock in the NewCo. But it does as well not generate any new cash for the parent company (Fig. 2.11). – Dual tracks: Dual tracks are a combination of different divestment strategies. In most cases, a potential IPO is run as a separate and parallel process to a trade sale. In a later stage, the company decides on the preferred exit strategy, depending on investor interest and the attractiveness of the offers. The different divestment approaches could be structured, using two dimensions, as Fig. 2.12 shows: – The most likely participation of existing shareholders with respect to the spin-off activities – The level of independence of the spun-off business from the former parent concerning financial, organizational and legal matters

2.2  M&A for Strategy Development on Corporate Portfolio …

Direct sale or IPO

Inial structure

public shareholders

public shareholders

new private or public owner cash

parent company

SBU A

51

public shareholders

shares Sub B

parent company

Shares or Assets of SBU B

parent company

SBU A

SBU B

Spin off

SUB A

SBU B

SUB B

Fig. 2.11   Comparison of different divestment strategies

+ +

Parcipaon of exisng shareholders1)

-

Public Investors: IPO

Full Spin-off/Split-off

Full financial, organizaonal, and legal separaon

Paral Spin-off/Split-off

Direct sale

Strategic investor2) Leveraged Buy Out: PE Leveraged Buy Out: MBO, MBI, BIMBO Tracking Stock

1) 2)

Equity Carve Out

Minority vs. majority with “old shareholders” with respect to shares and vong rights / control Means of payment: share vs. stock vs. mixed deal; with or without earn out

Fig. 2.12   Divestment strategies for portfolio restructurings

The preparatory, sequenced steps for the divestment strategies are similar: – As a starting point, the alternative transaction structures have to be evaluated. This includes also the assessment of a straight versus a multiple step divesture, where in the latter case the remaining shareholding has to be defined. The intended transaction structure must be detailed with respect to the carved out business. – In a second step, the assets and liabilities of the to be divested business must be transferred to a new legal entity, the NewCo, which must be inaugurated upfront. Additionally, the timeline and milestones for the separation have to be defined and targeted investors approached. – The third step involves the communication of the divestment and the design of the divestment or equity story. Additionally, the financial structure, meaning the capital

52

2  Embedded M&A Strategy

structure and allocation as well as the projections of the stand-alone performance for the remaining business and the NewCo have to be defined and analysed. The ­carved-out financials have to be audited. This might also include the assessment of separation costs, stranded costs, or dis-synergies. Besides, the allocation of legacy liabilities and service level agreements between the remaining and carved out business are important tasks at this stage. – In the last, the ultimate step the divestment has to be realized. This might include tasks like the definition of the NewCo management team and governance principles, the roadshow for the potential equity investors on the NewCo side, the fulfillment of the listing requirements, roadshow presentations, rating review processes, securing debt financing instruments, the signature of the defined service level agreements for the standalone NewCo business, the assessment of tax implications, and multiple employee-related issues.

2.2.2 M&A for Business Unit Strategies and Competitive Advantage Numerous explanations and theories try to explain why M&As happen on strategic business unit level. As a strategy-based transaction approach is recommended, the focus will be on rational explanations of M&As, which also have a close tie to corporate valuation and the financial justification of a transaction by its intended synergies, as will be discussed in detail in the next sub-chapter. M&A strategies on strategic business unit (SBU) level intend to lever the existing business model of the SBU to shape or gain a long-term, defendable and lucrative, in the sense of a strong cash flow generating competitive advantage. Such competitive ­advantage-based M&As could rest on two pillars (Galpin and Herndon 2014, p. 86; Davis 2012, p. 5) 1. Differentiation and growth advantages by: – Entering new markets (new geographies, customer segments or use cases) – Getting access to new distribution channels (including direct sales, new outlets, web-based sales) – Acquiring new products, services or functionalities which complement the own offerings or might create cross-selling opportunities – Gaining access to new competencies, technologies or capabilities, like brands, intellectual property, patents and others and which might leverage existing core capabilities of the acquirer, like R&D, marketing or brand management 2. Cost advantages which improve operating efficiencies by

6Compare

as well the 8 Cs concept as strategic deal rational from (Galpin and Herndon 2014, p. 8.

2.2  M&A for Strategy Development on Corporate Portfolio …

53

– Realising economies of scale or driving consolidation – Scaling economies of scope – Leveraging complementary capabilities and assets to achieve efficiency gains Differentiation and cost advantage-based M&As will also be discussed in Sect. 2.3.1 financially wise under the header of operational synergies. M&A Strategies Based on Differentiation Advantage and Growth Synergies Differentiation is still one of the strongest competitive advantages. Differentiation based advantages, like brand management, R&D capabilities or access to global distribution channels, are also in most instances longer lasting than pure cost advantages (Koller et al. 2015). Therefore, a transaction rational based on differentiation advantage might be a sound justification for an acquisition. Target companies, which enforce even multiple differentiation advantages in one stroke might be of special interest. One or any combination of differentiation-based transaction drivers might be therefore the trigger point for a dedicated transaction (Galpin and Herndon 2014, p. 8). – Entering new markets (new geographies, customer segments or use cases): – Getting access to new regions and countries was one of the primary route-causes of the fifth merger wave and is still a strong argument, especially in case of cross-border deals. A latest example might be the acquisition of the French conglomerate Alstom by its US competitor General Electric. The acquisition levered General Electric’s core strengths in multiple business units like transportation, power generation and others in the European markets and offered vice versa for Alstom’s products an excellent US market access. The same argumentation holds for the intended merger within the global liquid-air market between the German Linde Group and its US competitor Praxair. A quite extreme case is the merger endgame within the global agrochemical market: The merger of the two US-listed agrochemical giants Dow and DuPont, the acquisition of the Swiss Syngenta by ChemChina, with USD 43 billion the largest outbound Chinese acquisition ever, and the acquisition of US-based Monsanto by the German chemical giant Bayer reduced the number of players within the global agrochemical market in two years from six to three global players. The core transaction rational for these deals was the creation of global champions which have access to all important agricultural markets. – A second argument for entering new markets is the acquisition of targets which offer access to new customers or customer segments. The acquisition of new customer groups could also create substantial value as competitors might gain from the customer extension and therefore might not initiate retaliation strategies (Koller et al. 2015, p. 122). Synergies between customer segments could occur in principle in any market segmentation, e.g. between lower, middle and higher priced market segments, between male and female applications, or between younger and

54

2  Embedded M&A Strategy

elder customer groups. Acquisitions based on serving different price-segments are quite common in the consumer goods industry. An example of this approach is the beauty group L’Oréal, which built its business through a succession of targeted acquisitions of complementary brands. For example, with the acquisition of Biotherm, L’Oréal leveraged a successful female skincare product portfolio also to men. – A third pattern of market acquisitions are new use-cases. Within this category fit the acquisitions of aftermarket and service businesses by product centered companies, which is a common strategy of automotive suppliers or industrial goods manufacturers. This may as well be a smart acquisition approach, as aftermarket and service businesses are a natural extension of product centered businesses, might establish a true system-approach and leverage the customer buy-in. Furthermore, aftermarket and service businesses are in most industries even more profitable than the traditional OEM business. – Getting access to new distribution channels (Galpin and Herndon 2014, p. 8): The access to new distribution channels as an M&A argument gained in importance due to the exponential growth of web- and e-commerce-based sales and Business Designs. In a first step “real world” companies tried to get a footstep in the e-commerce world. But nowadays also vice versa holds true as the acquisition of Whole Foods by the e-commerce leviathan Amazon for USD 13.7 billion shows. Amazon also established a distribution pipeline in the pharma market by the acquisition of PillPack, which focuses on customers that need to take multiple daily prescriptions. – Acquisition of new products, services and functionalities: String-of-pearls M&A strategies are an example of adding new products and services. They use bolt-on acquisitions, which are characterized by a series of small- to mid-sized transactions in existing business fields and extend subsequently the existing product portfolio. IBM is a successful example of such a string-of-pearls approach. IBM acquired small software companies and leveraged them through their global sales and marketing network, realizing substantial sales synergies (Koller et al. 2015, p. 123). Another European example is the string-of-pearls acquisition approach of the German ­high-tech company Carl Zeiss (Rauss 2017). The most prominent case in recent times might have been the bidding war in the media industry between Walt Disney and Comcast for the acquisition of a majority shareholding of Twenty-First Century Fox. The later will allow the successful acquirer Disney to build their library content of attractive movies and gain scale to be able to compete against the streaming services of Netflix, Amazon and Apple+. – Acquisition of new or complementary core competencies and leverage of parent core competencies on target business: M&A as a driver and as a complementary approach of inhouse innovation strategies is at the forefront of the newer M&A literature and research (Bena and Li 2014; Cassiman and Veugelers 2006). As well in the corporate world innovation and capability-based acquisitions play an increasingly important role. The French multinational luxury goods and brands company

2.2  M&A for Strategy Development on Corporate Portfolio …

55

LVMH Moët Hennessy Louis Vuitton SE is a superb example. Already the origin of the luxury goods conglomerate was a merger between Louis Vuitton with Moët et Chandon and Hennessy, leading manufacturers of champagne and cognac. LVMH used its highly reputed brand management competencies to lever acquired luxury goods brands through their benchmark marketing and sales network on a global level and is now the parent of additional brands from Christian Dior to Loewe, Givenchy, Kenzo, Marc Jacobs, Tag Heuer, DKNY, Celine and others. Another case of ­competency-based transactions are upstream and downstream M&As within the oil and gas industry. Repsol’s acquisition of Talisman Energy and Encana’s acquisition of Athlon Energy are examples of upstream oil companies expanding their production base on downstream operations recently. A final example might be found in the acquisition patterns of leading pharmaceutical companies. Roche, a leading Swiss pharma company, extended its traditional drug pipeline business with digital capabilities by the acquisition of Flatiron. The later gives Roche access to billions of data points on millions of cancer patient treatments using real-world data to accelerate research and generate evidence. A second bolt-on acquisition of Ignyta’s precision medicine pipeline provides new tools for the treatment of molecularly defined cancers based on DNA assessments. M&A Strategies Based on Cost-Leadership and Cost-Based Synergies Still, up to the Global Financial Crises cost synergies have been the predominant argument for mergers and acquisitions. Such cost advantages might rest on economies of scale or scope as well as on complementary skills: – The theory of economies of scale is built upon the empirical finding within multiple industries that unit costs typically decrease if manufacturing scale increases. A more precise formula of economies of scale defines how much the unit cost declines by each doubling of the output volume. The original reasons for economies of scale are learning curve effects which drive the reduction in variable costs. A recent example is the cost development of lithium-ion batteries, one of the most critical components for electric and hybrid cars, which have fallen by 75% over the last eight years as measured per kilowatt hour of output. The battery manufacturers have been able, due to economies of scale, to reduce 5–8% of unit costs every time the battery production volume doubled. Another driver for the decrease in variable costs initiated by an increase in production volumes are often reduced material costs by bundling of purchasing volumes and the realized ­purchase price discounts of key suppliers. A broader definition of economies of scale limits them not only to the reduction in variable costs. A further reason for economies of scale might be fixed costs as for sales, general and administration (SG&A) which are spread on a wider output volume (Galphin and Herndon 2014, p. 8). Also, a better exploitation of fixed assets, like factories, machines or intangible assets, like brands or capitalized software, reduces depreciation and amortization on a unit level and therefore costs on a unit level.

56

2  Embedded M&A Strategy

The acquisition of SAB Miller by Anheuser-Busch (AB) InBev, the world’s largest brewer, for more than USD 100bn and the third largest acquisition ever serves as a good example. AB expects USD 1.4 billion of annual savings, which equates to 13% of SAB’s net sales. This is even at the lower end of a range of 12–21% that AB InBev has achieved in previous transactions. The synergies are cost-based by reducing 3% of the combined workforce due to efficiency gains, 30% of the cost savings should come from shutting down overlapping regional offices, 25% from a volume bundling in purchasing which will draw down raw material prices and packaging cost, and the remainder from higher brewing and distribution efficiencies, as well as productivity improvements. – Economies of scope occur only in case of multiple-product firms. The total costs for companies developing, producing and marketing multiple products might be lower due to efficiency gains if compared with single product companies. Like economies of scale, economies of scope might refer to declining variable costs or a better spread of fixed costs. An example might be appliance manufacturers, like Electrolux, Bosch-Siemens Household Appliances or Whirlpool, which offer a broad variety of household products and additionally by using multiple brands. Decreasing fixed cost in sales and a volume discount on marketing costs lead to a significant overall cost advantage in comparison to single product-brand companies. Another famous example is the consumer goods giant P&G. P&G markets hundreds of well-known brands under one roof, leveraging its sales and especially marketing capabilities. Economies of scope also occur on the manufacturing side. An example might be ­multiple-brand automotive companies like the Volkswagen Group, GM, Fiat-Chrysler and others by using one factory for producing multiple brands on a single platform and by using standardized modules between the brands to limit and bundle components which have not a direct customer exposure and are irrelevant for the brand image. – Leveraging complementary skills and capabilities are a third reason for cost synergies. Complementary effects might appear if the capability profile of one company perfectly substitutes the missing capabilities of another and vice versa. A case are  the pharmaceutical merger and acquisition activities. Pharma companies are exposed to high R&D expenditures and often missing critical patents. Using M&As, the patent portfolios of the target company and the acquirer could be combined and one partner’s patents might perfectly fit with the other partner’s missing patents allowing blockbuster developments and a downsizing of overlapping R&D programs. The Dark Side of Justifications for Transactions Excessive optimism and hubris The theory of the “winner’s curve” explains why acquirers often overpay for attractive targets. Excessive optimism and hubris on the buyer’s management team might let them overestimate potential synergies and therefore overpay for the target company (Billet and Qian 2008; Malmendier and Tate 2008; DePamphilis 2015, p. 15). Especially management teams and CEOs who have been successful in prior acquisitions are exposed to overconfidence driven by their past track record. That is the reason why this phenomenon is sometimes called the winner’s curse.

2.2  M&A for Strategy Development on Corporate Portfolio …

57

Principle-agent theory Agency problems are typically described as a misfit of interest between shareholders and employed management teams. Within an M&A context, managers on the buy side might use acquisitions for their own interests to build their empire, to increase their prestige or simply to leverage their compensation. Nowadays majority and activist shareholders, as well as hedge funds might limit the power of management teams to strive for self-preservation and thereby neglecting shareholder value. Also, valuation and governance tools, like fairness opinions of the target company on the appropriateness of the bidder’s offer price, could counterbalance the problems of agency conflicts. The same might be true for special M&A committees understood as subgroups of the board composed of independent directors being not part of the management team and evaluating the appropriateness of the purchase offer. Temporary undervaluation of the target Following the augmentation of behavioral economics, capital markets and their investors might, from time to time, over- or undervalue a company in comparison to its long-term fair value. Buyers might lever two potential arguments: Either acquiring undervalued targets or, in case they believe that their own shares are overvalued, using own shares as means of payment. This argumentation line should be taken very cautiously, as it assumes that the acquirer’s shareholders or management team have more insights and better information than the capital market on average. Additionally, mis-valuations should be very short lived, as latest within the integration shareholders will perceive the underperformance with respect to their underlining estimates and the realization of synergies (Akbulut 2013). Tax inversion deals Taxes have a double-sided impact on valuation: On the one side, higher taxes reduce FCFs and have therefore a negative impact on equity value. On the other side, higher taxes, lower due to their tax-shield, the after-tax cost of debt and, as a consequence, the weighted average cost of capital of a company. The latter has a positive impact on valuation as the discount factor is reduced. Therefore, no wonder, tax regimes and especially tax system changes played traditionally a major role for merger and acquisition activity. The first tax argument driving transactions are case where the acquirer might use accumulated tax losses carried forward or tax credits of the target post-closing by offsetting future profits of the joint company. A second, in the last years even more paramount argument, have been so-called tax inversion deals: If multinational firms in high tax countries realize a significant share of their profits and FCFs in foreign affiliates, they might relocate their corporate headquarters to lower tax countries by acquiring a firm in this country and using a reverse merger structure. This was a very common M&A argument within the pharmaceutical and high-tech industry between 2008–2016, were US multinationals relocated by tax inversion deals their headquarters to lower tax environments, like Ireland. New regulations and a lower corporate tax structure of the US administration reduced the attractiveness of this argument (DePamphilis 2015, p. 16). A pure tax driven argumentation bears the risk that the true drivers of a transaction rational, the intended strategic advantages and the potential synergies out an acquisition or merger, might be too less relevant.

Companies and strategic business units might be exposed to radical changes in their ecosystem. Those changes might be a consequence of significant regulatory changes, like in the financial industry after the global financial crisis, for utilities after the Fukushima disaster, or technology changes and business model innovations, like in the pharmaceutical, the media or the tech industries. These tectonic shifts challenge existing industries

58

2  Embedded M&A Strategy

and enforce a radical restructuring of corporate portfolios and strategic business units. Before kicking off M&A initiatives within such highly dynamic market settings or in case of designing own digital business model innovations, it does make sense to apply an Ecosystem-Scan of different potential future environments and scenarios of the company. Given this scan, the contribution of potential target companies concerning the chosen strategy and financial targets could be defined much more precisely.

2.3 Purchase Price, Synergies and Shareholder Value Mergers and acquisitions are intertwined with corporate valuation. An in-depth value add proof is the second litmus test, besides a proof-of-concept of the Transaction Rational, to be run before any transaction decision is taken. The Sect. 1.3 will stress the principles of corporate valuation and value added as well as the role of purchase prices and synergies. In a second step, the “tao” of corporate finance and valuation will be introduced by a first set of equations. This framework will be extended in Chap. 3 on valuation methodologies:

2.3.1 M&A Value Added Versus Dilution In the end, the net present value of realized synergies determines, if a transaction is value creating or value destructive. A more detailed assessment differentiates between the seller’s and the buyer’s perspective: – From the seller’s perspective, a divestment seems only to be attractive, if they receive, additionally to the stand-alone value of the company—in case of a ­stock-listed company the market capitalization if efficient market theory holds -, an additional premium. The average premium paid in M&A transaction is, as a broad average and independently from a country or industry perspective, round about 30% of the standalone value of the target pre-acquisition announcement.7 – From a buyer’s perspective, the starting point is as well the stand-alone value of the target. Besides, the potential improvement of the stand-alone performance of the target and the net present value of the synergies, which could be realized by the acquirer, might justify paying a premium and still to realize a shareholder value increase due to the transaction on the buy side. For a sensitive valuation, the buyer has also to define

7Kengelbach

et al. (2015, p. 4). Gaughan (2013, p. 298); Gaughan’s assessment of paid purchase price premia within the timeframe 1980–2011 based on Mergerstat Review and Econstats.com data show slightly higher values. The analysis also describes how that acquisition premia grew in line with the recent extension in market capitalization on global equity markets.

2.3  Purchase Price, Synergies and Shareholder Value

59

-10 NPV of Integraon costs

Win-Win Playground Transaconal value acquirer Premium (Transaconal value for seller)

25 NPV of Synergies

Standalone value improvement

90

25

50

Standalone value target Seller’s perspecve

50

Purchase price

Max. potenal price

Standalone value target

Acquirer’s perspecve

Fig. 2.13   Net-synergies, purchase price premium and value added

potential integration costs. As Fig. 2.13 explains, the maximum, in the sense of value neutral purchase price is defined as the stand-alone value of the target plus the net present value of likely synergies and improvements in the targets stand-alone performance (Müller-Stewens 2010, p. 9). In case, that the acquirer is not a better parent in managing the company than the seller, meaning that the acquirer cannot improve the stand-alone performance of the target, the potential premium is only justified by the net-synergies of the transaction. This underlines the important role of synergies for the value added of a transaction: The Case of a Value Additive Transaction (on the Buy-Side) The value neutral purchase price as the sum of stand-alone value and net synergies does provide a simple decision criteria on the buy side (Koller et al. 2015, p. 566; Gaughan 2013, p. 548; Sirower 1997, p. 20): A M&A transaction is only, from a shareholder value perspective, financially justified, if the net synergies overcompensate the paid premium, as described in Fig. 2.13.

8Gaughan

comes in the end to the same conclusion, despite using a slightly different walk of thoughts: He calculates the net value increase of an acquisition out of the combine stand-alone values of buyer and target post-closing and deducts the ­stand-alone value of buyer and target prior to closing, as well as the additional paid premium (including other transaction costs). This net amount is exactly equal to the overshooting of synergies in comparison with the purchase price premium.

60

2  Embedded M&A Strategy

Underlying Assumptions of Synergy and Valuation Concept It is assumed, that the stand-alone value of an intrinsic corporate valuation, which is typically based on Discounted Cash Flows (DCFs), is in line with the market capitalization of a listed company. This is only true, if the hypothesis of rational and efficient capital markets holds, which is the underlying assumption of the traditional corporate finance theory.9 Additional it is assumed that the pure stand-alone value of the target company is identical for the buyer and the seller. This assumption would  not hold, if the buyer could identify and realize value improvements post-closing by specific strategic programs, like restructurings, ­des-investments or aggressive growth strategies, which are not possible for the seller within a standalone scenario.10 Implicitly this assumption means, that the buyer might manage the target better than the seller, which is described in the corporate strategy literature as a part of parenting advantages.11 In reality, a crosscheck is requested, if it is indeed possible for the new owner of the business to launch on a stand-alone basis value increasing strategies, which have not been possible for the seller. An additional problem is a timewise dis-connectivity: the purchase price including the premium has to be fully paid by the acquirer at closing, but the assumed synergies, which might justify the premium, are realized post-closing within the Integration Management. This is phrased by the well-known formulation “prices is what you pay, value is what you get”. Therefore, the risk of the transaction is always on the buy side and depends on how the buyer could realize the targeted synergies.

The Case of a Value Dilutive Transaction (on the Buy-Side) In case, that the buyer underdelivers on the synergy side the acquisition may intend for the buyer’s shareholders a value dilution. This underperformance in synergy capture might only be perceived a couple of years post-closing along with the integration. Figure 2.14 shows this case of a value dilutive acquisition, in which the net synergies undershoot the paid premium:

2.3.2 Synergies Synergies are the net present value of the incremental cash flows realized by combining two or more businesses, independently from the transaction design as an acquisition or merger. Synergies might be realized on the target’s side, on the acquirer’s side or on both.

9In

case of a private company with a market value of equity could only be calculated by the intrinsic valuation of the stand-alone value. Normally this is done by calculating first in the enterprise value, based on forecasted discounted cash flows of the target company, and then deducting the net debt. Details could be found in Chap. 3. Harding and Rovit (2004, pp. 81–83), analyze the potential difficulties which could arise already in this calculation of the equity value. 10This is equal to the “unreal” synergies of the German accounting and valuation ­IDW-standards (2014, p. 27). 11Competitive advantage on corporate level should be monetarized on equity capital markets by a corporate premium.

2.3  Purchase Price, Synergies and Shareholder Value

61

Win-Win Playground

Standalone value target Seller’s perspecve

Integraon costs

Transacon loss acquirer

Premium (transacon value for seller)

Purchase price

Synergies

Max. potenal price

Standalone value improvement

Standalone value valuetarget target

Acquirer’s perspecve

Fig. 2.14   Net-synergies, purchase price premium and value dilution

 Synergy Patterns The two basic patterns of synergies are operating and financial synergies (DePamphilis 2015, pp. 9, 10): Operating synergies might be based on cost advantage driven synergies, like economies of scale, economies of scope or other efficiency gains as well as on differentiation and growth advantages by the joint leverage of new markets, products, services, distribution channels and complementary capabilities or assets. Financial synergies intend to reduce the tax burden or the cost of capital of the post transaction merged acquirer and target business. The later arguments for financial synergies rest foremost on the assumption of imperfect capital markets. E.g. the target company might be limited in its access to global equity and debt markets or might realize at least cost savings from lower securities’ issuances and transaction costs, like underwriting or brokerage fees, post transaction. Additionally, nowadays many global corporations have massive undeployed cash holdings on their balance sheet. This excess cash might be used to internally finance attractive investment opportunities of the target company, which might have been limited prior to the acquisition by the reduced funding possibilities of the target. A final reason might be uncorrelated cash flows of the target and the acquirer. The validity of these different synergy patterns and their details will be discussed in Chap. 5.

62

2  Embedded M&A Strategy

2.3.3 The Tao of Value The tao of M&A value creation rests on the following corporate finance and valuation framework, applying an Enterprise Discounted Cash Flow (DCF) model: The standalone Operating Value (OV) of a company for all its security holders, like shareholders and debt holders, is generated by the sum of DCFs:

Operating Value (OV ) =

∞ 

DCFt

(2.1)

t=1

With t = year By adding non-operating, excess cash and cash-like items, the Enterprise Value (EV) is achieved. By deducting debt and debt-like items, the Equity Value (EqV), as the market value of equity for the company’s shareholders, is derived:

Equity Value (EqV ) = OV − Net Debt =

∞ 

DCFt − Net Debt

(2.2)

t=1

The purchase price paid could be now decomposed on the seller’s side in the target’s standalone equity value EqVT and the paid premium and the value on the buyer’s side in the target’s standalone equity value and the present value of net synergies:

PP = EqVT + Premium �=� EqVT +

∞ 

DCF of Synergiest

(2.3)

t=1

Therefore, the evaluation of value accreditation or dilution simply rests on the comparison of the paid transaction premium with the net present value of realized synergies:

Value added (dilution) = Premium < (>)

∞ 

DCF of Synergiest

(2.4)

t=1

2.4 Embedded M&A Strategy Design Based on an in-depth understanding of the underlying corporate and business strategies, as well as on the principles of the M&A driven value added, a tailored M&A Strategy can be derived. Such an Embedded M&A Strategy describes the cornerstones of merger and acquisition initiatives, like: 1. The detailed definition of the intended Transaction Rational which should be achieved by a specific transaction: Given the above described general portfolio of the reason why of a transaction, any specific acquisition or merger has to be based on one

2.4  Embedded M&A Strategy Design

63

or multiple, but in-depth assessed rational, like providing market access for untouched regional or customer segments, acquiring innovative products or services, gaining new core capabilities and skills, to create cost advantages by economies of scale or to renew the corporate portfolio. Case Study: Strategic Rational of Big Pharma M&A The global pharma industry is a showcase for mergers and acquisitions based on multiple, often interconnected strategic reasons why: Renew the patent portfolio and build a blockbuster drug pipeline: In the last couple of years, the most prominent argument of M&A activity within the global pharma industry was to overcome the threat of the patent cliff. It is a characteristic of the pharma market, that as soon as a patent expires, the prices of drugs, especially for blockbusters, deteriorate due to the market entrance of competitors with competing over-the-counter (OTC) drugs. As a consequence, the profitability of patent protected drugs is typically significantly higher than for OTC ones. The core challenge for the global pharma companies is, therefore, to renew their drug patent portfolio in time before their own flagship patents expire. Additionally, the development and go-to-market process of drugs is a long-term endeavor. They have to pass three clinical trials before regulatory approval as well as the market test. Given the long lead time in the drug development process, global pharma champions use a “double blend” approach by in-house R&D and M&A-strategies. An interesting example is the Swiss pharma champion Novartis: The new incoming CEO overhauled in 2018/2019 the corporate portfolio by selling Novartis’ 36.5% stake in the consumer health JV to its partner GSK for USD 13 billion seeking to focus on its core innovative medicine business. Just a couple of weeks later Novartis pushed further forward with its corporate portfolio re-structuring in buying the US pharmaceutical company Avexis for USD 8.7 billion and strengthening its genetic therapy business, before a couple of Novartis’ high selling prescription drug patents will expire. Become a dominant player in specific client use cases and treatments: A second competitive advantage often intended by pharma champions is a substantial footprint and market share in specific, well defined client use cases. Therefore, pharma companies try to establish a multiple product platform and a complete patent portfolio around defined treatments. A holistic treatment of complex diseases needs in most instances multiple and differentiated drugs and a detailed understanding of the complex interrelationships between different treatments as well as their side effects. A showcase is here the newer approach in the treatment of cancer by the development of individualized immono-therapy solutions, including high sophisticated approaches like DNA sequencing and big data strategies. Renew the business model by getting access to new capabilities and digital businesses model innovations: The pharma business model was for decades build upon the development and market testing of new drugs, efficient manufacturing processes, and global sales and marketing capabilities. As digitalization with the potential of big data assessments—e.g. allowing DNA sequencing with billions of data points—or analytics applications challenge this traditional pharma business model pattern, the incumbents have to acquire missing capabilities to renew their own Business Design. An example is here the latest acquisition of the Swiss pharma company Roche. Roche bought the New York startup Flatiron Health for USD 1.9 billion. With the access to Flatiron’s billions of data points on millions of cancer patients, Roche might become a game changer in the way life science companies are using real-world data to accelerate research and generate evidence. A further example of acquisitions focusing on the renewal of the pharma business model are acquisitions of upstream and downstream capabilities, like clinical studies, trials and client data, or individualized treatments. Increasing cost competitiveness by reduced R&D and marketing costs: Horizontal integration and consolidation plays allow pharma companies to realize substantial economies of scale and scope, thereby improving their strategic cost competitiveness in comparison to their peer group. Such cost advantages are one the one side based on a reduction of R&D costs. As the development

64

2  Embedded M&A Strategy

of a single blockbuster costs nowadays between USD 0.8–1.0 billion, the R&D synergies in case of a pharma acquisition by the integration of R&D platforms could be substantial. Another pool of synergies might be realized in case of an acquisition of a start-up by an incumbent by leveraging the start-up drug pipeline within the global sales and marketing network of the incumbent.

2. The corporate financing framework defines how potential M&A projects might be financed and the limits with respect to financial leverage and risk: In a first step, the excess cash, as well as equity and debt funding volumes and short-term bridge financing capabilities have to be assessed. As part of the debt financing strategy, multiple levers have to be specified, like the preferred kind of debt—bonds versus loans -, the maturity, the preferred interest rate structure—floating versus fixed rates -, the underlying currency, and, in case of interest and currency exposures, potential hedging strategies. Even more lead time is necessary on the equity side, as stock markets and shareholders dislike short term communication on necessary capital increases. 3. The top-down value creation and contribution targets, including the synergy deliverables of the M&A project: As the M&A Strategy is a rough draft, a bandwidth of value and synergy targets seems to be more applicable at this stage than precise targets. Besides, the likely impact of the intended transaction on corporate performance and the consolidated financial statements of the acquirer has to be forecasted: Bestand worst-case scenarios may be used to define robust and reasonable bandwidths of potential impacts on group level. 4. The preferred external growth design: As described in Sect. 1.2.1, especially in dynamic and technology disrupted markets, besides the traditional mergers and acquisitions multiple growth opportunities, like JVs, CVC, incubating or accelerators have to be compared with any specific M&A case setting. Finally, those options have to be evaluated and a preferred option selected. 5. The criteria for the description of the target profiles as well as for the selection of the ideal target company, the Fit Diamond assessment: Selecting targets along a long-, and later, short-list requests on the one side a defined and standardized set of strategic, business and financial data for the company profiling, so-called Target Scorecards. On the other side, the selection criteria must be objective and measurable to avoid management bias or power plays. The detailed Diamond Fit assessment of a specific target must be rationalized by defined strategic, business, financial and further criteria. Besides, the likelihood that the target shareholders, in the end, will sell their business or that a deal materializes has to be assessed. The latter point also involves first thoughts on likely antitrust approvals or restrictions. 6. The targeted integration vison and a Blueprint of the Joint Business Design and Culture Design: Most acquirers still define integration specific topics earliest after signing or closing, meaning at the intersection between the Transaction and the Integration Management. A Frontloading of these activities into the M&A Strategy process serves an E2E view. It also enables that the overall targets concerning the integration and intended synergies are not changed during the typical vibes within the integration process (Fig. 2.15).

2.5  M&A Target Profiling and Pipeline

65

Fig. 2.15   A corporate and business strategy Embedded M&A Strategy and its cornerstones

As the strategic, financial and value targets, as well as the different kind of external growth options, have been discussed already, the focus is in the following on the target profiling and selection, the Fit Diamond evaluation and on the Blue Print of the Integration Approach with the Joint Business and Culture Design as core elements. The M&A Strategy will be summarized in an consistent M&A Playbook.

2.5 M&A Target Profiling and Pipeline Summarizing the assessment so far, M&As are an important tool of corporate development, but bear also a significant risk, especially within the integration of the Joint Business and Culture Design. Based on the Embedded M&A Strategy framework a first assessment of potential target companies in the sense of a long-list could be defined (Fig. 2.16). In a second step, the long-list of target companies has to be boiled down by predefined criteria, which are summarized by the Fit Diamond, to a short-list of highly attractive targets. This short-list is the starting point of a specific transaction.

2.5.1 Criteria for Target Profiling and Target Scorecards In the first step, the hemisphere of potential targets has to be analyzed, each of those potential targets roughly described and the most attractive of them—with a strong fit to the acquirer’s core competencies and intended strategic rational—selected for a first long-list. The identification of attractive target companies with a high fit to the acquirer’s intended competitive advantages is an important success factor for a transaction (Lahovnik 2011).

66

2  Embedded M&A Strategy Target company profiling and Company Scorecards

First rough strategic and financial (synergy) fit assessment Detailed Fit Diamond assessment M&A project

target 1

target 2 target 4

target 3

target 6

target 5

Sales

Long list

2 0 5 m Target 2

Target 3

3 3 2 m 1 6 5 * m

target 7

Target 4

2 9 m

…

target 8

Focus

Products

Strategic fit

Target 1

Target 5

5 1 5 * * m

9 5 %

9 9 %

1 0 0 %

…

…

…

P

P

P

P

P

P

P

P

P

P

P

P

1 0 0 %

2 0 %

F l e e t / T r a i l e r / B u s

Region

Strategic Value Add

Short list

Top 5-7

M&A top targets

P * * *

Willingness to sell

Standalone aracveness assessment

Fig. 2.16   Cascading the competitive universe to a shortlist of highly attractive targets

The initial broad set of potential targets might include not only the direct competitors of the acquirer but also companies with complementary capabilities of the wider ecosystem, which might be especially interesting for the future development of the strategic key success factors of an industry. According to a study of the Boston Consulting Group (2015) within the assessment process 60% of the potential targets are immediately turned down and only 5% of the original targets get to the closing of the deal. Therefore, an initial broad scope is mandatory. For the profiling of an individual target, a set of screening criteria is to be determined. The selection criteria have to be tailored around the strategy, the Business and the Culture Design of the acquirer. Nevertheless, a basic set of screening criteria could be determined, which might be applicable for more or less any industry and could be used for a first-hand description of the potential targets (Galpin and Herndon 2014, p. 32): – Market-product footprint, value proposition and target strategy The overall market, the regional footprint and the customer focus groups of the target company are mandatory parts of any target profiling. In a more detailed step, the core products and services, as well as the according customer use cases and value prepositions may be described. On the market side a detailed breakdown of the target’s overall market in its segments and customer use cases, e.g. business-to-consumer versus business-to-business applications or price segments, is requested to get a detailed understanding of the market attractiveness of the target’s business. This could be mirrored with the target’s market competitiveness in those dedicated segments measured by its market share and other indicators. Especially for M&A strategies were

2.5  M&A Target Profiling and Pipeline



–

–

67

consolidation plays or the acquisition of complementary products and services are intended, a very granular understanding of the product and market portfolio of the target is of essence. Given this market-product footprint, the strategy and the core competitive advantages of the target have to be assessed and briefly described. The competitive advantage of the target has to fit with the strategic reason why argumentation of the acquirer and the intended potential synergies. Financial profile The key financial metrics on a corporate level, and, in case of a conglomerate, also for the different SBUs, have to be analyzed. Typical indicators, independently of specific industries, might be: – Revenues and their development (growth rates based on CAGR) – Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA), as this high-level indicator of the profitability of the target company, might be the most independent from accounting standards and is a close relative to Free Cash Flows – Earnings before Interest and Taxes (EBIT), as it takes also necessary investments by the deduction of depreciation and amortization into account – Invested Capital, which mirrors the capital intensity of the target’s Business Design by summarizing fixed assets and net working capital items, like accounts receivables, accounts payables and inventory – Return on Invested Capital (ROIC)12, as it is the most important indicator for assessing the operating performance of the target company – Free Cash Flows as the ultimate value drivers Besides, a couple of industry specific financial indicators, which mirror the value drivers of the underlying industry and the target’s Business Design might be as well relevant. Business and Culture Design The Business Design is a brief description of the target’s operating model and includes the financial value drivers, the customer value proposition offered by the company’s products and services, the distribution channels used for the delivery process by the target, a detailed assessment of the value chain, the organizational structure and core capabilities, the key partners and suppliers of the target and it’s most important competitors.13 Selective parts of the Business and Culture Design might have the highest priority for a first glance of the target profile: – The core competencies and the aligned value proposition of the target company – The served markets, their attractiveness and the target’s competitiveness within those markets as described above. For additional, already more granular insights and to get a first idea about potential cross-selling opportunities the share of wallet of the target business at the most important customers might be of interest.

12With 13The

and without goodwill. Business Design concept will be discussed more detailed within the next sub-chapter.

68

–

–

2  Embedded M&A Strategy

Additionally, the applied channel strategy of the target should be assessed, and, especially for tech businesses, the web-channel presence and competence. – The overall regional, corporate and management Standalone Culture Design Synergy levers: A first top-down strategic and financial assessment of the potential synergies should also be included in the first high-level assessment. A separation between operational and financial synergies is recommended. As the synergies are the crucial driver of the overall valuation they have to be assessed, at least broadly, in an early stage. Target availability: Also, for a couple of targets, there might exist limitations for a potential acquisition, like a missing willingness to sell by the target’s shareholders or due to anti-trust reasons. Like the synergy levers, the likelihood to sell and antitrust hindrances have to be detected early, to avoid worthless investments in target assessments (Fig. 2.17).

The details of this target company assessment might be integrated into a Company Scorecard for each target. This Company Scorecard provides a brief overview of a single target, and, due to their standardized assessment criteria, also a starting point for the comparison and the selection of the most attractive targets:

2.5.2 Assessment of the Fit Diamond The assessment of the attractiveness of a company as a potential merger partner or acquisition target must be based on an in-depth strategic, financial, Business Design M&A target profiling criteria for long list Screening Criteria Industry / market footprint & strategy Financial profile

Indicators     

Market profile & compe

veness



Business & Culture Design



      

Synergy levers



Availability



Standalone arac veness & synergy value



Core markets Core products & use cases Strategy & comp. advantage

Scaling Meet corporate requirements and having enough touch points with buyer Within certain defined range

Market volume and growth Market segmentaon Market share

Meet at least certain lower limit

Revenue & cost drivers Customer value proposion Distribuon channels Core capabilies Core partners & suppliers Culture Map

Fit high / med / low

Strategic & financial assessment:  Operaonal synergies  Financial synergies Willingness to sell (shareholder) Antrust assessment

High / med / low

 

Financial Strategic & Business design Culture Deign

Sources of informa on  

Core financials like revenue, growth, EBITDA, EBIT, RoIC Business specific drivers



Methodology

     

Branch-organisaons Company databases Reports Investment Banking analysis External researchers Web researches Annual reports First contacts

Methodology   

Install project/screen team Use external support (e.g. consultants) Conduct 80/20 esmates wherever appropriate

Likely / Unlikely Quanficaon & qualitave assessment

Fig. 2.17   Target screening criteria for company profiling (long list)

Specific’s for detail screen  

Use external research Only top-down-analysis

2.5  M&A Target Profiling and Pipeline

69

Standalone Aracveness

Culture Design Fit

Fit Diamond

Strategic Fit (Transacon Raonal)

M&A Risk Assessment Business Design Fit

Financial (Synergec) Fit

Fig. 2.18   Fit Diamond

and Culture Design fit assessment.14 Besides, the standalone attractiveness of the target’s business has to be evaluated. The unique pattern of companies which make them outstanding as a target for the potential buyer is here summarized under the term “Fit Diamond” and is based on five selected criteria, the stand-alone attractiveness of the potential target, the value upside the target does potentially possess due to the synergies in case of an acquisition or merger, the strategic fit of the target and the potential acquirer, including the definition which competitive advantage the target company could deliver for the prospective buyer (strategic rational), the fit between the target’s and the acquirer’s Business Design, and, last not least, the Culture Design fit between the acquirer and the target. Only the first criterium is independent of a potential buyer, and therefore called the standalone attractiveness of the target. The criteria two to five, on the other side, are based on a specific acquirer-target match. The strategic, financial, Business or Culture Design fit assessment of different acquirers could lead to substantial differences in the evaluation of the Fit Diamond of the same potential target (Fig. 2.18):

14Galpin & Herndon underline two component, the strategic fit and the organizational fit, which should be assessed (Galpin and Herndon 2014, p. 33).

70

2  Embedded M&A Strategy

Standalone Attractiveness of the Target The first assessment criterium for the selection of attractive target companies is the evaluation of their stand-alone attractiveness. This assessment has to answer two important questions: 1. Does the company address an important value proposition of its customers by its products or services? 2. Does the company have a unique, attractive and long-term competitive advantage and outstanding capabilities? The first question has to assess how far the products and services offered by the target company solve an important customer problem. The second question is even more complex. The assessment of uniqueness as the core of a target’s competitive advantage asks, if the target has a stand-alone position, which is based, for example, on outstanding capabilities or patents, and could be hardly copied by a competitor. Attractiveness means, that the competitive advantage is highly valued by its customers and therefore could realize substantial Cash Flows. Long-term finally requests that those advantages and aligned FCFs are lasting and are not a short term phenomenon. Financial Fit: Value Upside By Potential Synergies (Volume and Likelihood) The financial fit assessment evaluates how far the target business could be improved in its stand-alone performance and how far synergies could be realized by the combination of the acquirer’s and the seller’s Business Design. The first lever of improvements in the standalone performance is independent of the potential acquirer. In contrast, true synergies depend always on the potential acquirer as they only could be realized by the combination of the specific target with the acquirer. Therefore, a specific target might deliver not the same value contributions for different acquirers due to differences in likely synergies for potential parent companies. The value of the synergies is calculated by their net present value. This implies, that also the timing of the synergies is of relevance for their value contribution. Besides, the likelihood of the synergies has an impact and should be as well evaluated by a focused risk assessment. Strategic Fit: Lever to Shape Competitive Advantage for the Buyer The strategic fit evaluation is one of the core elements of the Fit Diamond. Due to the importance of the transaction rational, it has to be assessed if and how a potential target pays in on a defined competitive advantage on corporate or strategic business unit level, as discussed in prior subchapters. A specific target might also offer not just one, but multiple competitive advantages for the buyer and therefore being highly attractive. The strategic fit and the underlying competitive advantages of the target which might be of value for the acquirer are, like the synergy fit evaluation, dependent on the specific parent.

2.5  M&A Target Profiling and Pipeline

71

Joint Business Design Fit For the sounding of the transaction rational and the later integration process the fit between the Business Designs of the acquirer and the target, meaning if and how a winning Joint Business Design could be achieved, is of utmost importance. Especially in industries where the reason why of the transaction is based upon the specific capabilities of a target, as it is nowadays in industries like automotive, media, pharma or technology the case, the complementarity of the Business Designs of the acquirer and target is decisive. For the risk assessment, the comparison of the two Business Designs might additionally provide insights where the companies might fit, where they might misfit and where therefore potential conflicts might arise. The latter could be used as an early warning signal and provide insights for the Due Diligence assessment, the final design of the Joint Business Design and integration needs. Details on the assessment of the ­Stand-alone Business Designs as well as on the first draft of a potential Joint Business Design and the underlining theoretical model are addressed in the next subchapter. Joint Culture Design Fit Significant differences in the culture of the target’s and the acquirer’s organization, meaning in their values, believes or management attitudes, might end in a culture clash and derail a transaction. The relatedness and fit of the Culture Design are directly correlated with transaction performance. Therefore, an early Culture Diagnostic assessment is a crucial part of the Fit Diamond. The Two Sides of the Coin: Fit vs Risk Profile of a Potential Transaction Mergers and acquisitions offer on the one side a potentially fast way forward to create  value, accelerated growth and establish new competitive advantages. On the other side, they bear also multiple risks. The Diamond Fit assessment analyses only the most critical areas and a negative fit means implicitly a high risk. The first important risk to be addressed is a potential underperformance on the synergy realization, which is in line with the synergy fit assessment. Closely linked to the synergy realization risk is the assessment if a potential acquisition of the target could endanger financially wise the acquirer. This financial risk could be assessed by integrating the target financials into the forecasted consolidated financial statements of the acquirer. Based on this set of integrated financial statements multiple scenarios could be analyzed. To address the financial risk the worst-case scenario might be of special interest. Based on this scenario the buyer could analyze if the balance sheet and finance structure could bear a substantial underperformance of the target or a market downturn. Last not least the Culture and Business Design integration risks have to be evaluated. This includes in-depth Business Design and Culture Diagnostics of the target and the acquirer. The latter may provide insights and early warning signals of potential culture clashes, which could arise out of regional, corporate or management culture differences. Closely related is the question, if the acquirer’s management team might be overstretched by the potential integration.

72

2  Embedded M&A Strategy

2.5.3 The Process of Screening and Target Pipelining Based on the detailed scorecards for each potential target and given a sensitive assessment of the five criteria of the Fit Diamond—the stand-alone attractiveness, the potential synergies, the strategic fit, the Business and Culture Design fit and a transparent view of the most important risks of an intended acquisition -, a priority list of attractive targets could be deducted. In case of a wider defined and vibrant ecosystem of the acquirer or in situations of a non-consolidated global competitive environment a two-step approach might be recommended for the selection of attractive targets. For the latter, in a first step, a long-list of potentially attractive targets might be defined, based on a less detailed assessment. In the second step the long list is reduced to a shortlist of highly attractive targets by evaluating the first-round front-runners in much more detail along the Fit Diamond (Fig. 2.19) Beside the profiling with the Target Scorecards and the Fit Diamond assessment, the likelihood of the availability of the targets has to be assessed. This availability assessment has to address two questions: – Might the target management be open-minded to an M&A approach, or, in case of a hostile takeover attempt, could the target’s shareholders most likely be convinced to sell at least a majority stake and at which price bandwidth. – Are there any anti-trust limitations on a national or international level in case of an acquisition or merger to be expected. If yes, could those anti-trust issues be solved by targeted divestments and spin-offs. In the latter case, is the remaining acquired target business still attractive post divestments. The failed merger talks in the US mobile communication market or the massive anti-trust driven divestments in case of the acquisition of SABMiller by AB InBev might be warning signals concerning antitrust issues.

LONG-LIST Criteria



Standalone aracveness

Target Scorecard:



Industry & market footprint Strategy Market profile Business design Core competencies



Standalone aracveness



Rough strategic fit Rough synergy fit

   



M&A project

SHORT-LIST

Fit Diamond

Culture fit

M&A risk assessment Business Design fit 

Strategic fit

Financial (synergec) fit

Availability?

Output



Long list of potenal targets



Shortlist of aracve targets

Example



Selecon of 20 global competors with detailed Company Scorecard and rough fit assessment



Database with 5-7 targets with detailed Fit Diamond assessment

Fig. 2.19   Two-step fit assessment: Long- and short-list of attractive targets

2.6  Frontloading of Integration Approach Blueprint

73

Only if solutions for both questions could be found for a highly attractive target with a strong fit to the buyer’s business, the substantial investment in the next phase, the Transaction Management—and here especially for the Due Diligence—might be justified.

2.6 Frontloading of Integration Approach Blueprint To kick-of integration planning already within the Embedded M&A Strategy phase and to involve the integration team already at this stage increases the likelihood of a potential transaction success. Providing a first road map for the potential integration approach at an early stage is a tectonic shift if compared with the traditional M&A pattern to start integration planning at or even after closing (Chatterjee 2009; PWC 2017; Galpin and Herndon 2014). Such a Frontloading of integration questions enables both companies, the target and the acquirer, to jumpstart on integration questions. The design of a Blueprint of the potential Integration Approach as a sketch of the Integration Masterplan is, therefore, a mandatory ingredient for a holistic M&A Strategy. Such an early set-up of the potential integration design has the advantage, that the draft of the Integration Masterplan could be back-tested with respect to the likely achievement of the transaction rationale and synergies as well as to its robustness within the Due Diligence. Besides, based on the stress-tested Integration Masterplan during the Due Diligence process, the latter’s implementation could be scaled from Day One of the integration onwards, offering an integration head start. A sensible Integration Approach must be transaction specific by mirroring the targeted strategic rational of the transaction, the specific ecosystem, the risks and the complexity of the potential integration and intended synergies. Integration Approaches exists thereby along a continuum (Galpin and Herndon 2014a, p. 10; Napier 1989, p. 277), from a venturing like collaboration approach with very limited integration efforts to an alignment approach which fosters a partial integration at defined touchpoints, to a full integration in the sense of a “one company” approach. The chosen Integration Approach frames the structure and intensity of the Integration Masterplan (IM), the integration work streams and the detailed integration activities. Collaboration Integration Approach A Collaboration Integration Approach is characterized by a loose knit integration at very selected, precisely defined touchpoints between the potential parent company and the target. The advantage of the Collaboration Approach of integration is, that the target’s Business and Culture Design are preserved, culture clashes avoided, and critical talent is retained. The Collaboration Approach intends to provide on the one side the needed flexibility and stand-alone characteristics to develop the target’s business strategically and in day-to-day matters, and, on the other side, to realize on the buy side the mandatory touchpoint in often adjacent markets (Puranam et al. 2009).

74

2  Embedded M&A Strategy

Nevertheless, the Collaboration Integration Approach is not to be understood as a full stand-alone approach, as the target business has to be overseen in its financial, Business Design and strategic development process. Therefore, compliance principles, defined reporting lines, aligned budgeting and investment processes, dedicated resources and capabilities from the potential parent to scale the target’s Business Design, and also top management attention especially at critical milestones are mandatory for a successful alignment and soft touch integration of the target. To create a value-add in comparison to the stand-alone target development, the acquirer has to define the expected parenting advantage and the necessary integration resources, if it is in financing, or providing the necessary management capabilities for the growth phase and scaling of a start-up business or by simply providing customer and client contacts. Based on the defined parenting advantages the buyer has to plan how to manage the transfer of these necessary resources and capabilities. If these pre-conditions are fulfilled, the Collaboration Integration Approach might be, for example, an ideal hybrid model for combining corporate research process excellence with start-up entrepreneurship. Alignment Integration Approach The Alignment Integration Approach goes beyond the Collaboration Integration Approach by integrating a defined, selected set of elements of the post-closing Joint Business Design. But it is still not a full-sized integration approach, as other elements, especially those which are decisive for the necessary autonomy of a successful development of the target business, will be kept independently. A success factor for this integration approach is a tailored selection and definition which modules and processes of the post-closing Joint Business Design will be coordinated or merged. As in the Collaboration Integration Approach strategic planning, budgeting and monitoring of the target’s business model will be centralized at the parent. Additionally, parts for the development of core capabilities at the target which might lever the value of its business might be integrated or combined with the acquirer’s organization, whereas more day-to-day operations will remain often autonomous. An example might be the successful acquisition and integration strategies of luxury goods companies, like LVMH. With their “string-of-pearl” approach they acquire regional high-end brands and scale them with their best-in-class marketing and brand-management capabilities globally. On the other side, they keep, for example, the manufacturing footprint or R&D focus foremost independent. One Company Integration Approach The One Company Integration Approach is not a small change program, it is a tectonic shift in the Business Designs of both companies. Foremost are significant ­cost-synergies intended by slimming structures and scaling best-of-both standardized processes. All modules and processes of the former independent two Business Designs will be mapped, merged and consolidated. As well all management processes will be integrated by selecting best-practices between acquirer, target and maybe third-party

2.6  Frontloading of Integration Approach Blueprint

75

benchmarks. This means implicitly, no preservation of the target’s Business and Culture Design is intended. This significant change, especially at the target organization, bears the risk of culture clashes and integration hurdles. From a conceptual point of view the One Company Approach could be fulfilled by two alternative strategies: – The full transition of the target’s Business and Culture Design onto the acquirer’s Business and Culture Design footprint. In this approach, all parts of the Business Design like assets, employees and capabilities of the target are transferred. This was the dominating integration model of most global champions like GE, Shell, Daimler or Siemens in the 1990s and early 2000s, as they had the belief that their global business model could only improve the target’s performance. – In the best-of-both approach, the target and the acquirer would evaluate and benchmark each module and process of the two Standalone Business Designs (SBD) and would choose the better performing one as the new joint standard. Integration must here be understood as a fundamental paradigm shift for both companies, not just the target.15 The problematic point of the One-Company Integration Approach might be employee resistance and anxieties, risking a culture clash or “not-invented-here syndrome”, if the cultural origins of both companies are not addressed within the new Joint Culture Design. The departure of key talent and a decreasing employee moral might, in the end, endanger integration success. Figure 2.20 describes the pattern of the different Integration Approaches along important criteria like the overall Integration Strategy, their impact on the Business and Culture Design as well as for the synergy capture and financial targets.

2.6.1 Standalone Business Design Diagnostics and Joint Business Design Blueprint The Frontloading of the Joint Business Design Blueprint from the Integration Management into the Embedded M&A Strategy phase fosters the E2E idea. It enables the crosscheck of the Integration Approach and intended Business Design along the Transaction Management with respect to plausibility and robustness, as shown in Fig. 2.21. This proofof-concept of the Joint Business Design will highlight where the most crucial integration risks are to be expected, how those could be addressed by integration countermeasures and how the overall Integration Approach should be adjusted. Based on this assessment, the detailed interfaces and needs of integration between the acquirer’s and the target’s Business Designs could be assessed, as they are crucial for the leverage of synergies (Fig. 2.21).

15Davis describes this best-of-both approach as cherry picking the best from each company (Davis 2012, p. 22).

76

2  Embedded M&A Strategy

Collaboraon Approach

Financial impact

CD Change

BD Change

Integraon Strategy

Integraon Approach & Paern

Alignment Approach

One Company Approach Target transion to buyer BD

“best-of-both approach”

Integraon depth

1

2

3

4

5

6

7

Integraon resource need

1

2

3

4

5

6

7

Integraon speed

7

6

5

4

3

2

1

Governance allignment

1

2

3

4

5

6

7

Top Mgt. involvement

1

2

3

4

5

6

7

Target

1

2

3

4

5

6

7

Buyer

1

2

3

4

5

6

7

Target

1

2

3

4

5

6

7

Buyer

1

2

3

4

5

6

7

1

2

3

4

5

6

7

7

6

5

4

3

2

1

Synergy capture Investment need

Fig. 2.20   Integration Approach Blueprint and mapping of integration patterns #1

#2

Embedded M&A Strategy Standalone (pre-transacon) Business Design Diagnoscs

Joint Business Design Blue Print

#3

Transacon Management

Integraon Management Joint Business Design freeze and implementaon

Joint Business Design verificaon

Acquirer‘s SBD CS CA CP

CC

CV

Integraon Approach

CR CH

CS CM

CF CO CS CA CP

CC

CV CF CO

CS

Definion of JBD

CA CP

Target‘s SBD

CV

CH

CM

Proof-ofConcept of JBD

CF CO

CR CH

CC

CR

Masterplan

CM

• • • • •

Idenfying integraon risks within the Due Diligence Test of plausibility and robustness of JBD in Due Diligence Definion of integraon tasks, projects, workstreams and Integraon Scorecards Definion of meline and milestones Addressing and management of integraon risks

Fig. 2.21   Standalone Business Design Diagnostics and Joint Business Design Blueprint

2.6  Frontloading of Integration Approach Blueprint

77

The definition of the Joint Business Design Blueprint at this early stage involves the following sub-steps: – The Diagnostics, meaning the detailed assessment and evaluation of the Standalone Business Design (SBD) of the target and the potential acquirer – The blending and potential fit assessment between those two Standalone Business Designs – The assessment of alternative Joint Business Designs (JBDs) and Integration Approaches and a first selection of the most likely preferred Joint Business Design. The evaluation of the most promising Integration Approaches indicates the necessary depth, speed and complexity of the potential integration process. The Integration Approach and JBD have to be mirrored with the intended synergies as well as with the acquirer’s management capabilities. – A Blueprint of the modules of the intended Joint Business Design: For the description of the Business Designs the 10C model might be applied, which will be described in detail within the background information. The ten elements of the 10C Business Design provide a clear picture of the intended post-closing organizational and customer approach as well as the jointly addressed value proposition. 10C Business Design (BD) for Standalone Business Design Diagnostics and Joint Business Design Blueprint For the description of the target’s and the acquirer’s Standalone Business Designs, and the blending, as well as fit assessment of those two Business Designs, a sound definition what is understood as a Business Design, is a precondition. The latest research within the corporate strategy and innovation management theory provides here insights under the framework of business model innovation. Nevertheless, still, today exists no universal definition of what a business model or Business Design—whereby both terms should be used in the following interchangeable—is or is not. In a common understanding, a Business Design addresses the holistic architecture of a business and covers the working principles of an underlying business. Therefore, a Business Design could be understood as a simplistic description of how a company fulfills with a specific service or product offering a core value proposition for a dedicated customer use-case, and how the company delivers this value proposition with its organization and ecosystem (Teece 2010). A Business Design must answer questions, like: – “who are the targeted customers and markets”, – “what are the most critical use cases and trends?”, – “what is the unique offer of the company for its customers and which value proposition is therefore fulfilled?”, – “what are the necessary organizational ingredients, processes and capabilities to deliver on the promised value proposition?” – “what makes the company unique, what is its competitive advantage and core capability if compared with best-in-class competitors”, – and finally “how does the company generate Cash Flows and value with this Business Design?” Most business model definitions consist of several core parts, describing an organizational footprint and the relationships between those parts. Magretta included in his business model concept customers and their values, the ways of delivering the promised value proposition to the customers, the

78

2  Embedded M&A Strategy

M&A Strategy: 10C Business Design (definion)

Compeve Strategy: Strategy, Purpose and Transacon Raonal

CS describes the compeve advantage and purpose of the SBDs and JBD, defining the way of compeng and the relaonship with key competors for the parent, the target and the potenal joint company as well as the strategic raonal of the intended transacon

CooperaveEcosystem

CEs are important ingredients and should pay in in the design of the JBD and in creang the joint CV. Nevertheless, they are not an integral part of the BD

Core Assets

Core Value (Proposion)

CAs as important tangible, intangible assets and HR

Core Capabilies

CCs as unique sources of compeve advantage are mission crical capabilies and skills of the JBD

CV is the product / service / digital offering by the new JBD for a defined customer usecase & sasfies specific customer (B2B or B2C) needs

Customer Relaon

CRs are the glue between the company to their CM

CHannels CH describe how CV are communicated, delivered and sold to CM

Cash Flow Model: Valuaon & Synergies

Customer & Markets CM describes the market segments and customer (clusters) targeted by the new joint CV Prposion of the JBD

The CF Model as financial architecture assures value creaon (standalone value and synergy capture) decomposed in the tailored value drivers of a specific JBD

Corporate Organizaon

CO mirrors regional, SBU and shared service structures, reporng & governance principles, funconal roles and responsibilies, as well as the management layers

Fig. 2.22   The 10C Business Design Model

revenue streams and the cost levers. Business models are in his understanding “stories that explain how enterprises work” (Magretta 2002). Osterwalder and Pigneur have a similar understanding: “A business model describes the rationale of how an organization creates, delivers and captures value” (Osterwalder and Pigneur 2010, p. 14). The 10C Business Design extends and tailors existing business model concepts of Christiansen, Magretta, Teece, Osterwalder & Pigneur and others with respect to the specific needs of the M&A context. The 10C Business Design is built upon ten elements mirroring the logic of how a company fulfills target customer needs, cooperates therefore with its ecosystem, competes with alternative offerings of its best-in-class competitors, realizes Cash Flows and value for its shareholders, captures synergies and designs its organization (Fig. 2.22). Given these major building blocks, the detailed elements of the 10C Business Design are: 1. Competitive Strategy (CS) describes where—in the sense on which markets and with which products and services—and how—based on which competitive advantage—the company competes. The core of the competitive strategy is the company’s unique, attractive—meaning strong Cash Flow generating—and differentiating competitive advantage. The CS is, on the one side, closely linked to the Core Value Proposition (CV) and, on the other side, with the company’s competitors as a competitive advantage has always to be defined from a “relative view”. CS is also the origin of a strong Cash Flow (CF) generating model. For M&A purpose the CS is decisive for the JBD as it defines the transaction rational. 2. Customers and Markets (CM) are, besides the customer relationships (CRs) and channels (CHs), one of the three closely related customer parts of a Business Design. They describe around which customer groups, characterized by their specific pattern of needs and behaviours, a Business Design is built. Customer segments are intertwined with the company’s core value proposition (CV) and its specific product and service offerings, which fulfill a specific use-case for the targeted customer segment. Customer segments also mirror the willingness to pay for a defined value proposition and have therefore an impact on the revenue driver of the Cash Flow model (CF). Typical patterns are mass-market offerings which do not distinguish

2.6  Frontloading of Integration Approach Blueprint

79

between different segments, diversified customer segments with specific needs, multi-sided markets with several customer groups dependent on one another, or niche market segment applications (Osterwalder and Pigneur 2010, pp. 20–21; Schallmo 2014). Within an M&A context, the attractiveness of the target’s key customers and markets serves often as the true transaction rational. 3. Core Value Proposition (CV) addresses an important customer need or use-case. The CV is the “northern star” of a Business Design, as it has an impact on all other elements of the Business Design. The CV summarizes all for the targeted customer segment valuable products, services or digital offerings, which contribute to solving a specific customer problem. CVs could be built around innovative solutions to deliver on so far unfulfilled customer needs, like streaming solutions in the media industry or the first social media networks. Other CV approaches are built upon product or service performance improvements, tailored products and services for specific customer segment needs, CVs addressing status, prestige or image, or customer co-creation to customize offerings (Osterwalder and Pigneur 2010, pp. 22–25; Schallmo 2014). In case of transactions the joint CV integrates the offerings of the acquirer and the target and create in a best case a more valuable customer experience than the two standalone offerings in the sense “1 + 1 > 2”. Especially string-of-pearl M&A approaches typically supplement product offerings with additional product and service solutions building system offers. 4. Customer Relationships (CR) are the bridge between the CV offered by the company and the needs of specific CM. CRs should foster a deep customer understanding, including their real needs, as this understanding is mandatory for any customer acquisition. Besides, CRs should initiate customer feedback loops between the company and its customers, as this enables customer retention, loyalty and the exploitation of a share-of-wallet optimization by cross-selling opportunities. Traditional CRs are built by sales personal and assistants on the shop floor or by technically enabled support through call centres or online chats. The trade-off within the CR strategies is between the higher cost competitiveness of online solutions and the potentially deeper customer insights by personal interaction. But the newest artificial intelligence solutions and big data approaches might combine the best of both approaches. A sensitive integration of the CR is a mission-critical task for M&As to assure customer retention. 5. Channels (CH) transfer the CP to the customer. Channels are used as an umbrella term for all communication, distribution and as well sales channels which are levered by a specific Business Design to get in contact with targeted CMs, to inform them about the company’s specific service and product offerings (CVs), to enable customers to evaluate those and last not least to physically or virtually deliver products and services, which includes after-sales services and support. A company might scale its own channels like branches, internet pages, online shops or deliver own offerings through partner networks and distribution channels. Especially web-based channels and customer access are nowadays strong arguments for acquisitions, especially in markets with strong platforms. 6. Core Assets (CA) describe all mission-critical tangible and intangible assets as well as human resources which enable a specific CV. By exploiting CAs, the company develops, manufactures, offers, and sells its products and services. CA could be described along the value stream of a company. They are often not only characteristic for a defined Business Design but as well for an overall industry, especially if a dominating Business Design exists. In case these assets are owned by the company they are CAs. Alternatively, the company might source or acquire those assets from their co-operation partners and ecosystem (CE). Nowadays intangible assets, like brands, patents, licenses or know-how are in multiple industries the true source of competitive advantage and therefore the crucial CAs. In a transaction context, the streamlining and coordination of the CAs on the acquirer’s and target’s side are important mid- to long-term deliverables of the Integration Management.

80

2  Embedded M&A Strategy

7. Core Capabilities (CC) are a further source for competitive advantage, as Prahalad and Hamel described in their landmark paper on “the Core Competence of the Corporation” (Prahalad and Hamel 1990). A CC could be e.g. manufacturing excellence in the automotive industry, best in class research skills in the pharmaceutical industry, outstanding brand management in the fashion or luxury goods industries, benchmark problem-solving skills in consulting or other service businesses, as well as global platform and network capabilities in social media, e-commerce or online search. It is a characteristic of CCs that they are deeply embedded with the Business Design and are decisive for the uniqueness of the company’s competitive advantage (CS) and its offerings (CV). Like CMs are CC nowadays important arguments to acquire a target, as M&As are a much faster way forward to get access to ­mission-critical core capabilities. 8. Co-operation Partners (CP) frame the key suppliers and ecosystem partners which contribute to the inner workings of a Business Design and are important for a holistic CV fulfillment. Co-operations must be mutually beneficial and could be of various types like simple buyer-supplier relationship, alliances, as in the Japanese Keiretsu systems, or even JVs. Co-operations often intend to realize economies of scale or getting access to complementary resources and capabilities (Osterwalder and Pigneur 2010, p. 39; Feix 2017). 9. Cash Flow Model (CF) is the financial architecture of the Business Design which assures value creation by delivering through CR and CH, based on the company’s CA and CC, a defined CV to a specific CM. The value drivers of the CF could be decomposed in revenue, cost, balance sheet and financial drivers. This extends the view of traditional business model approaches, which focus foremost on revenue streams and cost structures (Gassmann et al. 2017). A more value-based view is essential within an M&A and synergy context. Revenue drivers are foremost based on delivering an attractive CV to customer segments. They may be built upon one-time payment transactions like single product sales or recurring revenues like in the case of membership fees of Netflix, Amazon Prime or the likes. Alternative revenue designs might be licensing models, brokerage fees, usage fees like telecommunication companies charging fees per call minute, or leasing and rental payments which depend on the length of a product or service usage. Cost drivers are closely linked to the CAs, CCs and CPs. Their relative importance is Business Design specific. Typical drivers are development costs, the purchase or acquisition of CAs or from co-operation partners, the manufacturing of products and services, and the delivery process through CH and CR activities. According to Porter’s traditional competitive strategy approach, cost leadership may serve for some companies and business models as an own source of competitive advantage, especially in case of economies of scale or scope, while other companies might compete on value creation and differentiation (Schallmo 2014) and therefore on revenue stream optimization. As the CAs are an important part of the Business Design their financial implication, meaning the balance sheet—at least for tangible assets -, is the third important part of the FCF drivers. As described in the CA section, a shift from tangible to intangible, foremost off-balance assets is typical for many Business Designs. The fourth and ultimate part are financial drivers with an impact on the cost of capital or with tax implications. All four drivers are the key inputs for any valuation and the synergies within an M&A framework. 10. Corporate Organization (CO) describes the regional, Strategic Business Unit (SBU), headquarters and shared service structure of a company, its defined reporting & governance principles, functional roles and responsibilities, as well as the management layers and responsibilities. The blending, benchmarking and design of a joint organizational architecture, as well as the definition of management responsibilities, might be one of the toughest parts of integration processes.

2.6  Frontloading of Integration Approach Blueprint

81

The 10C Business Design is applicable for the Diagnostics of the Standalone Business Design of the target company and the acquirer, as well as for the Blue-Print of a potential Joint Business Design: (Pre-transaction) Standalone Business Design Diagnostics The first assessment of the target’s and the acquirer’s Business Design is achieved by a brief description of the 10C Business Design elements and by evaluating each of them with respect to their strength and weaknesses. This will provide the ingredients for the blending of the two Business Designs to achieve a comprehensive overview of the to be expected chances and risks of a potential transaction and integration. Example

The rough principles of the Standalone Business Design Diagnostics are applied in Fig. 2.23 on the USD 65 billion acquisition of US corporation Monsanto by its German competitor Bayer. The starting point was a merger-endgame within the agrochemical industry. The merger of the US players Dow Chemical and DuPont and the acquisition of the Swiss Syngenta Group by the Chines market-leader ChemCina built up significant pressure on Bayer to assess a potential acquisition of Monsanto within this global agrochemical M&A endgame.

+

Monsanto offers potenal for staying compeve in „global agro-endgame“ due to economies of scale and cross-selling

Cooperao-Partners

+

Three mergers driving global agrochemical merger-endgame: • Dow & DuPont • ChemCina & Syngenta • Bayer & Monsanto

Compeve Strategy

Core Assets Consolidaon of

+ -

manufacturing footprint Monsanto brand reputaon

Global partnering with research instuons and leading universies

Core Capabilies

+ +

Core Value (PropoSion)

+

Monsanto product porolio

Strong sales capabilies

Healthy operang margins

Cash Flow

+

Efficient working capital manag.

Customer Relaon

+

Long term farmer relaonships

CHannels

-

Customer & Markets

+ +

Access to US farmers Monsanto‘s global reach

Missing integraon of lobbying

Pending legal disputes

Corporate Organizaon Fig. 2.23   Business Design Diagnostics based on the 10C Business Design: Bayer-Monsanto transaction

82

2  Embedded M&A Strategy

The Standalone Business Design profile of Monsanto provides a first idea about its standalone strength and weaknesses within the global agrochemical market and as an acquisition target. The 10C Business Design profile highlights as well the potential strategic rational of acquiring Monsanto’s capabilities in the global agrochemical endgame. Besides, it makes it transparent that the number of potentially gained strengths of a Monsanto acquisition is at first glance significantly higher than the number of weaknesses. But, if even the degree of strengths and weaknesses would be evaluated, the potential significant loss of the combination of pending legal disputes and potential customer distrust by a negative impact on Monsanto’s brand reputation might outstrip the strengths (Buck 2019). ◄ Joint Business Design Blueprint and Targeted Integration Approach The detailed description of a target’s Standalone Business Design and the blending with the acquirer’s pre-transaction Business Design provides a framework to identify the potential fit of the two Standalone Business Designs and likely integration risks. Furthermore, this assessment is an ideal starting point for the Blue-Print of a winning Joint Business Design as shown in Fig. 2.24: This Blueprint of the Joint Business Design could be stress-tested within the Transaction Management, especially the Due Diligence, concerning applicability, robustness and implementation hurdles. For the Integration Management, this JBD Blueprint Joint Business Design (JBD) Blue Print

Standalone Business Design Diagnoscs & Fit Assessment Acquirer‘s SBD CS SBD Buyer‘s CA CP

CC

CV

Integraon Approach

CR CH

CS CM

CF CO CS CA CP

CC

CV CF CO

CS

Definion of JBD

CA CP

Target‘s SBD

CV

CH

CM

Proof-ofConcept of JBD

CF CO

CR CH

CC

CR

Masterplan

CM

• • • • •

Idenfying integraon risks within the Due Diligence Test of plausibility and robustness of JBD in Due Diligence Definion of integraon tasks, projects, workstreams and Integraon Scorecards Definion of meline and milestones Addressing and management of integraon risks

Fig. 2.24   Business Design fit and integration risks

2.6  Frontloading of Integration Approach Blueprint

83

serves as a first sketch and reference point for the final design. Based on the JBD all the integration details, like the definition of integration tasks, projects, work-streams, scorecards, timelines and milestones could be defined. Last not least, expected integration risks could be addressed as well. The transition of a Business Design is even more powerful if it goes hand-in-hand with a structured Standalone Culture Design Diagnostics and Joint Culture Design Blueprint:

2.6.2 Standalone Culture Design Diagnostics and Joint Culture Design Blueprint Many studies highlight, that culture differences or simply top-management negligence of culture gaps within M&A processes are core hindrances of integration and M&A success. For example, 95% of executives in a latest study of the management consulting firm McKinsey described culture fit as critical element for integration success, but surprisingly 25% see as well still missing culture alignment even as primary reason of integration failures (Engert et al. 2019, p. 2; compare as well PWC 2017; Lau et al. 2012). The cultural differences between two organizations, its management teams and its employees have to be addressed from the very beginning of an M&A project onwards in order to capture the value of the deal, to retain talent, and to avoid culture clashes during the integration which might endanger M&A success. A Culture Design that supports the necessary culture transition and change while capturing the companies’ intended synergies and deal rational is for any transaction a mission-critical ingredient. The management of a detailed cultural integration process might be of paramount concern especially in case of cross-border transactions, where besides gaps in corporate culture values additionally regional culture differences have to be addressed. Nowadays, the acquisition of start-up businesses with their entrepreneurial spirit by multibillion incumbents with a more mature, traditional and often process minded culture is another showcase, where cultural integration issues might decide on a successful transaction or failure. A systematic assessment of culture differences and a smooth transition to the intended joint culture within the integration process is, therefore, an integral part of the E2E M&A Process Design. Nevertheless, cultural integration might be even more challenging than building a Joint Business Design or deliver on synergy capture, as culture and cultural context have a highly tacit touchpoint. This makes cultural change hard to measure, but this is nevertheless mandatory for navigating the transition to a joint value architecture.

84

2  Embedded M&A Strategy

Multiple definitions of the term culture and specifically corporate culture exist for decades (Krober et al. 1952).16 Therefore, as a starting point, a consistent understanding of the term “culture” has to be framed. In a first, very general definition culture might be understood as a set of values, norms, traditions, mind-sets, and patterns which influence our thoughts and behavior, as well as the way how we interact with other humans and our social environment. Culture is important due to multiple reasons. It reduces uncertainty, provides guidance on how to decide and act in untested situations, it creates identity and has as well a substantial impact on how groups interact to deliver on given tasks. Based on this broad definition of the term culture, corporate culture describes the interaction of humans within an organization and with the latter’s ecosystem. It is closely related to the norms, the corporate values, the management style, the broadly accepted behavioural patterns and the symbols within an organization. A healthy culture enables a company to deliver on its overarching strategy. Corporate culture should be understood in the following as a bread of regional, corporate and management style specific values, norms, believes and attributes that guide management and employee decisions as well as behaviors within a given organization. Besides, it frames and navigates the company’s interactions with its ecosystem. One of the very first definitions described corporate culture as “the pattern of basic assumptions that a given group has invented, discovered, or developed in learning to cope with problems of external adoptions and internal integration, and that have worked well enough to be considered valid, therefore, to be taught to new members as the correct way to perceive, think, and feel in relation to those problems (Schein 1984, p. 3). “Corporate culture is a collective phenomenon as its members have a set of common values and share joint beliefs and patterns of orientation. It influences the organization’s employee and management thinking, perceptions and emotions. Therefore, corporate culture acts as a filter which interprets information and categorises them in good or bad. Furthermore, corporate culture is based on experience and therefore is learned. It is developed and shaped by routines within the company which have been successfully applied to achieve corporate targets. Especially these latter characteristics of culture could be used for the culture transition within integration processes. Also, corporate cultures are created by the interaction of the company, meaning its management team and its employees with the company’s internal environment and external ecosystem. Corporate culture is internalized by the employees and the management

16Kroeber

et al. developed a very distinguished understanding of culture in their early landmark paper from 1952 as in their understanding “culture consists of patterns, explicit and implicit, of and for behavior acquired and transmitted by symbols, constituting the distinctive achievements of human groups, including their embodiments and artefacts; the essential core of culture consists of traditional (i.e. historically derived and selected) ideas and especially their attached values; culture systems may, on the one hand, be considered as products of action, and on the other as conditioning elements of further action (Kroeber et al. 1952).”

2.6  Frontloading of Integration Approach Blueprint

85

Strategy Corporate values, believes, norms

Society

Compeve & co-operave ecosystem

Management style: tone-ofthe top

Business Design

CORPORATE CULTURE Regional culture embeddedness

Management & employees

Capabilies

Fig. 2.25   Corporate Culture core and context

in a process of socialization. In so far, corporate cultures are embedded and could only be understood as well as defined within a broader, holistic framework (Fig 2.25). Corporate culture was defined by the company’s specific values, norms, mindsets, practices and behaviours of its management team and employees. A specific company culture is always intertwined with its vision, mission, strategy, Business Design and organizational structure. Besides, if corporate culture is the malaria, the company’s management team, its employees, especially their actions as well as their backgrounds and capabilities, are the mosquito carrier. Therefore, management teams, employees and their values and behave-ours are not only the architects but as well the visible outcomes of any culture change. But not just those internal factors are closely linked to the corporate culture, also external factors like the competitive environment, the wider ecosystem of the company and even the society in which the company is embedded have a significant culture impact. To get a grip around culture complexity, most culture definitions start with the different layers of culture. The so-called iceberg definition separates between the artifacts, which are the visible culture components, like the design of corporate headquarters, applied technologies or the way how management meetings are run, and the two more invisible levels of norms and values, like the definitions of success or the risk appetite, and of basic beliefs, which define the core of the company culture (Schein 1984; Schein and Schein 2018).17 Artifacts could easily be perceived, but could only be interpreted by

17Compare

also the onion model of Hofstede (Hofstede 2011).

86

2  Embedded M&A Strategy

an assessment of the deeper routed levels of corporate cultures. Artifacts are the tangible symbols of culture, like mission statements on posters, or the statues associated with top management offices, company cars or corporate headquarters. Besides, they cover intangible forms, like management attitudes within board-meetings or simply the massages implicitly included in the walk-and-talk, whereby those intangible forms might be even more powerful in influencing and forming the corporate culture than tangible ones (Kennedy and Moore 2003; DePamphilis 2015, p. 227). Corporate values, as a bridge between the materialized elements of organizational cultures as well as the basic beliefs, are only partially visible. Values are created over time and guide individual behaviours. Basic beliefs are created by routines and learning loops of successful solutions (Schein and Schein 2018). The pattern of solution is thereby partially based on intentional and unintentional values. A continuous confirmation of values transforms them into beliefs, which are long-term and deeply organizational ingrained opinions of the environment, the company and employee behaviours. Another important separation is between strong and weak corporate cultures, whereby strong and weak have no normative meaning, as a strong culture could impact a company positively or negatively. Strong cultures are characterized by clear and dominant attitudes and values, which are accepted and followed by the management team and most employees. Strong cultures provide organizations with stability and orientation. This might reduce uncertainty and misinterpretations due to the homogeneous preference system in decision-making processes. Further, a strong culture might support a consistent execution of the corporate strategy and foster the motivation of the employees due to a joint pattern of behaviours, consistent values and a broad acceptance of joint beliefs. Nevertheless, a strong culture could also lead, especially during times of change like in integration processes, to hindrances or delays in necessary adjustments and ­re-organisations. This is especially the case if the new Culture Design is inconsistent with the so far established and accepted norms and values of the company. On the other side, weaker cultures, like in the case of many start-up companies, might have the advantage to foresee changes in their ecosystem at an early stage and by being more openminded to rapidly adjust the own Business and Culture Design. Given this complexity and interdependencies of corporate cultures, three interdependent layers might be defined which summarize together a consistent corporate culture, as shown in Fig. 2.26. The three layers are defined as:18 – the corporate value footprint – the management style described as tone-on-the-top and – the regional culture embeddedness

18Carleton and Lineberry (2004, 20–22) as well as Rootig et al. (Rottig et al. 2017) sperate the national from organizational culture footprints.

87

2.6  Frontloading of Integration Approach Blueprint

Corporate value footprint 1

• Ecosystem (customer) oriented vs. inward centric • Entrepreneurial, innovaon spirit vs. process excellence • Agile vs long-term orientaon • Diversity vs “one company” spirit • Team oriented vs. individualisc • Indirect, diplomac vs. direct communicaon

Corporate Culture

2

3 Regional culture embeddedness • • • • •

Low vs. high power distance Individualism vs. collecvism Masculinity vs. Femininity High vs. low uncertainty avoidance Long term vs. short term orientaon

Management style t-o-t-t

• • • • • •

Delegaon vs. control leadership style Team vs. top-down decision making Fostering creavity vs. structured thinking Fast soluon vs. excellence driven Risk taking vs. risk avoidance Target vs. operaonal driven

Fig. 2.26   Corporate Culture: Corporate values, management style and regional culture embeddedness

The management style is an integral part of the corporate culture and values, but as the “tone-on-the-top” has a decisive impact on values and behaviors, the management style is seen here as a separate layer. Each of those culture layers could be described and specified by a characteristic set of drivers. To get on the one side a detailed pattern of a specific corporate culture, and on the other side to be able to identify culture gaps between two companies, each of those drivers should be supplemented by antipodes, meaning contradicting extremes, and a suitable scaling. For example, for the layer “management style” the criteria “leadership attitude” could be characterized by the antipodes of “full delegation versus control attitude”. Which kind of drivers are counted as characteristic for a culture pattern is still an open debate and it is not the intent of the following to find an ultimate culture framework. Therefore, the following suggested structure shows one possible approach, but obviously not the only sensible one. The target of this framework is to make culture transition from two independent Standalone Cultures to on joint high-performance culture a seamless journey: The corporate value footprint might be described by the following set of characteristic drivers and their pairing of antipodes:19 – Centricity: Ecosystem (e.g. customer) oriented versus inward (e.g. efficiency) centric – Spirit: Entrepreneurial, innovation spirit versus process excellence

19Compare

with the criteria in the models of Hofstede (2011); Cartwright and Cooper (2014).

88

– – – –

2  Embedded M&A Strategy

Mindset: Agility driven versus long-term, strategy driven Diversity: highly diverse versus “one company” (paternalistic) spirit Group values: Team oriented (sharing culture) versus individualistic (competitive) Communication: Indirect, diplomatic, non-hierarchical versus direct and hierarchical

The supplementing management style (tone-of-the-top) could be described by a further set of specific drivers and antipodes:20 – – – – – –

Leadership attitude: Delegation, decentralized versus control, centralized Decision making and accountability: Team/collectively versus top-down/individually Corporate spirit: Fostering creativity versus structured thinking Working principle: Fast solution versus excellence driven Risk tolerance: Risk-taking versus risk avoidance Achievement drivers: Target versus operational driven

Last not least, the regional culture embeddedness might culminate in the following criteria, which are based on Hofstede’s breakthrough work on regional and national culture differences (Hofstede 2011): – Power distance: Low versus high. Power distance describes on the one side in how far members of a society accept inequalities. Low power distance means that hierarchies are not important and members of a society will interact on the same level. High power distance societies accept authoritarian behaviors, even if those limit their own development possibilities. – Social “contract”: Individualism, loosely-knit versus collectivism, tightly-knit. The social contract describes the relationship of humans to their environment and society. Collectivism means that the core value of a society is to be part of a group in the sense of a large family and group interests are perceived as more important than individual interests and vice versa for individualistic societies. – Co-opetition: Masculinity, competitive versus femininity, cooperative. A masculine society is performance oriented and gender is strictly separated, whereas in feminine cultures social behaviors dominate and tolerance and cooperation play a much more important role than gender and competitive behavior. – Uncertainty avoidance: High versus low. Uncertainty avoidance describes how far members of a society try to avoid risky and unknown situations. In societies with high uncertainty avoidance rules and regulations will dominate to limit uncertainties of day-to-day situations, whereas low uncertainty avoidance societies accept uncertainties. The latter might use time in a relative sense, meaning punctuality might not be an important criterium.

20For

the impact of managerial behavior in integration projects compare also Creasy et al. (2010).

2.6  Frontloading of Integration Approach Blueprint 1

2

Corporate value footprint 2

3

Entre1 preneurial

2

3

4

5

6

7

5

6

7

Spirit 4

Inward centric

Low

1

2

3

Process Collecvism 1 excellence

2

3

Midset Agility focus

1

2

3

4

5

7 Long-term focus

6

Diversity Highly diverse

1

2

3

4

5

6

7

2

Diplomac 1

2

3

4

5

4

5

6

7

High

5

6

7

Individualism

3

One company

Femininity 1

2

3

Longterm 1

2

7

Individualisc

6

7

Direct

2

4

4

3

4

4

6

7

Control

6

7

Topdown

5

1

2

6

7

Low

5

6

7

Masculinity

6

7 Shorerm

5

3

4

5

Corporate Spirit

5

Gender 4

3

Decision making Team

Uncertainty avoidance High

2

6

Delegaon 1

Group

1

Communicaon 3

Management Style t-o-t-t Leadership atude

5

4

Orientaon

Group values 1

Team

3

Regional culture embeddedness Power distance

Centricity Ecosystem 1 centric

89

Creavity 1

2

Fast 1 soluon

2

3

4

5

7

6

7 Excellence

6

7

Risk avoidance

7

Operaonal

Working principle 3

4

5

Risk tolerance

Risk taking

1

Target driven

1

Structure thinking

6

2

3

4

5

Driver for decisions 2

3

4

5

6

Fig. 2.27   Culture Design Map: Drivers and measures for Corporate Culture Diagnostics

– Normative orientation: Long term versus short term orientation: The normative orientation assesses the role of the future, the present and the past for culture. Long term orientation in this understanding is an orientation towards the future and values like austerity or persistence might dominate. In a short-term normative pattern, the past and present play a more important role and traditions are of major importance (Fig. 2.27). For a more detailed view of culture patterns, each antipode of the corporate culture layers is measured by a standardized grading system. The granularity of the culture assessment could be even increased by defining a second layer of sub-criteria for each of the top-criteria.21 E.g., the first pairing of the management style “delegation vs control orientation of the leadership style” might be assessed with measurable sub-criteria like how centralized or decentralized an organization is designed or how decision processes are structured. Corporate Culture Diagnostics at Work: A Digital Start-up Culture Pattern

Each culture pattern of a digital start-up business is somehow unique. Nevertheless, a couple of common grounds exist, as most of them are empowered by developing and scaling technical capabilities within an entrepreneurial ecosystem, having a more informal working environment and loosely defined job-profiles and career paths. A digital

21This deep-grained corporate Culture Design approach with a 2 level structure will be assessed in an international benchmark and research project in 2020.

90

2  Embedded M&A Strategy

culture reputation is also a driver for the acquisition and retention of critical, especially digital talent due to its promise of a collaborative and creative working environment. The management style and decision-making process are foremost highly informal, and compensation most likely based on performance-based measures, like, for example, stock options or even intangible values. Status symbols, like large individual offices or company cars, are on the other side untypical (DePamphilis 2015, p. 227). The following might just be a short-cut of criteria of a typical digital start-up Culture Design:22 – Centricity: Typically, digital native cultures are more outward, ecosystem centric, meaning that they take customers and ecosystem-partners to the center position for the development, manufacturing and delivery of customer solutions. – Group values: Start-up value system put collaboration and team efforts in most instances on top and not individual stardom. Digital cultures are strongly team based and interactive. – Spirit: Digital cultures encourage boldness and entrepreneurship over perfectionism. A trial and error attitude combined with a fast learning and scaling approach applying sprint-based processes is foremost the preferred innovation attitude. Taking a risk to achieve the intended goal is accepted, status-quo and old habits neglectable. – Leadership attitude: Digital native management teams use in most instances a more on delegation based mindset then control, fostering participation and identification. – Working principle: Fast action and scaling is more important than detailed planning, as digital cultures promote speed, multiple track trials, scrum approaches and continuous iterations with feedback loops. – Decision drivers: Digital teams intend to achieve results and are committed to their work and the company’s purpose and strategy. Insofar, they are clearly target driven. Applying the multiple criteria Culture Design footprint based on the three culture layers might provide a typical, but not tailored Culture Design Map (CDM) for digital start-up businesses (Fig. 2.28) ◄

22Compare Ahern

et al. (2019) and the manifesto for agile software development.

2.6  Frontloading of Integration Approach Blueprint 1

2

Corporate value footprint 2

3

Entre1 preneurial

2

3

4

5

6

7

5

6

7

Spirit 4

Inward centric

Low

1

2

3

Process Collecvism 1 excellence

2

3

Midset Agility focus

1

2

3

4

5

7 Long-term focus

6

Diversity Highly diverse

1

2

3

4

5

6

7

2

Diplomac 1

2

3

4

5

6

7

High

5

6

7

Individualism

2

3

One company

Femininity 1

2

3

Longterm 1

2

7

Individualisc

4

5

6

7

Direct

2

4

4

3

4

4

6

7

Control

6

7

Topdown

5

1

2

6

7

Low

5

6

7

Masculinity

6

7 Shorerm

5

3

4

5

Corporate Spirit

5

Gender 4

3

Decision making Team

Uncertainty avoidance High

1

6

Delegaon 1

Group

Communicaon 3

Management Style t-o-t-t Leadership atude

5

4

Orientaon

Group values 1

Team

3

Regional culture embeddedness Power distance

Centricity Ecosystem 1 centric

91

Creavity 1

2

Fast 1 soluon

2

3

4

5

7

6

7 Excellence

6

7

Risk avoidance

7

Operaonal

Working principle 3

4

5

Risk tolerance

Risk taking

1

Target driven

1

Structure thinking

6

2

3

4

5

Driver for decisions 2

3

4

5

6

Fig. 2.28   Typical pattern of a start-up Standalone Culture Design Map (CDM)

SCD Diagnoscs Blending of the Standalone Cultures Designs (SCDs) and culture gap assessment

JCD scaling Measure JCD transion and implementaon success and foster winning culture values

Joint Culture Design

JCD Blueprint Definion of the intended Joint Culture Design (JCD) as new value architecture

JCD transion Transion of Standalone Cultures Designs (SCDs) to new intended Joint Culture Design (JCD)

Fig. 2.29   Standalone Culture Design (SCD) Diagnostics, Joint Culture Design (JCD) Blueprint and Transition

Given this corporate culture understanding, the four milestones for the transition to an intended Joint Culture Design could be defined (Fig. 2.29): The starting point in designing a new corporate culture is a detailed Culture Design Diagnostic, being defined as an assessment of the pre-transaction Standalone Culture Designs (SCD) of the target and the buyer, by evaluating the three layers of the corporate culture in detail. For the assessment of the SCDs a set of advanced diagnostic tools

92

2  Embedded M&A Strategy

like management and employee interviews, one-on-one deep dives, surveys, questionnaires, focus groups or management style observations, and external data, like benchmarks, reports or web-based information23, might be used. A broad set of tools should be applied to get a broad culture understanding, as social-media-based assessments or surveys might offer a broad, but therefore not so detailed culture understanding, whereas in-depth or one-by-one interviews might offer deep, but maybe not fully representative culture insights. Especially the deeper grounded cultural criteria like values and basic beliefs could only be fully understood by in-depth interviews of the management or focus groups. Therefore, Culture Diagnostics is an iterative process along which a more and more detailed culture understanding should be gathered. Based on this in-depth culture understanding of the SCDs their similarities and differences can be analyzed by a structured Culture Gap assessment (Siegenthaler 2009, pp. 147–149; Carleton and Lineberry 2004, pp. 53–60). In a second step, and in close alignment with the SCD Diagnostics and the Culture Gap assessment the targeted new Joint Culture Design (JCD), framing and codifying the intended values, principles, believes and norms for the new joint company is derived. Comparing the intended JCD with the given SCDs highlights the necessary culture transition and the most likely culture assimilation challenges. Implicitly, this also defines the degree of the culture transition of the target’s and the acquirer’s culture footprint (acculturation process). The chosen degree of culture transition has to balance the necessary partial preservation of the target’s and acquirer’s culture with the necessary need for alignment in the sense of a joint value mindset. If those culture footprints are combined with existing culture typologies and theories, an even more powerful culture understanding and crafting of a Joint Culture Design is possible. An older culture typology from Deal and Kennedy (Deal and Kennedy 1989) is a two-dimensional approach, using on the one side the risk attitude of the company’s market and on the other side the speed between corporate action and market response. This approach could be smoothly linked to a couple of the discussed cultural assessment criteria. The bet-your-company culture is characterized by high-risk attitude, but slow response time of the market. Decisions are well-thought, the investment focus is ­long-term, and the product focuses on high-quality, innovative solutions. The process culture describes a combination of low risk and slow response time, which might be characteristic for a couple of traditional industries and incumbent’s Business and Culture Designs. Formalities and process standards are common. The tough-guy culture and the work hard/play hard culture are based on a fast market response and short-term success, where the first is exposed to higher risk and is driven by individualism, whereas the latter being exposed to lower risk attitude and a belief that persistence and endurance are the success formula.

23For SCD Diagnostics websites as LinkedIn.com, Xing.com or Glassdoor.com might provide, at least a partial, insider perspectives on a company’s corporate culture.

2.6  Frontloading of Integration Approach Blueprint

93

Culture Integration Approaches: The model of Nahavandi and Malekzadeh One of the first culture integration concepts was the acculturation matrix of Nahavandi and Malekzadeh (Nahavandi and Melekzadeh 1988), which applies two dimensions, the relationship between the acquirer and the target and the degree of culture preservation of the target, thereby defining four typical acculturation patterns (Fig. 2.30) The integration and assimilation approach are characterized in the Nahavandi and Malekzadeh model by a positive relationship between the acquirer and the target, which might be the case in a merger or friendly takeover situation. The difference is that in case of an integration approach the acquirer’s and the target’s Culture Designs will have a more or less balanced impact on the Joint Culture Design and the target’s culture will be partially preserved, whereas in the assimilation approach the target will accept and implement most of the culture elements of the buyer, thereby giving up its own ­pre-transaction specific culture identity. Not surprisingly, the integration approach is in case of a merger the more suitable Joint Culture Design approach. Segregation and deculturation are on the other side exposed to a deteriorated relationship between the acquirer and the target, e.g. due to an unfriendly takeover attempt of the acquirer. In case of segregation, additionally, the integration of the stand-alone cultures is not realized, therefore leading also in the post-transaction phase to a m ­ ulti-culture footprint. The degree of integration might be limited here to a pure financial integration. Within the deculturation, neither an intense implementation of the acquirer’s

Buyer-target relaonship

good

Integraon

Segregaon

bad

Assimilaon

Deculturaon

high

low

Degree of culture preservaon Fig. 2.30   Culture integration model of Nahavandi and Melekzadeh (1988)

94

2  Embedded M&A Strategy

culture mindset is achieved, nor the target’s employees perceive their own culture as ­well-performing, which leads to a deculturation. But due to the missing culture understanding, these two latter approaches are exposed to a significant failure rate with respect to the culture integration within a transaction. Culture Integration Approaches: The model of Olie Olie’s model of cultural integration is based on the approach of Nahavandi & Malekzadeh, but separates between a merger or an acquisition environment and integrates three layers by adding a regional culture perspective (Olie 1990). The three layers used by Olie are: • the integration intensity, • the way or power distance within the cultural integration, and • the attractiveness of the own and the foreign culture. If the integration intensity is low, the focus of integration will be more or less limited on financial systems, and high, if an overall integration of the Business Design is intended and therefore significant cultural changes for the employees on the acquirer and the target side are to be expected. According to Olie, with the intensity of integration also the resistance to change might increase. The way of cultural integration and change distinguishing between co-operation, which is a balanced approach, and dominance, where there might be a significant power distance between the acquirer and the target. The attractiveness of their own and the partners’ regional culture is seen from the perspective of the acquirer and the target. Based on the intensity and the power distance of integration Olie described four typical integration patterns, which he called initial configurations (Olie 1990; Fig. 2.31): – Portfolio acquisitions are described by a low integration intensity and a balanced power of the acquirer and target. Culture disruptions are minimal, as the acquirer’s integration efforts are low and are based on a co-operative style. – Redesign acquisitions have as well a low integration intensity but a strong power distance. The acquirer as the dominating party has a significant influence on the target, in an extreme case exchanging the target’s management team before the integration even starts. – In case of absorption acquisition, the intensity of integration as well as the power distance is high and the driver is most likely significant intended synergies. This might be often the case in horizontal acquisitions. – Last not least, the merger case is characterized by a high integration intensity with low power distance by combining two strong companies. The potential of culture clashes is high as two strong culture patterns are merged. The solution might be the design of a third, “one company” culture, but demands adjustments on both strong SCDs and an acceptance of change.

2.6  Frontloading of Integration Approach Blueprint

• • • • •

Buyer Moves Expectaons Bargaining power Aracvity of partner Keeping own identy

• • • • •

95

External impacts Industry structure Market condions Legal restricons Polics Socio-polical framework

• • • • •

Target Moves Expectaons Bargaining power Aracvity of partner Keeping own identy

Powerdistance

Co-operaon

Dominang

Porolio acquision

Redesign acquision

low

Merger

Absorpon acquision

Degree of integraon

high

Fig. 2.31   Culture integration models (initial configurations) of Olie (1990)

A more detailed, tailored, and transaction specific culture integration approach for the transition to the intended Joint Culture Design is feasible by applying the three culture layers, the corporate culture value system, the management style and the regional culture embeddedness. The first advantage is, that this culture understanding and definition are based on multiple criteria. Second, it enables a detailed and consistent comparison of the acquirer’s and the target’s culture pattern. By mapping the two SCDs, the detection of potential culture gaps is possible and could be addressed at an early stage. Additionally, it makes it more transparent that in today’s highly dynamic ecosystems also on the acquirer’s side there might be certain needs to adjust the own SCD for achieving a winning JCD. Last not least, the most suitable JCD pattern could be applied to design a ­tailor-made culture integration approach and transition. Such a tailored, transaction specific approach has to answer questions like: – In line with the JBD approach, should there be a cultural alignment between the target and the acquirer or should the stand-alone cultures more or less be retained? – Should the target’s SCD be adjusted to the buyer’s SCD or should there be a blending of the two SCDs in the sense of a best-of-both, new “one” company approach? – Which parts of the culture footprint should be aligned, and which ones not, meaning keeping culture value independence? – What could be a suitable joint value and culture footprint in the sense of a truly Joint Culture Design? (Fig. 2.32)

96

2  Embedded M&A Strategy

Culture Integraon Approaches

Keep Standalone Culture Designs 1

Corporate value footprint

Centricity 1 2 3 4 5 6 7

2

Regional culture Embeddedness

Power distance 1 2 3 4 5 6 7

3

Management style Leadership atude 1 2 3 4 5 6 7

Tailored Culture Design Transion 1

Corporate value footprint

Centricity 1 2 3 4 5 6 7

2

Regional culture Embeddedness

Power distance 1 2 3 4 5 6 7

3

Transion to Joint Culture Design 1

Management style Leadership atude 1 2 3 4 5 6 7

Corporate value footprint

Centricity 1 2 3 4 5 6 7

2

Regional culture Embeddedness

3

Management style Leadership atude 1 2 3 4 5 6 7

Power distance 1 2 3 4 5 6 7

Spirit 1 2 3 4 5 6

Group 1 2 3 4 5 6 7

Decision making 1 2 3 4 5 6 7

Spirit 1 2 3 4 5 6

Group 1 2 3 4 5 6 7

Decision making 1 2 3 4 5 6 7

Spirit 1 2 3 4 5 6

Group 1 2 3 4 5 6 7

Decision making 1 2 3 4 5 6 7

Midset 1 2 3 4 5 6 7

Uncertainty 1 avoidance 2 3 4 5 6 7

Corporate Spirit 1 2 3 4 5 6 7

Midset 1 2 3 4 5 6 7

Uncertainty 1 avoidance 2 3 4 5 6 7

Corporate Spirit 1 2 3 4 5 6 7

Midset 1 2 3 4 5 6 7

Uncertainty 1 avoidance 2 3 4 5 6 7

Corporate Spirit 1 2 3 4 5 6 7

Diversity 1 2 3 4 5 6

Gender 1 2 3 4 5 6 7

Working principle 1 2 3 4 5 6 7

Diversity 1 2 3 4 5 6

Gender 1 2 3 4 5 6 7

Working principle 1 2 3 4 5 6 7

Diversity 1 2 3 4 5 6

Gender 1 2 3 4 5 6 7

Working principle 1 2 3 4 5 6 7

Group values 1 2 3 4 5 6 7

Orientaon 1 2 3 4 5 6 7

Risk tolerance 1 2 3 4 5 6 7 Driver for decisions 1 2 3 4 5 6 7

Group values 1 2 3 4 5 6 7

Orientaon 1 2 3 4 5 6 7

Risk tolerance 1 2 3 4 5 6 7 Driver for decisions 1 2 3 4 5 6 7

Group values 1 2 3 4 5 6 7

Orientaon 1 2 3 4 5 6 7

Communicaon 1 2 3 4 5 6 7

Communicaon 1 2 3 4 5 6 7

Risk tolerance 1 2 3 4 5 6 7 Driver for decisions 1 2 3 4 5 6 7

Communicaon 1 2 3 4 5 6 7

Target SCD Transion to Buyer’s SCD

Best-of-Both JCD (one new company)

Culture Diagnoscs during Due Diligence Test of intended Joint Culture Design (JCD) with respect to feasibility, applicability and robustness

Fig. 2.32   Culture integration decision tree and Joint Culture Design (JCD) approaches

Technically, the Joint Business Design is developed in three steps: The first step is to map the two SCDs in one graph, in a second step the culture gaps between those SCDs are assessed and in the last, the third step, the JCD Map is defined along the questions of the culture integration decision tree and the Culture Design criteria. This involves decisions which characteristics of the acquirer’s and the target’s cultural pattern to integrate and which ones to leave untouched, to avoid or limit culture clash. By comparing the SCDs with the intended JCD the necessary culture transition for both companies could be derived and initiated. Assessing Culture Gaps and Defining the Joint Culture Design (JCD) Blueprint

Not only the differences in size, complexity and regional origin of the acquirer and target, but as well the maturity of the two companies might have a decisive influence on cultural patterns. For example, in case of a start-up acquisition by an incumbent, as a starting point for the SCD Diagnostics, the before described pattern of a typical start-up Culture Design Map could be used, where the incumbent culture pattern is added. The latter might be characterized briefly by a more structured organization, clearly defined top-down decision-making processes and job profiles, traditional compensation benefits and a process excellence mindset throughout the organization. In the below SCD Map the grey line in Fig. 2.33 might indicate the culture pattern of a start-up business. Additionally, the pattern of the acquirer, which should be the incumbent within a traditional industry in another country, is depicted in

2.6  Frontloading of Integration Approach Blueprint

1

2

Corporate value footprint 2

3

Entre1 preneurial

2

3

4

5

6

7

5

6

7

Spirit 4

Inward centric

Low

1

2

3

Process Collecvism 1 excellence

2

3

Midset Agility focus

1

2

3

4

5

7 Long-term focus

6

Diversity Highly diverse

1

2

3

4

5

6

7

2

Diplomac 1

2

3

4

5

6

7

High

5

6

7

Individualism

2

3

One company

Femininity 1

2

3

Longterm 1

2

7

Individualisc

4

5

6

7

Direct

Start-up Culture Map

2

4

4

3

4

4

6

7

Control

6

7

Topdown

5

1

2

6

7

Low

5

6

7

Masculinity

6

7 Shorerm

5

Incumbent Culture Map

3

4

5

Corporate Spirit

5

Gender 4

3

Decision making Team

Uncertainty avoidance High

1

6

Delegaon 1

Group

Communicaon 3

Management Style t-o-t-t

Leadership atude

5

4

Orientaon

Group values 1

Team

3

Regional culture embeddedness Power distance

Centricity Ecosystem 1 centric

97

Creavity 1

2

Fast 1 soluon

2

3

4

5

7

6

7 Excellence

6

7

Risk avoidance

7

Operaonal

Working principle 3

4

5

Risk tolerance

Risk taking

1

Target driven

1

Structure thinking

6

2

3

4

5

Driver for decisions 2

3

4

5

6

JCD Map

Fig. 2.33   Standalone Culture Design (SCD) Map of start-up and incumbent and JCD Map

black. The comparison of the two SCD lines provides a detailed culture gap assessment and shows significant culture differences. Based on this understanding of the ­pre-transaction SCD footprints and the culture gap, the intended JCD and culture integration strategy is defined by the dotted line. A set of common values and goals combined with the jointly defined vision might be highly supportive of the transition to the new JCD and the overall integration process. The gaps between the SCD and the JCD patterns describe the necessary culture transition, which has to be addressed within the Integration Management in the culture transition program: The comparison of the different Culture Maps provides multiple insights: The standalone cultures of the two companies seem to be quite contradictory, which might be not astonishing given a start-up and an incumbent position. A One Culture integration strategy could be indicated by the dotted line. This JCD footprint might be the outcome where the incumbent tries to innovate also his corporate culture by the transaction and to become more agile and innovation-driven. The challenging side of the strategy would be the necessary, quite significant culture change which is indicated by the distance between the SCDs and the JCD Maps. This highlights that also the acquirer has to adjust significantly the own culture footprint. If the cultural differences are perceived as to be too significant to form one unified JCD an alternative approach would be to focus the culture alignment on a very selective joint cultural value set, but keeping foremost the SCDs at the target and incumbent. This approach has to be aligned with the overall Integration and the Synergy Management, as in this case, a loosely-knit integration might be the most suitable match. ◄

98

2  Embedded M&A Strategy

These so far discussed steps for the definition of a JCD could be Frontloaded already into the Embedded M&A Strategy module. The first SCD Diagnostics, based on CD surveys, selected interviews and focus groups, and the Blueprint for the intended JCD could then be back-tested on plausibility, applicability, and potential implementation risks within the Due Diligence. The transition to the new JCD should be based on a detailed culture-transition program which reinforces the intended values, norms and behaviors, besides fostering engagement and momentum. A successful culture transition depends on a smooth execution of the culture transition, an open communication on the new joint values, a structured approach to bridge existing culture gaps, as well as on the consistent measurement of the culture change by applying e.g. pulse checks and interviews. In the last, fourth step, the implemented JCD might be reassessed and leveraged for the post integration period. A more granular culture transition process, which covers as well the individual workflows, is described in Fig. 2.34, whereas sub-processes three and four will be discussed in much more detail within Chap. 4: For a successful culture transition, a sensitive change program which balances the “new” values of the joint company with the preservation of potentially desirable cultural differences is a challenging task. This can be seen in the before discussed case of a multibillion incumbent which tries to innovate its business model by acquiring a start-up business, but failing to keep the entrepreneurial spirit and momentum once the

SCD Diagnoscs & Gap Assessment Mapping of SCDs of buyer and target on 3 levels: • Regional value embeddedness • Corporate value system • Management style during M&A Strategy phase

Joint Culture Design (JCD) Blueprint Definion of consistent set of core values and norms for JCD

Transion to “New” JCD

Scaling of JCD

 Leverage JCD beyond Transion to JCD by culture transion program integraon process by • Measuring culture • Balancing joint value change architecture with…  Blending culture context, • Reassessing JCD • preservaon of desirable especially with integraon • Adjusng JCD for the culture differences vision, mission, approach long-run and intended synergies  Definion of culture transion program: change  Fostering core values on  Assessing values, norms,  Test JCD Blue Print within champions, test runs, and believes and their roots all organizaonal levels DD on applicability, sequenced rollouts and  Mapping the culture gap: plausibility, robustness workshops similaries vs. differences  Idenficaon of necessary  Top-management between the SCD Maps culture change program iniaves to fosters JCD  Culture Due Diligence with and potenal culture  Measuring culture change • external view on target clashes and mirror with (pulse checks, interviews) • Internal assessment integraon approach 





Intent   

Create holisc, consistent, powerful Joint Culture Design with clear set of joint core values Align new JCD with reason why of acquision and core synergies Avoid culture clash and keep core capabilies and talent ”on-board”

Fig. 2.34   Process model and milestones for the transition to the Joint Culture Design

2.7  Embedded M&A Strategy for Digital Targets

99

integration of the startup within the incumbent’s complex organizational layers starts. For the transition to the new JCD Chap. 4 will provide more details. Last no least, the most important targets for the overall culture integration are summarized: – To create a holistic, consistent and powerful new Joint Culture Design with a focused set of joint core values – To address the necessary culture transition by identifying the SCD Maps and the pre-transaction culture gap – To align and blend the new JCD with the transaction rational and the targeted synergies – To avoid culture clashes and to keep core capabilities and talent on-board

2.7 Embedded M&A Strategy for Digital Targets The strategic rational of transactions involving digital targets is foremost based on getting access to mission-critical digital capabilities, to innovate the own Business Design or to ride blue oceans by creating new markets due to the identification and exploitation of white spots by the target’s and the acquirer’s joint capability mix. This unique pattern demands a tailor-made E2E M&A Process Design for digital targets. It starts in the M&A Strategy phase with the assessment of the future ecosystem, especially market and technology trends, and the identification of attractive white spots. Digital targets and Business Designs lack in most cases historical evidence and their likelihood of success is hard to predict. Additionally, their true competitive advantage is foremost built on intangible assets like IP rights, patents, know-how, platforms or brands, which are much harder to evaluate than tangible assets. Therefore, the precise definition of the intended digital competitive advantage and capabilities is of paramount importance before kicking-off digital M&As. Especially for digital targets the discussion of the appropriate growth strategy within the BMI-Matrix is another important task, as incubating and accelerators offer attractive alternatives. The latter, combined with a loose-knit Integration Approach, might find the right balance for the JBD and JCD between alignment needs and necessary target autonomy to maintain the entrepreneurial start-up spirit and to keep critical digital talent on board (Fig. 2.35). Especially in case of an acquisition of a digital target by an industrial incumbent, the sketch of the JBD and JCD between a successful, but maybe out-aged acquirer driven by process excellence and an entrepreneurial driven, but not jet fully established start-up have to be addressed early on. The synergies of such transactions are in most cases revenue and capability driven and demand the scaling of the new Business Designs. This is in stark contrast to the traditional cost synergy driven consolidation plays and traditional M&A literature. An in-depth assessment, verification—by a detailed Due Diligence, as addressed in

100

2  Embedded M&A Strategy

The End-to-End M&A Process Design for Digital Business Designs Embedded M&A Strategy

#1

#2

• Ecosystem Scan with focus on: − Digital disrupve technologies (IP scan and VC investment flow) − Use-cases: White spots detecon • Embedded M&A Strategy: Idenficaon and assessment of future digital competeve advantage and capability needs • BMI-Matrix for tailored growth strategy • Integraon Approach JBD & JCD Blue Print • Fit Diamond focus on digital targets and capabilies

#4 • • • •

Transacon Management

• Valuaon and (F)DD addressing the unique FCF paern of digital BDs: − High growth rates, but risky and volale FCFs − Foremost B/S light BDs, therefore focus on P&L − JBD & synergy model based on revenue scaling • Applying advanced DCF methods − DCF scenarios and simulaons (Monte Carlo) − Reverse DCF and VC valuaon for back-tesng • Verificaon of Integraon Approach − SBD Blending and JBD Proof-of-Concept − SCD Blending and JCD Proof-of-Concept

Integraon Management

• Tailored Integraon with balance of − Leveraging defined parenng advantage to scale targets SBD − Sustaining targets standalone momentum and BD success factors • Retain and develop crical talent • Implement necessary compliance • Scale targeted culture transion • Back-Track integraon progress

Synergy Management

Idenficaon of digital synergy levers • Back-tesng Synergy Scaling Approach Parenng advantages to scale target SBD • Back-tesng parenng model Revitalize buyer’s SBD by target capabilies • Synergy-valuaon Blending Tailored Synergy Scaling Approach definion

#5

#3

• Rapid scaling of target’s SBD • Focused implementaon of (revenue) Synergy Scaling Approach

M&A Project Management & Governance Digital M&A playbook

Fig. 2.35   Tailored E2E M&A Process Design for digital transactions: Embedded M&A Strategy

Chap. 3—and thorough implementation and tracking of capability- and revenue-based synergies—as addressed in Chap. 4—is therefore mandatory. This might be especially true for: – Cases, where the re-innovation of the buyer’s own SBD is the core intent of the transaction. Examples are cases where the use of digital sales channels and direct customer access of the target might be deployed on the acquirer’s core business – Cases where the definition of totally new markets and use-cases—blue oceans, e.g. by deploying Big Data, AI or VR approaches, like in the pharma industry or B2B business models—are the reason why for the transaction Furthermore, in these kinds of transaction patterns, the buyer clearly has to address its parenting advantage, meaning how the target’s business could be scaled within the acquirer’s Business Design framework and which touchpoints are the most important for the full value leverage of the target’s business. The latter defines instantaneously as well in which parts of its Business Design the target’s business should be kept autonomous. The integration of a digital target is a delicate balance between standalone necessities to further develop the digital business and soft integration where it is mandatory to realize the joint vision. This is especially true for culture issues and the question of how to preserve the digital target’s capabilities, talents and entrepreneurial spirit.

2.7  Embedded M&A Strategy for Digital Targets

101

Due to the importance of digital targets and business model innovations for most industries, the specifics of transactions focusing on digital targets will be discussed at the end of each chapter. Therefore, a closer and more in-depth view on the Embedded M&A Strategy for the acquisition of digital targets and Business Designs is taken here: Embedded M&A Strategy Applied for Digital Targets The Eco-System Scan for digital targets might focus on the assessment of technology trends and the impact of new digital capabilities as well as on new customer use cases driven by innovative products, services or digital solutions. For the Eco-System Scan new digital technologies like big data approaches, artificial intelligence and analytics could be used for the identification, analysis and evaluation of white spots. Here, especially the likelihood to create new, untested markets and breakthrough use cases, as well as the analysis of the connectivity, embeddedness and touch points with other parts of the ecosystem, might be of dominating interest. Based on this in-depth technology and market understanding the future competitive advantage to explore attractive white spots and the therefore necessary set of unique capabilities to create these new, protected blue oceans could be defined. By comparing the existing set of capabilities with the mission-critical capabilities of the future ecosystem the crucial capability gaps may be identified which have to be either closed by in-house business model innovation or by acquiring dedicated target companies having access to those skill sets. The latter might be especially interesting were talent shortages limit in-house developments. The application of the Business Model Innovation ­(BMI)-Matrix to compare alternative growth options like inhouse business model innovation, incubating, accelerators, JVs or acquisitions might provide a holistic view and the selection of the best fitting approach. For the identification of target companies within those attractive white spots, a digital target scan may be applied. Core ingredients of such a digital target search are a detailed IP assessment and tracking by big data mining approaches, semantic text citation and application analytics. Further insights might be gained by verifying the identified investment themes with research institutes, leading universities and industry expert networks. Additionally, by analyzing venture capital and early-stage investment flows within the defined digital search fields, potential technology investment priorities might be identified. For the evaluation and Fit Diamond assessment of digital targets, the typical financial data might be very limited due to the newness of the business. Additional market indicators, like customer win rates, number and size of new customer use cases, social media feedback or technology indicators, like patent filings or co-operations, might be applied to get a broader understanding of the growth potential and attractiveness of the target company. Besides the assessment of the attractiveness of the target’s Standalone Business Design, the draft of the potential Joint Business Design with the dedicated touchpoint between the acquirer and the digital target is sensitive. By applying the 10C Business

102

2  Embedded M&A Strategy

Model Design those parts of the Business Design where the parent might offer advantages for the target to scale its business model could be identified. Additionally, where the parent expects a re-innovation of its own Business Design by the digital capability of the target, the integration or touchpoints of the JBD have to be defined in detail. On the other side and to preserve the maximum amount of autonomy of the target, other parts of the target’s Business Design might be kept independent. The same holds true for the Joint Culture Design.

2.8 Summary of Embedded M&A Strategy Finally, critical cross-checks and questions should serve as a platform to challenge Embedded M&A Strategies, before a summary, with key success factors and takeaways, will close the chapter.

2.8.1 Critical Cross-Checks and Questions The critical cross-checks and question section, which will be applied also for the following modules of the E2E M&A Process Design, defines a brief set of questions which address the cornerstones of an Embedded M&A Strategy and highlight thereby the common route-causes of M&A Strategy failures. Crucial Questions to Challenge Corporate, Strategic Business Unit and M&A Strategies

Review corporate and strategic business unit strategies – What will be the drivers of the future eco-system of the company and its strategic business units? What will be likely technology disruption and which technological capabilities will drive those? What will be the most attractive markets (or, with higher granularity, market segments and use-cases)? – How could the corporate and strategic business unit strategies be described in three sentences to achieve the intended competitive advantage? What are the ­mission-critical core-capabilities to achieve those competitive advantages? – Given this strategy and eco-system assessment, how should the future corporate portfolio be designed in comparison with today’s one? For this transition, what are the crucial portfolio investment and divestment needs to be addressed by M&A? – What are the most important strategic programs and projects to deliver on the intended strategy? Does the company possess all core competencies, talent and resources to execute those strategies or do they have to be acquired by external growth strategies? – What is the targeted and winning Business and Culture Design?

2.8  Summary of Embedded M&A Strategy

103

Design an Embedded M&A Strategy – What should be the contribution of M&A for the corporate strategy and the business unit strategies? How does the M&A approach compare with other external growth and co-operation models and internal growth options as alternatives (application of Business Model Innovation (BMI)-Matrix)? – What are the specific strategic targets, intended value contributions and most likely synergy levers of the acquisition strategy? – How to define a first broad, ecosystem specific target list and a suitable set of selection criteria (definition of tailor-made Fit Diamond)? – How could acquisitions be potentially financed by plowed back Free Cash Flows, equity and debt? – How does the M&A pipeline of attractive targets (from long- to shortlist) look like? – How to challenge and check with respect to robustness the strategic, Business Design, synergetic and Cultural Design fit (the Fit Diamond)? – What would be the potential crucial risks of an acquisition, especially for the integration? How to address and mitigate those? – How could the Joint Business and Culture Design look like? What might be the most suitable Integration Approach?

2.8.2 Key Success Factors and Takeaways The key success factors and takeaway subchapter summarizes24 the most crucial lessons learned of the Embedded M&A Strategy chapter: TAKE AWAY – Embedded M&A Strategy: M&A Strategies should be in-depth embedded in the corporate and business unit strategies. Therefore, the review of the corporate portfolio and business strategies might be a good starting point. An Eco-System Scan may provide insights of the ­mission-critical IP, technology and market developments. – M&A is one of a distinct set of strategic tools for leveraging shareholder value and growth. The Business Model Innovation (BMI)-Matrix compares M&As with alternative value and growth strategies, like Corporate Venture Capital (CVC), incubation, acceleration, JV, alliances and inhouse business model innovation approaches. – Transactions and Embedded M&A Strategies are a double-sided challenge as they must ensure the realization of the intended transaction rational as well as value and synergy capture.

24The key success factors of the five modules of the E2E M&A Process Design will be found at the end of each chapter.

104

2  Embedded M&A Strategy

The strategic rational could be based on portfolio level or strategic business unit level advantages: – M&As might play an important role in renewing the corporate portfolio by the acquisition of new business models and core competencies with a strong strategic and synergetic fit to the existing portfolio, by growing in attractive adjacent market segments which might shape the future of the existing core businesses, a very selective diversification by entering unrelated, but highly attractive businesses where still parenting advantages could be exploited, or last not least by streamlining and restructuring the corporate portfolio by targeted divestments. – M&As on business unit level may rest on differentiation or cost advantages or by acquiring core capabilities. These might be achieved by acquiring target companies offering supplementary products or services (“string-of-pearl” and system-offering M&A Strategies) or allow to enter new markets. On the cost side economies of scale or scope might be a suitable trigger for M&As. – The Tao of Value: A transaction is only value accreditive if the net present value of the synergies is higher than the paid transaction premium. – A holistic view is also recommended for the screening of attractive targets. The Fit Diamond evaluates, besides the standalone attractiveness of the target, the potential strategic, the ­financially-synergetic, as well as the Business and the Culture Design fit. – The Blue Print of the Integration Approach (Collaboration, Alignment or One Company Approach) should be tailored with the strategic needs and the ecosystem of the acquirer and should be Frontloaded into the Embedded M&A Strategy Phase. Especially the Frontloading of Standalone Business Design and Standalone Culture Design Diagnostics, as well as the drafting of the Joint Business Design and Culture Design Blue Print, offers a true ­End-to-End (E2E) view.

References Ahern, C., Donaesastro, M., Hemerling, J., Kilmann, J., & Stutts, L. (2019). It’s not a digital transformation without a digital culture. Boston Consulting Group (ed.). https://www.bcg.com/ digital-bcg/digital-transformation/how-to-drive-digital-transformation-culture. Akbulut, M. (2013). Do overvaluation-driven stock acquisitions really benefit acquirer shareholders? Journal of Financial and Quantitative Analysis, 48, 637–668. Akbulut, M., & Matsusaka, J. (2010). 50+ years of diversification announcements. The Financial Revenue, 45, 231–262. Andreau, P., Doukas, J., Louca, C., & Malmendier, U. (2010). Managerial overconfidence and the diversification discount. Limassol: Cyprus University of Technology. Backer, R. D., Manley, R., & Todd, J. (2019). Fit for the future: Shaping the corporate portfolio. McKinsey & Goldman Sachs 2019. Warwick University Summit 2019: London. Bena, J., & Kai, Li. (2014). Corporate innovations and merger and acquisitions. The Journal of Finance, 69(5), 1923–1960. Best, R., & Hodges, C. W. (2004). Does information asymmetry explain that the diversification discount? Journal of Financial Research, 27, 235–249. Billet, M., & Qian, Y. (2008). Are overconfident managers born or made? Evidence of ­self-attribution bias from frequent acquirers. Management Science, 54, 1036–1055. Buck, T. (2019). Monsanto risk takes root with Bayer investors. Financial Times Online 2019/03/21. https://www.ft.com/content/ba67adba-4b26-11e9-bbc96917dce3dc62?emailId=5c931623bcd2 b90004d98730&segmentId=22011ee7-896a-8c4c-22a0-7603348b7f22.

References

105

Carleton, J. R., & Lineberry, C. S. (2004). Achieving post-merger success: A stakeholder’s guide to cultural due diligence, assessment, and integration. San Francisco: Wiley. Cartwright, S., & Cooper, C. L. (2014). Mergers and acquisitions. The human factor. Elsevier Reference Monographs. Cassiman, B., & Veugelers, R. (2006). In search of complementarity in innovation strategy: Internal R&D and external knowledge acquisition. Management Science, 52(1), 68–82. Chatterjee, S. (2009). The keys to successful acquisition programs. Long Range Planning, 42(2), 137–163. Creasy, T., Stull, M., & Peck, S. (2010). Understanding employee-level dynamics within the merger and acquisition process. Journal of General Management, 35(2), 21–42. Davis, A. A. (2012). M&A integration: How to do it—Planning and delivering M&A integration for business success. West Sussex: Wiley. Deal, T. E., & Kennedy, A. A. (1989). Corporate cultures. The rites and rituals of corporate life (14th ed.). Reading: Addison-Wesley. DePamphilis, D. M. (2015). Mergers, acquisitions, and other restructuring activities (8th ed.). Oxford: Elsevier. Engert, O., Kaetzler, B., Kordestani, K., & MacLean, A. (2019). Organizational culture in mergers: Addressing the unseen forces. McKinsey & Company March 2019. https://www.mckinsey. com/business-functions/organization/our-insights/organizational-culture-in-mergers-addressing-the-unseen-forces. Accessed on 22 April 2019. Feix, T. (2017). Advanced M&A management. Lecture Notes 2019/20. Galpin, T. J., & Herndon, M. (2014). The complete guide to mergers & acquisitions—Process tools to support M&A integration at every level (3rd ed.). San Francisco: Wiley. Gassmann, O., Frankenberger, K., & Csik, M. (2017). Geschäftsmodelle entwickeln: 55 innovative Konzepte mit dem St. Galler Business Model Navigator. München: Hanser. Gaughan, P. A. (2013). Maximizing corporate value through mergers and acquisitions—A strategic guide to growth. New Jersey: Wiley. Grant, R. M. (2013). Contemporary strategy analysis (8th ed.). West Sussex: Wiley. Hamel, G. (2006). The why, what, how of management innovation. Harvard Business Review -Special: Breakthrough ideas for 2006, February 2006, 72–87. Harding, David, & Rovit, Sam. (2004). Mastering the merger—Four critical decisions that make or break the deal. Cambridge: Harvard Business School Press. Hofstede, G. (2011). Culture’s consequences. Comparing values, behaviors, institutions, and organizations across nations (2nd ed.). Thousand Oaks: Sage. Hoechle, D., Schmid, M., Walter, I., & Yermack, D. (2012). How much of the diversification discount can be explained by pure corporate governance? Journal of Financial Economics, 103, 41–60. IDW, & WP Handbuch. (2014). Wirtschaftsprüfung, Rechnungslegung, Beratung (14th ed., Vol. II). Düsseldorf: IDW, WP Handbuch. Kengelbach, J., Kleiburg, G., Gjesrad, K., Nielsen, J., Walker, D., & Walker, S. (2015). From buying growth to building value. The Boston Consulting Group. Worldwide Research. Kennedy, K., & Moore, M. (2003). Going the distance. Why some companies dominate and others fail. Upper Saddle River: Practice-Hall. Kim, C., & Mauborgne, R. (1999). Creating new market space. Harvard Business Review, 1999, 83–93. Kim, C., & Mauborgne, R. (2004). Blue ocean strategy. Cambridge: Harvard Business Review Press. Koller, T., Goedhardt, M., & Wessels, D. (2015). Valuation—Measuring and managing the value of companies (6th ed.). New Jersey: Wiley.

106

2  Embedded M&A Strategy

Krober, A. L., Kluckhohn, C., Untereiner, W., & Meyer, A. G. (1952). Culture. A critical review of concepts and definitions. Papers of the Peabody Museum of American Archaeology and Ethnology, Harvard University, Vol. 47, 1., Cambridge, Massachusetts. Lahovnik, M. (2011). Strategic fit between business strategies in the post-acquisition period and acquisition performance. Journal for East European Management Studies, 16(4), 358–370. Lau, R., Liao, S., Wong, K. F., & Chiu, D. (2012). Web 2.0 environmental scanning and adaptive decision support for business mergers and acquisitions. MIS Quarterly, 36(4), 1239–1246. Magretta, J. (2002). Why Business Models Matter. https://hbr.org/2002/05/why-business-models-matter. Accessed on 14 February 2019. Malmendier, U., & Tate, G. (2008). Who makes acquisitions? CEO overconfidence and the market’s reaction. Journal of Financial Economics, 89, 20–43. Megginson, W. L., Morgan, A., & Nail, L. (2003). The determinants of positive long-term performance in strategic mergers: Corporate focus and cash. Journal of Banking & Finance, 28, 523–552. Müller-Stewens, G. (2010). Mergers & Acquisitions: Eine Einführung. In G. Müller-Stewens, S. Kunisch, & A. Binder (Eds.), Mergers & Acquisitions – Analysen, Trends und Best Practices. Stuttgart: Schäffer-Poeschel. Napier, N. (1989). Mergers and acquisitions, human resource issues and outcomes: A review and suggested typology. Journal of Management Studies, 26(3), 271–289. Nahavandi, A., & Malekzadeh, A. R. (1988). Acculturation in merger and acquisitions. Acadamey of Management Review, 12(1), 79–90. Olie, R. (1990). Culture and integration problems in international mergers and acquisitions. European Management Journal, 8(2), 206–215. Osterwalder, A., & Pigneur, Y. (2010). Business Model Generation: A handbook for visionaries, game changers, and challengers. New Jersey: Wiley. Porter, M. (1985). Competitive advantage—Creating and sustaining superior performance. New York: The Free Press. Prahalad, C. K., & Hamel, G. (1990). The core competence of the corporation. Harvard Business Review, 67(3), 79–91. Puranam, P., Singh, H., & Chaudhuri, S. (2009). Integrating acquired capabilities: When structural integration is (un)necessary. Organization Science, 20(2), 313–328. PWC. (2017). M&A Integration: Choreographing great performance—PwC’s 2017 M&A Integration Survey Report. https://www.pwc.com/us/en/press-releases/2017/pwcs-2017-ma-integration-survey.html. Rauss, T. (2017). M&A als Element für wertsteigerndes Wachstum und die Portfoliostrategie. In T. Feix, J.-P. Büchler, & T. Straub (Eds.), M&A – Erfolgsfaktoren im Mittelstand (pp. 158–176). München: Haufe. Roberts, E. B., & Wenyun, K. L. (2001). Ally or acquire? How technology leaders decide. MIT Sloan Management Review, 43(1), 26–34. Rottig, D., Schappert, J., & Starkman, E. (2017). Successfully managing the sociocultural integration process in international acquisitions: A qualitative analysis of Canon’s Acquisition of Océ. Thunderbird International Business Review, 59(2), 187–208. Schallmo, D. (Ed.). (2014). Kompendium Geschäftsmodell-Innovation: Grundlagen, aktuelle Ansätze und Fallbeispiele zur erfolgreichen Geschäftsmodell-Innovation. Wiesbaden: Gabler. Schein, E. (1984). Coming to new awareness of organizational culture. Sloan Management Review, 25(2), 3–16.

References

107

Schein, E. H., & Schein, P. (2018). Organisationskultur und Leadership. München: Vahlen. Seru, A. (2014). Firm boundaries matter: Evidence from conglomerates and R&D activity. Journal of Financial Economics, 111, 381–405. Siegenthaler, P. J. (2009). Perfect M&As: The art of business integration. Cornwall: Academy-Press. Singh, H., & Montgomery, C. (2008). Corporate acquisition strategies and economic performance. Strategic Management Journal, 8, 377–386. Sirower, M. L. (1997). The synergy trap. New York: The Free Press. Teece, D. J. (2010). Business models, business strategy and innovation. Long Range Planning, 43(2–3), 172–194.

3

Transaction Management

Contents 3.1 Valuation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.1 M&A Valuation Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.2 M&A Valuation Process. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.3 Valuation Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.1.4 Valuation Summary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2 Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.1 Due Diligence Targets. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.2 Due Diligence Management and Process . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.3 Due Diligence Tools. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.2.4 Core Parts of the Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3 Blending of SCDs and SBDs and Redrafting of JCD and JBD. . . . . . . . . . . . . . . . . . . . . . 3.3.1 Business Design Due Diligence: Blending of SBDs and  Redrafting of JBD Blue Print. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.2 Culture Design Due Diligence: Blending of SCDs and  Redrafting of JCD Blue Print. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.3.3 Due Diligence and Verification of Integration Approach. . . . . . . . . . . . . . . . . . . . . 3.4 Valuation and Due Diligence of Digital Business Designs. . . . . . . . . . . . . . . . . . . . . . . . . 3.5 Summary of Transaction Management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3.5.1 Critical Cross-Checks and Questions of Transaction Management. . . . . . . . . . . . . 3.5.2 Key Success Factors of Transaction Management. . . . . . . . . . . . . . . . . . . . . . . . . . References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_3

117 118 120 123 141 142 143 144 149 152 159 159 162 162 163 168 168 169 170

109

110

3  Transaction Management

Abstract

In the first step of the E2E M&A Process Design, the Embedded M&A Strategy aligned with the overarching corporate and SBU strategies was defined. Based on this framework of the Embedded M&A Strategy a distinguished shortlist of suitable M&A targets with a strong financial, strategic, Business and Culture Design fit have been distilled. The Transaction Management, as the follow-on module of the E2E M&A Process Design, is focused on a specific transaction with a selected target company or merger partner. Core parts of the Transaction Management are the valuation of the target company (Standalone Value) and the potential synergies (Integrated Value), the Due Diligence of the target company which should identify the risks and upsides of the potential transaction, as well as the blending of the Standalone Business and Culture Designs and the Redrafting of the Joint Culture and Business Designs according to the Due Diligence outcomes. Supplementary parts of the Transaction Management as the negotiation of a share or asset purchase agreement, the acquisition financing, and the Purchase Price Allocation (PPA), will be not discussed in detail. (These parts will be incorporated in the second edition). The Transaction Management, as the second module of the E2E M&A Process Design, consists of the following parts (Fig. 3.1): – Valuation of the target company (Standalone Value) and synergies (Integrated Value) – Due Diligence – Blending of SBDs and SCDs as well as the redrafting of the JCD and JBD Blue Print – Negotiation of (share or asset) purchase or merger agreement – Acquisition financing – Purchase Price Allocation (PPA) An E2E M&A Process Design as a holistic approach stresses the importance of the close ties between the different modules and also within each of the modules themselves, as discussed in the introductory chapter. Within the Transaction Management, the indicative valuation of the target company and likely synergies could be defined as the starting point. But this first valuation of the target company and potential synergies determines

3  Transaction Management

111

#1

Embedded M&A Strategy

#2

• • • • •

Embedded M&A Strategy: BMI Matrix Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − SBD Blending and JBD Proof-of-Concept − SCD Blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

Synergy Diagnoscs and Blue Print of Synergy Scaling Approach

Synergy Paern and Scaling Approach Proof-of-Concept

Transacon Management

#3

Integraon Management

• Integraon Strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan (IM) • Transional Change: Implement JBD • Culture Transion • Integraon Tracking & Controlling • Integraonal Learning & Best Pracce

Synergy Management

#4

Synergy Capture: Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and digital M&A Tool Plaorm

M&A Knowledge Management

M&A Playbook

Fig. 3.1   The E2E M&A Process Design: Transaction Management

already the priorities for the forthcoming Due Diligence assessment. The future value add  is based on the mission-critical value drivers, the Return on Invested Capital (RoIC), the growth momentum and the sustainability period of the competitive advantage, as these are the lever for the ultimate source of value, the future Free Cash Flows (Koller et al. 2015a, pp. 22–23, 137). The likelihood of the assumed performance of those value drivers has to be verified during the Due Diligence. Vice versa, the results of the Due Diligence have to be feed-back into the update of the final valuation and the draft of the purchase agreement. Based on a final valuation a preliminary Purchase Price Allocation (PPA) and the upper limit of the purchase price could be defined (Fig. 3.2). The Transaction Management ends with the fullfillment of the contractual closing conditions of the transaction. The length of the Transaction Management might be two months for small deals but could last more than a year for significant transactions with multiple bidding rounds and significant antitrust hurdles. First, an overview of the different core elements of the Transaction Management will be provided. Based on this overview, the Due Diligence and valuation, as core parts of the Transaction Management, will be discussed in depth. At the end of this chapter the specific challenges of the Transaction Management, especially the valuation and Due Diligence, of digital Business Designs will be highlighted. Last not least, core lessons learned as well as mission-critical top-management questions for the Transaction Management will be summarized:

112

3  Transaction Management

Valuaon • Rough • Outside-in perspecve

Negoaons • First contacts • Outside-in perspecve

Due Diligence • Back-tesng investment thesis • Gathering detailed informaon for further valuaon • Searching for „hidden“ risks • Synergy proof • Gaining insights for integraon & negoaons

Valuaon • Thorough • Informaon from inside

Deal Closure • Aer detailed negoaons • Based on final valuaon & DD

Fig. 3.2   Core parts of the Transaction Management and their interdependencies

Valuation (Sect. 3.1) Valuation is a substantial part of the Transaction Management. Within an M&A context, the valuation has to fulfill two needs. On the one side, a fair value or valuation bandwidth of the standalone value of the target company has to be derived, on the other side the likely synergies on the buyer’s and target’s side evaluated. The sum of those two values, the so-called Integrated Value, will define the upper financial boundary for the purchase price, and therefore the maximum premium the acquirer could afford to pay without risking value destruction. Within Sect. 3.1 alternative valuation methodologies and a process model for the valuation of the target company as well as for the potential synergies will be described. From a conceptional point of view two valuation approaches, the Income Approach and the Market Approach are the most applied corporate valuation methods for  M&As. But, only the Income Approach is a true, intrinsic valuation approach, as it evaluates a company on its forecasted and discounted Free Cash Flows. The transaction or trading multiple concept is, in essence, a pricing methodology, as it evaluates the target company based on prices paid in recent transactions (Transaction Multiples) or on a peer-group of comparable listed companies (Trading Multiples): – The Income Approach derives the Enterprise Value, as the market value of the ­(target-) company for all its investors like equity and debt holders, based on the forecasted Free Cash Flows (FCFs) of the company. The most used methodology within the Income Approach is the Enterprise Discounted Cash Flow (Enterprise DCF)1 1As

an alternative to the Enterprise DCF method the Discounted Economic Profit model will also be briefly discussed. Discounted Economic Profit models have in comparison to the Enterprise DCF model the advantage to highlight the yearly value creation, the Economic Profit, by comparing the RoIC with the Cost of Capital in any specific year.

3  Transaction Management

113

method (Koller et al. 2015a, pp. 137–142; Damodaran 2006; Fernandes 2012). The Enterprise DCF method discounts future FCFs at the Weighted Average Cost of Capital (WACC). The WACC addresses the time value of money as well as the underlying risk of the target’s Business Design. The latter is embedded in the beta factor of the cost of equity by applying the Capital Asset Pricing Model (CAPM) for the calculation of the equity risk (DePamphilis 2015). As the Enterprise DCF model evaluates the FCFs as available to all investors, like equity holders, debt holders, and any other non-equity investors—e.g. mezzanine investors—and discounts those consistently by using the WACC, it evaluates in the first step the Enterprise Value, meaning the value of the target company for all investors. To define the Equity Value, defined as the market value of equity for the shareholders of the target company, debt and other non-equity claims have to be subtracted from the Enterprise Value. The advantage of the Enterprise DCF model is that it separates operating performance from capital structure impacts and non-operating items. Additionally, it offers the possibility for portfolio companies with multiple strategic business units to use the same valuation framework for the valuation of the company as well as for the valuation of each of its strategic business units (SBUs) due to the value additivity characteristic of the underlying Net Present Value (NPV) concept (Brealey et al. 2020). This value additivity is typically used in sum of the parts valuations of conglomerates with multiple strategic business units. Discounting future FCFs at the WACC is especially straightforward in situations where the company’s financial structure, measured by its debt-to-value ratio, does not or only marginally change. Periodic specific WACCs could also be determined but would imply a yearly recalculation of the Cost of  Capital, what might be demanding. Therefore, in situations of more volatile financing structures at the target company, like in restructuring cases or levered Private Equity deals, the Adjusted Present Value (APV) and the Capital Cash Flow (CCF) model (Ruback 2000) might be more suitable models. The APV model is a two-step approach, which is also sometimes referred to as sum-of-the parts assessment. In a first step, the value from the pure operating performance without any financial benefits is calculated by discounting the same FCFs as in the Enterprise DCF model by the unlevered cost of equity instead of the WACC. In a second step, the FCFs of any financial side effects, like tax benefits of leverage (value of the tax shield), or costs of distress are evaluated. The sum of those two components leads to the same Enterprise Value as by applying the Enterprise DCF method if a consistent set of assumptions is used (Koller et al. 2015a, p. 137)

114

3  Transaction Management

The common ground of the Enterprise DCF, the APV and the Capital Cash Flow models is that all of them evaluate in the first step the value of the company for all its investors and then deduct all non-equity claims, like debt and debt-like items, to derive the Equity Value as the market value of equity of the enterprise. Equity valuation methods on the other side evaluate in one step the equity value of the company. This might sound straight forward but mixes up operating performance with ­non-operating performance and capital structure impacts on FCFs. Therefore, the FCF to equity method is foremost used for and limited to the valuation of companies where the capital structure is an integral part of their Business Design, like in the banking and insurance industry. – The market (pricing) method applies the law-of-one-price: Companies within the same industry and with comparable risk pattern should trade or be sold at similar valuation multiples, meaning having roughly the same relative valuation. Typically applied valuation multiples are Enterprise Value-to-EBITDA, Enterprise Value-toEBIT or Enterprise-Value-to-revenue ratios. Multiple assessments could also be used to value non-traded companies by comparison with listed companies within their peer group. In case of Trading Multiples, the unknown price of the target company is derived by the median or mean multiple of stock-listed companies within the peer group. In case of Transaction Multiples, recent acquisitions in the same industry are used for the definition of the multiple and the determination of the target’s price. The key limitation of this method is, that it only takes the actual market prices of listed companies for the valuation into account and not the pattern and variance of forecasted FCFs. It also neglects the specific strategy and Business Design of the target company in the valuation process by applying a simplistic peer-group assessment. Therefore, the Multiple Approach might be used for the framing of a DCF valuation but not as a standalone approach or even as a substitute for the DCF method. Section 3.1 discusses in-depth the pros and cons of the different valuation and pricing techniques. Due Diligence (Sect. 3.2) In the very end, the Due Diligence is the proof-of-concept of the investment thesis, meaning the stand-alone valuation of the target company and the intended synergies as well as the underlying strategic rational of the transaction. Additionally, the Due Diligence has to identify the chances and risks of a potential transaction. The challenge of the Due Diligence is the information asymmetry between the buyer and the seller. Therefore, another subject of the Due Diligence is to increase the level of information on the buy side by a focused and tailored Due Diligence process as close as possible to the seller’s knowledge about the target company.

3  Transaction Management

115

The Due Diligence was in former times understood as a simple summary of the potential risks of a transaction. Today, the Due Diligence is a focused, but also well enough detailed process with standardized modules and tools. An efficient and professional project management is therefore mandatory for this essential subprocess of the Transaction Management. Besides, a professional M&A team is obligatory for the orchestration of the overarching Due Diligence process and the management of the individual Due Diligence modules as well as for the integration and coordination of the different modules. The M&A Team has to identify and address the most severe risks and potential upsides. Also, the input of the Due Diligence outcome for the final valuation and synergy estimate have to be assured. Using consistently the 10C Business Design model of the M&A Strategy, the Due Diligence could be tailored around 5 core parts, the strategic Due Diligence (CS module), the financial DD (CF module), the legal Due Diligence, the Due Diligence of the operational Business Design covering all other processes and capabilities (CA, CC, CE), as well as customer-oriented modules (CV, CR, CH, CM), and last not least the organizational and culture assessment (CO): – Strategic Due Diligence (SDD): The SDD  has to assess the market attractiveness of the target’s businesses and the competitive positioning and advantages of the target company within those distinct markets. As competitive advantage is a “relative concept” a deep-dive of competitor profiling and benchmarking is also a mandatory part of the SDD. Another implicit task is the identification of the true core competencies of the target firm. Last not least, the confirmation of the transaction rational is as well part of the SDD. – Financial Due Diligence (FDD): The FDD has to analyze on the one side the audited financial statements of the target company of the last couple of years to assess the past performance, on the other side the actual financial performance has to be analysed. The assessment of the audited financial statements, especially of the balance sheets and the income statements, might provide a first overview of the past performance and an understanding of the likelihood of the forecasted financial performance of the target company. But an advanced FDD has to go beyond a simple headline analysis by identifying and assessing the most important value drivers of the target’s Business Design. Besides, the transparency, accuracy and completeness of the financial reporting system have to be assessed. An aligned field of the FDD is the Tax Due Diligence. The Tax Due Diligence does not only address the potential tax liabilities and risks. It might also have a significant impact on the design of the transaction as an asset or share deal. This could lead to complicated and prolonged discussions as the tax impacts of different transaction designs might be inversely related to the interests of the acquirer and the seller. – Legal Due Diligence: Intent of the Legal Due Diligence is the assessment of the most important contracts and to identify the underlying legal risks which have to be addressed either in the purchasing agreement or the Integration Management.

116

3  Transaction Management

Potential fields of interest of the Legal Due Diligence are corporate charters, employment contracts, supplier contracts, JV contracts, IP rights and further mission-critical legal documents. A newer subpart of the Legal Due Diligence is the Compliance Due Diligence, especially in case of large-sized, international transactions. Compliance problems might have a significant negative impact on the value and reputation of the target company and might involve in a worst-case scenario significant liability risks on the acquirer’s side. Due to the importance of the Business Design and the Culture Design, these two Due Diligence modules will be discussed in detail within a separate subchapter: Blending of SCDs and SBDs and Redrafting of JCD and JBD Blue Print (Sect. 3.3) After the closing date, the Integration Management starts immediately. An early identification of potential integration hurdles and risks and the design of the Integration Approach which addresses those risks is therefore mandatory. Within a benchmark M&A process the first draft of the Integration Approach should be Frontloaded into the Embedded M&A Strategy, as discussed in Chap. 2, and back-tested concerning applicability and robustness during the Transaction Management. This enables the buyer and the target company to define a tailored Integration Approach, including the ideal depth and speed of the integration. The same holds true specifically for the JBD and JCD, as essential parts of the Integration Approach. Based on the detailed Blending of the two SCDs and SBDs within the Due Diligence and the assessment of their gaps and similarities the Blue Print of the JCD and JBD, as defined in the M&A Strategy, could be redrafted, detailed and tailored. This process provides a skeleton of the intended joint value proposition, organization, operational processes and culture. The Frontloading ensures that both companies work on the integration execution along the to be defined Integration Masterplan already from Day One of the integration onwards. The Business Design Blending includes, besides others, the traditional commercial, operational, management and HR Due Diligence. The priority of the Management Due Diligence is foremost to identify and select the top management and the talents for the joint operations post-closing and plays, therefore, an important role in nowadays Due Diligence processes. The HR Due Diligence focuses on best practice HR processes and the assessment of necessary capabilities as well as the traditional employee management. The assessment of the two Standalone Culture Designs, which could be described as Cultural Due Diligence, analyzes the potential fit or misfit of the SCDs by Blending the two companies’ organizational value systems, believes, management attitudes and behaviors. Based on this culture understanding a sound targeted Joint Culture Design could be drafted. Within this book not in detail discussed parts of the Transaction Management are the Purchase Price Allocation (PPA) and the acquisition financing: Within the PPA the transaction price has to be allocated on the to be identified assets and liabilities of the target

3.1 Valuation

117

company. As the competitive advantages are in most industries more and more based on brands, intellectual property rights, or customer access, intangible assets play often a more prominent role than tangible assets like manufacturing sites or land and buildings nowadays. This development increased the importance of the PPA. The PPA has to identify the tangible and intangible assets as well as the liabilities of the target company, assess in how far the identified assets and liabilities could be recorded on the balance sheet and to determine their appropriate value. This involves the detailed analysis of the purchase price and the Business Design of the target company, the identification and valuation of the tangible assets, intangible assets and liabilities, the allocation of the purchase price on those identified assets and liabilities as well as the final calculation of the goodwill. The goodwill has to be stress-tested yearly with respect to a potential impairment under US-GAPP and IFRS accounting principles. The second, not in detail discussed part of the Transaction Management is the acquisition financing. Questions concerning the financing structure of the transaction start with the assessment of how to pay for the transaction. This determines the structure of the transaction as a cash or share deal or a mix of both, as it was the case in most of the recent transactions within the technology industry. The strategic structuring of the acquisition currency, that means to use either cash or own shares, does also have a significant impact on the financing structure: In case of a cash deal the purchase-price has to be either funded by cash reserves or must be financed by additional equity, debt, like bonds or loans, or hybrids, like convertibles. In case of a share deal, the acquirer pays with own shares. This could be existing shares or the issuance of new shares. PPAs and financial matters will be integrated into the second edition of this book.

3.1 Valuation The overarching idea of value creation is as well the foundation of the valuation principles within an M&A context. An investor expects, by acquiring a financial asset, that the value of this financial asset will grow sufficiently to compensate her for the underlying risk of that specific asset, meaning financially above the asset’s risk-adjusted opportunity costs of capital. This guiding principle of value creation could be transferred to the corporate world: Companies raise capital on equity and debt markets to finance their investments. They invest this capital in projects which are forecasted to generate future Free Cash Flows (FCFs) at rates of return, more specifically Returns of Invested Capital (RoICs), that exceed their specific cost of capital. The latter is the blended rate of return of investors on equity and debt markets and other forms of funds which they require to be paid for the use of their provided capital (Koller et al. 2015a).2

2The

principles of value creation, or at least the basic idea, could be dated back to Alfred Marshall who already addressed in 1890 the trade-off between the return on capital and the cost of capital.

118

3  Transaction Management

ROIC

Free Cash Flows

Growth

Value Added

(acquirer’s side)

Risk adjusted Cost of Capital

Compeve advantage period

Fig. 3.3   The Tao of Value Creation

The bedrock of value creation is the underlying Free Cash Flow stream which should generate a Return on Invested Capital (RoIC) which is larger than the cost of capital. The cash flows by themselves could be decomposed in the core value drivers of Return on Invested Capital (in comparison to the cost of capital), the growth rate and the competitive advantage time period at which the RoICs could be sustained above the cost of capital. These value drivers are intertwined with the pattern of competitive advantage. This breakdown of value creation in its fundamental drivers is the Tao of Value and is described by Fig. 3.3: These principles have to be addressed by any valuation method. Besides, the general M&A valuation framework (Sect. 3.1.1) and a dedicated valuation process (Sect. 3.1.2) could serve as a guideline:

3.1.1 M&A Valuation Framework As M&A projects are in the end also investment decisions, they have as well to pay in on the principle of value creation, as Fig. 3.4 shows. The characteristic of M&A transactions is that they involve two parties, the acquirer and the seller, which have contradicting interests with respect to the target’s standalone valuation and the value of potential synergies of a transaction: – The sell side perspective: The value of the target company for its shareholders is the sum of its stand-alone, discounted future FCFs. The target’s shareholders are

3.1 Valuation

Standalone Value target company

119

NPV of joint synergies (target + acquirer)

Integrated Value (incl. synergies) (= purchase price upper boundary)

Purchase Price (incl. premium)

Transacon SHV added on buy side

Premium (Transacon SHV added on sell side)

Fig. 3.4   M&A valuation framework (buy versus sell side perspective)

therefore only interested to sell their company if, and only if, they are paid a premium, meaning a transaction price that exceeds this stand-alone value. The seller’s shareholders participate, at least partially, in so far on the acquirer’s synergy capture. – The buy side perspective: The gross value of the potential transaction to the acquirer starts once more with the target’s stand-alone value defined by its discounted FCFs, but takes additionally into account the NPV of the synergies that the acquirer may capture by the specific underlying transaction. This means, that the combined FCFs of the two companies are increased beyond the two standalone values. Synergies are realized therefore  if, and only if, the sum of discounted FCFs of the joint company— Integrated Value including synergies—is greater than the sum of the acquirer’s and target’s standalone discounted FCFs (Clark and Mills 2013, pp. 92–95). The targeted synergies might be captured on the acquirer’s side, the target’s side or on both. The allocation of the total synergy value of a transaction on the buy or sell side might depend on the uniqueness of the synergy capture, meaning if the synergies could only be realized by the combination of the specific acquirer’s and the target’s Business Design or by more or less any acquirer. To identify the shareholder value added on the acquirer’s side, from the Integrated Value the purchase price, which includes the acquisition premium, has to be deducted. Therefore, the acquirer’s value add of a transaction is, in the end, the difference between the NPV of all synergies and the premium paid. Another interpretation of this equation means, that if the acquirer pays the full value of the net synergies to the seller in the form of a significant takeover premium, then the deal offers no value added on the buy side (Coates 2017, pp. 16–17). Thus a rational acquirer seeks a price somewhere between the target’s standalone value and this stand-alone value plus the NPV of the synergies, meaning the Integrated Value. By sharing the synergies with the seller, the acquirer

120

3  Transaction Management

may pay a premium that induces the seller to conduct the transaction while still enabling both, acquirer’s shareholders and seller’s shareholders, to realize a value added by the transaction. More or less all empirically M&A studies show thereby, that the distribution of the total value added of a transaction as defined by the sum of synergy based discounted FCFs, tends to be lopsided: The lion’s share of a transaction’s value added flows typically into the target shareholder’s pocket, leaving just a small fraction for the acquirer (Sirower and Sahni 2006, p. 85). In the following a detailed M&A valuation process will be developed which addresses these principles of the valuation framework:

3.1.2 M&A Valuation Process Following the above argumentation that the value of the transaction on the acquirer’s side is defined by the Standalone Value of the target and the NPV of the synergies two separate, but parallel valuation workstreams are proposed: 1. The Standalone Valuation of the target company 2. The calculation of the NPV of the forecasted synergies By deducting from the sum of the Standalone Value and the NPV of the synergies, the Integrated Value, the purchase price including the premium, the Transaction Value Added (TVA) of for the acquirer is defined. As an alternative, the two Standalone Values of the target company and the acquirer could be evaluated first without (Standalone), and second with synergies (Integrated Value). By subtracting the first from the latter the NPV of the synergies is reverse calculated. The difference between the NPV of the synergies and the premium mirrors again the value added of the transaction for the acquirer. The valuation process, following the decomposition into the twofold valuation of the Standalone Value and the NPV of synergies along six work streams, is described in Fig. 3.5: For the valuation of the TVA the following workstream model with six steps might be applied: Workstream 1: Past performance diagnostics For a sensitive valuation of a target company and likely synergies a detailed assessment of the target’s past performance, especially if it created or destroyed value in the last years, and the identification of its Business Design specific value drivers is mandatory. Business specific value drivers demand a higher granularity than the first decomposition of the FCFs in the top-level value drivers of RoIC performance, growth and competitive advantage time period. The value drivers could then be benchmarked with the peer-group to get an even deeper understanding of the relative target performance, standalone value upsides and potential synergies.

3.1 Valuation

STANDALONE VALUATION

1

121 2

3

Past performance & value driver assessment

Forecasng FCFs & performance: Operang Value

 P&L  B/S

BP period

Free

Cash Flow (conversion)

CV

 Mulples  Scenarios  Simulaons

Future performance

Synergy paern & benchmark

Valuaon of synergy levers

NPV of synergies

 Past M&As  Peer group  Benchmarks

(serving as a blue print for Synergy Scorecards)



volume ming  likelihood



5

6

Framing the valuaon & robustness check

CoC

Past performance SYNERGY VALUATION

Operang Value to Enterprise Value to Equity Value conversion

4

Synergy proofof-concept

IV Integrated Value

_

PP Purchase Price

TVA Transacon Value Added (acquirer’s perspecve)

Fig. 3.5   M&A valuation process model and its 6 workstreams

The past performance diagnostics is derived from the audited financial statements of the last three to five years prior to the transaction and the latest management reports. The second purpose of this past performance analysis is to reorganize the financial statements to carve out a clean operating performance of the target company by separating ­non-operating items and capital structure impacts of the operating performance. Workstream 2: Forecasting Free Cash Flows Workstream 2 is timewise flip-sided to workstream 1 by moving from past performance diagnostics to future performance forecasting. The valuation of a target company is based on its forecasted Discounted FCFs (DCFs). This involves three sub-processes: – The projection of the FCFs over the short and medium-term often called forecasting or business plan (BP) period: The FCFs mirror the company’s operating performance, less any necessary reinvestments, like capital expenditure or working capital increases. As FCF is the CF available to all investors—equity holders, debt holders, and any non-equity investors—they are independent of capital structure. As well non-operating impacts are carved-out. The FCFs are typically built up by ­short-to-medium term forecasts of the detailed value drivers, decomposing the forecasted P&L statements and Balance Sheet. – The calculation of the long-term value—as soon as the target has achieved its assumed steady state growth—is described by the Continuing Value (CV). CV models are typically applications of perpetuity approaches. Here we follow the Goedhart

122

3  Transaction Management

et al. (2016) approach by applying the value driver formula for the calculation of the CV as it is closely linked to the true value drivers of the target company, like RoIC and growth, and therefore avoids simplified, but misleading short cuts. – The projected FCFs and the CV have to be discounted by the appropriate cost of capital. In the following, at first, an Enterprise DCF valuation approach is applied. Here, consistently with the framework, the FCFs must be discounted applying the Weighted Average Cost of Capital (WACC) of the target company. The WACC blends the expected rates of returns of all investors, like the company’s debt, equity and—if applicable—mezzanine holders, and represents the company’s opportunity cost of its financing sources. Later alternative approaches, like the Adjusted Present Value which applies the unlevered cost of equity, will be discussed. The Value of Operations is achieved by summing up the discounted future FCFs realized in the forecasting period and the discounted CV. Workstream 3: Conversion from Operating to Enterprise to Equity Value  For a detailed flow from the Value of Operations to Enterprise and in a final step to Equity Value two sub-steps are necessary: – Flow from the Value of Operations (OV) to Enterprise Value (EV): For the transition from the OV to Enterprise Value non-operating cash and other non-operating ­equity-like items have to be added. – Flow from Enterprise  Value (EV) to Equity Value (EqV): For the final calculation of the Equity Value, meaning the market value of the target company for all its equity holders, all debt, like loans and bonds, and debt-like items have to be subtracted. The latter includes all nonequity claims against the EV, like the underfunding proportion of pension liabilities in case of defined benefit schedules, capitalized operating leases, restructuring provisions, employee options, or preferred stocks.

Workstream 4: Framing the valuation  To get a sound understanding of the “fair” market value of the target the plausibility of the Enterprise Valuation by the DCF based model should be framed by alternative valuation approaches. Typically, Transaction and Trading Multiples and alternative scenarios of the DCF model are applied to get a more robust understanding of a reasonable Equity Value bandwidth of the target. Workstream 5: Integrated Value, NPV of synergies and Purchase Price  The Integrated Value IV of the intended transaction is the sum of the target’s Equity Value and the NPV of the forecasted joint synergies. The synergies should be transaction specific and should not be achievable within a standalone environment, to avoid double-counting. Synergies could be captured on the acquirer’s side, the target’s side or on both sides.

3.1 Valuation

123

Workstream 6: Transaction Value Added  In the final step, the TVA is defined by subtracting the purchase price, which includes the premium paid, for the target from the Integrated Value of the target. The purchase price should include all components and means of payments, like cash, shares, and further price components. This valuation process and workstreams could be applied for more or less any transaction. Nevertheless, a couple of limitations exist. In case of start-up and venture capital investments the first workstream to understand the past performance of the target company might be substituted by a thorough analysis of the intended Business Design— based on the proposed 10C framework, the revenue scaling possibilities and the quality and capabilities of the management of the start-up company. Specifics of start-up and new approaches for platform valuations will be discussed at the end of this chapter. Private Equity (PE) investors might not have the advantage of a corporate acquirer to lever synergies, therefore focusing on potential improvements of the stand-alone performance of the target company. For such PE investment environments within the first phase, the synergy evaluation might be skipped. But at the same time, the analysis of value improvements by changing the strategy, the Business Design or management team of the target company on a standalone basis might be intensified.3 In the case of a merger, both companies have to be evaluated for the calculation of the coresponding shareholding in the NewCo of the former independent shareholders. For the NewCo value post-closing the value of the jointly captured net synergies have to be added. Given this overall valuation workstreams the valuation methods for the calculation of the target’s standalone value will be discussed:

3.1.3 Valuation Methods Multiple M&A valuation methods exist to calculate the market value of a company’s equity. The Income Approach derives a company’s value by its forecasted FCFs, which are driven by the operating performance (ROIC), the growth rate and the length of the period where the target company could sustain its competitive advantage by earning a ROIC above its Cost of Capital (Fig. 3.6). Within the Income Approach, a set of specific valuation methods might be applied, whereby the pattern of calculating the Enterprise and Equity Value separates two streams of valuation approaches.

3Most

PE investors use the Internal Rate of Return (IRR) calculation instead of the DCF model. The investment rule of the IRR to invest in any investment project where the IRR of the project is higher than the risk-adjusted cost of capital—PEs use foremost hurdle rates—will deliver in most instances the same outcome as the DCF models, with its decision rule to invest in any project with a positive NPV, or in the M&A context in any project where the value of the net synergies is higher than the transaction premium paid (Brealey et al. 2020).

124

3  Transaction Management Valuaon techniques Market Approach Transacon mulples

Income Approach Enterprise Valuaon

Equity Valuaon

Enterprise DCF

Equity CF / Income Approach

Enterprise value / EBITDA

Discounted Economic Profit

Dividend discount

Enterprise value / EBIT

APV: Adjusted Present Value

Equity value / EAT (1/EPS)

Capital Cash Flow CCF

Tradingmulples

Enterprise value / turnover

Cost Approach Reproducon value

Liquidaon value

• Real Opon Approaches • Simulaons (Monte Carlo) • Scenarios

Fig. 3.6   M&A valuation approaches and methods

On the one side, Enterprise Valuation based approaches calculate the value of the FCF for all investors as generated by the company’s operating assets and liabilities. To this Enterprise Value, the non-operating assets have to be added and debt, as well as ­debt-like items, have to be subtracted to calculate the Equity Value. The Equity Valuation approaches, on the other side, value each financial claim separately, i.e. calculate the Equity Value directly.4 As equity cash flows mix up operating, non-operating and financial cash flows, the Enterprise Valuation method is the preferred valuation technique in most applications. The most important exception is the valuation of financial institutions, where the financing structure is an integral part of the company’s Business Design and performance. A second valuation, or more precisely pricing approach is the application of Trading or Transaction Multiples. Multiples derive the unknown Equity Value of the target company by multiplying a performance indicator of the target company with the corresponding multiple of a peer group of comparable, listed companies or based on recent transactions within the target’s industry. Comparability means thereby, that the companies of the peer-group have to be in the same industry, must have the same risk profile, and—in the best case—even the same performance characteristics as the target company.

4Enterprise

and Equity Valuation approaches provide—according the “Lücke Theorem”—the same results, if the same underlying assumptions and the corresponding costs of capital are applied. The Enterprise DCF techniques use the WACC to address risk and discount the FCFs, and by adding non-operating items and deducting the value of debt the Equity Value is calculated. The Equity Valuation techniques evaluate the Equity Value directly by discounting cash flows to equity by the levered cost of equity.

3.1 Valuation

125

Principles and advantages

Market Approach

Income Approach



More PRICING than valuaon



True intrinsic VALUATION



Earnings or sales mulples based upon prices of recent comparable transacons or on capital market Close to resent market prices



Based on FCFs and closely linked to the value drivers of the BD Integrated financials: FCF, P&L, B/S Shows full value of target business within acquirer’s context (synergies) Dynamics: Simulaons & scenarios Internaonally accepted



  

Disadvantages

  

 

Applicability

   

Comparable transacons or listed peers might be difficult to find Transacon mulples include premia of recent transacons, depending on individual acquirer context See-saw with market valuaons Pricing, no true intrinsic valuaon No forward looking view First rough valuaon From outside-in, before DD Framing intrinsic valuaon

 

Requires forecast BP Detailed analysis (me and efforts) needed, otherwise “garbage in, garbage out!”

Cost Approach 

Foremost ACCOUNTING view



Based on book value of assets and liabilies Only useful when exing the business is an opon / liquidaon processes



  

 

Detailed and thorough valuaon based on in- and external financials Applicable throughout an E2E M&A Process

 

Does not analyse value of company’s going concern No linkage to future FCFs, therefore not addressing valuaon view No value driver perspecve

Asset and past performance oriented Only applicable in case of exing a business

Fig. 3.7   Comparison of valuation approaches

The backbone of the multiple concept is the “law of one price”, meaning assets in the same risk class should be evaluated on efficient capital markets at similar prices. Typically applied multiples are Enterprise-Value-to-EBITDA or EBITA or EBIT, and Enterprise-Value-to-revenue, whereby the latter has no direct linkage to the target’s underlying earnings or FCFs. The Cost Approach, last not least, derives a company’s value based on the book value of its net-assets, either by taking the liquidation or reproduction value of those assets into account. As book values do not mirror market values and the goinc concern principle is not addressed the applicability of the Cost Approach for M&A valuations might be very limited and will be here not further discussed. The advantage-disadvantage profile of the valuation and pricing techniques is summarized in Fig. 3.7: Income Approach  Valuations based on the Income Approach apply forecasted FCFs for the evaluation of the target company. A couple of valuation advantages of the Income Approach are unique: From an application point of view, the Income Approach, especially the Enterprise DCF model, has the advantage to be the internationally most accepted valuation technique. Additionally, the Income Approach is broadly applicable, e.g. for the valuation of conglomerates, with a multi-business portfolio, one consistent valuation method for the company as a whole, as well as for its different strategic business units could be applied. The Enterprise Value of a conglomerate is equal to the sum of its parts, meaning the value of its individual strategic business units less the NPV of headquarter costs, plus the value of any non-operating assets. This is an outcome of the value additivity principle of NPVs. Also, other strategic growth options and strategy

126

3  Transaction Management

approaches can be evaluated by using NPVs based upon DCFs and are therefore comparable concerning their financial valuation. From a conceptual point of view, the Income Approach is advantageous as it is based on one integrated set of financials: The FCFs are built upon P&L and balance sheet data, mirroring the intertwined characteristics from financial statements. A second conceptual advantage is, that DCF based valuation scenarios and simulations5 might provide a more robust valuation by indicating a reasonable valuation bandwidth. This might increase the awareness of the top-management of the potential spread in valuation outcomes and the impact of worst-case scenarios. The Income Approach could also be used to model the full value of the target’s Business Design within the acquirer’s context by integrating the likely synergies. But, the most important advantage of the Income Approach is its going concern characteristic as the valuation is built upon future DCFs. Multiples are based simply on the actual capital market and target performance and the Cost Approach has, due to its accounting view, a pure backward-looking pattern. One of the disadvantages of the Income Approach is based on the need for a robust set of forecasted financials to model the FCFs. Only if such a business plan projection with the necessarily detailed financials is available, a sensible Income Approach-based valuation is possible. This is the backbone of the well-known phrase in the corporate finance literature “garbage in-garbage out”. Therefore, a demanding and time-consuming preparation is mandatory for a detailed valuation. Typically, the DCF models are applied within an M&A context for the detailed and thorough valuation of the target company based on in- and external financial data, starting with the indicative offer, as well as for valuation updates during the Due Diligence and the final valuation. Multiple Approach  The Multiple Approach could be applied using earnings multiples, like Enterprise Value-to-EBITDA or EBIT, or sales multiples and could be based on an Enterprise or Equity Value perspective, in the latter case e.g. by using price-earnings multiples. One advantage of multiples is, that they could be applied to value also non-traded companies or strategic business units within a conglomerate by comparing the target or specific strategic business unit with listed peers, which are pure plays—Trading Multiples—or recently published transactions—Transaction Multiples -. Companies in the same industry and with a similar financial performance and risk profile should trade in efficient capital markets at the same multiple. As multiples are based upon prices of recent comparable transactions or stock market valuations they are therefore as well close to actual equity or transactional market prices. One of the limitations of the application of the Multiple Approach is that comparable transactions or listed peers might be difficult to identify for a dedicated industry

5Most

simulations for corporate valuations are based upon Monte Carlo simulations.

3.1 Valuation

127

or Business Design. From a theoretical point, one criticism is, that at least Transaction Multiples include the premiums paid in past transactions and depend therefore on the individual acquirer-target situation. But, the most serious disadvantage is the very simplistic approach to derive the target value by comparing recent market prices with earnings or revenues of peers. This has the serious downside that multiples and the valuations built upon them see-saw like the underlying capital or M&A markets. Accordingly, the Multiple Approach could be interpreted more as a pricing than an intrinsic valuation approach. Most valuations based on multiples are used for a rough initial valuation, like in the case of simplified indicative offers. In those circumstances, an outside-in perspective with limited financials and—so far—missing Due Diligence insights might have to be applied. Besides, multiples are suitable for the framing and robustness check of Income Approach-based valuations. Cost Approach  The cost approach is an accounting-based model, as it builds the valuation upon the book value of the target’s underlying assets and liabilities. The cost approach is substantially limited for a valuation purpose as it does not address the value of a company’s going concern. Besides, due to its asset and past performance orientation it has no linkage to the future FCFs and value drivers of the underlying business. Therefore, it is only applicable for valuation purposes when exiting the business is a viable option to be assessed.

3.1.3.1 Income Approach The Income Approach values the company by its FCFs, that is solely on the cash flowing in and out of the company. These cash flows have the advantage, in contradiction to earnings, to be independent of any accounting standards. In the following, the focus will be first on the Enterprise Discounted Cash Flow (Enterprise DCF) model. The FCFs in the Enterprise DCF model mirror the Free Cash Flows (FCFs) as generated by its operating Business Design, less any necessary reinvestments in the business, like capital expenditure or working capital. These FCFs are also the pool of funds attributable to all investors. Consistently the Enterprise DCF model uses as the opportunity costs and discount factor for the FCFs the Weighted Average Cost of Capital (WACC). The WACC blends the cost of equity and debt with its relative contribution to the financing mix. By using the WACC approach financing effects on the value of the company, like tax shields, are embedded in the cost of capital, rather than in its FCFs. The Enterprise DCF approach is useful in times where the company maintains a relatively stable financing mix, meaning debt-to-equity ratio. If a company’s financing ratio is volatile or changing, like it might be the case in restructuring situations, in the years after a financial-crises, in the aftermath of the Covid-19 crises or for the early years of a start-up company, this could be in principle modeled as well by yearly adjusted WACCs. But, as this might become fuzzy, in such circumstances the Adjusted Present Value method (APV) might be better suited. The

128

3  Transaction Management

APV model separates the pure operating value of the company without any financing impact from the value impact attributable to the company’s capital structure. The APV model uses the same FCFs as the Enterprise DCF model, but discounts those FCF at the unlevered cost of equity, instead of the WACC.6 Enterprise Discounted Cash Flow (DCF) Model  The Enterprise DCF model values a company by its FCFs which are defined by the Net Operating Profit Less Adjusted Tax (NOPLAT) and the corresponding necessary investment in Invested Capital to realize the NOPLAT performance. The FCFs are calculated after tax, as taxes are cash-outflows. Besides, the FCFs are defined to be attributable to all investors7, therefore being independent of any financing structure or non-operating items8. Consequently, NOPLAT is defined prior to interest expenses:

FCF = NOPLAT + depreciation − Investment in Invested Capital = NOPLAT − Net Increase in Invested Capital. A more precise definition of NOPLAT is revenues minus operational costs, less any taxes. Tax expenses are calculated as if the firm held only core assets and would be financed only with equity. The advantage of debt that interests are tax-deductible (tax shield) is addressed in the WACC instead of the FCFs. Invested Capital covers  the necessary, meaning operating assets and liabilities as required for the company’s core business. It  includes typically items like capital investments (PP&E) and working capital, like inventories or accounts payable, less any financing provided by suppliers—accounts payables—customers, or employees. The definition of Invested Capital is equal to the source of funds for its operational business, but is independent of and does not incorporate the financing structure. FCFs are closely linked to the value drivers of the company, as described in Fig. 3.3, like the growth rate, RoIC and the sustainability of the competitive advantage of the target company. The ROIC is defined as the company’s after-tax operating profit (NOPLAT) divided by the average Invested Capital as contributed by all investors. Whereas the NOPLAT is derived from the income statement the Invested Capital is derived from the balance sheet.

6Cash

Flow to Equity models will be not in detail discussed in this book as they mix operating performance with ­non-operating items and capital structure. These valuation models are foremost used, as described, for the valuation of financial institutions, where capital structure is an important ingredient of the company’s Business Design. 7The investors might mirror the variety of capital markets, like financial institutions providing loans, bond holders, convertible debt holders, mezzanine holders, preferred and common equity holders. 8Therefore, the FCFs as defined for the Enterprise DCF differ significantly from the Cash Flow from operations as defined by the financial statements.

3.1 Valuation

129

RoICti =

NOPLATti InvestedCapitalti

The competitive advantage period, as the third driver with a lasting value impact, is the period along which the ROIC consistently outperforms the WACC. Workstream 1: Past Performance & Value Driver Assessment  By a deep-dive assessment of the target company’s past performance and value creation a better understanding of its strategy and Business Design could be achieved and true value drivers, like RoIC and growth, identified. To calculate FCFs and the corresponding ROICs, the balance sheet has to be ­re-organized to capture the Invested Capital and likewise the income statement to calculate NOPLAT. As NOPLAT and Invested Capital mirror the pure operational performance of a company, the audited financial statements have to be reorganized (Koller et al. 2015a) to separate: – operating performance – non-operating performance, and – capital structure. After this restructuring of the financial statements and the carve-out of the operating items Invested Capital and NOPLAT and thereafter FCF and RoIC could be determined for the last years. Based on those financials the target’s past performance may be analyzed in detail. This involves assessments if and how the target company created value, if and how its competitive advantage converts into high RoICs, if the target grows more significantly than industry peers and if its competitive advantage seems to be sustainable. A good grasp of the target’s value creation and value driver performance in the past might foster a more robust and reliable forecast of its future performance. Additionally, the performance diagnostics could go even beyond the first layer of value drivers by increasing the granularity of assessment of the income statement and balance sheet on a line item level. Workstream 2: Forecasting FCFs & Performance: Operating Value The forecasted future operating performance determines the NOPLAT, the Invested Capital and, in the end, the FCF forecasts. The FCFs within the business plan period are forecasted explicitly, whereas the Continuing Value (CV) covers the long-term value, understood as the value generated by the company beyond the business planning horizon. CV performance and formulas should be in line with the assumptions about the steady-state performance of the target’s value drivers, like RoIC or growth. For the calculation of the Operating Value, the FCFs and CV have to be discounted by the specific cost of capital, which means in the Enterprise DCF model, by the WACC.

130

3  Transaction Management t

OV = ∑DCFt + 1

DCFt =

FCFt (1+ WACC )t

CVt (1+WACC )t

CVt =

g ) RONIC t (WACC − g)

NOPLATt+1 ⋅(1−

BP Period Valuaon Period Fig. 3.8   Operating value, DCF, FCF and planning period

Planning Period Rather than forecasting the future FCF within the planning period directly, the FCFs computation should be based on their underlying drivers like NOPLAT, depreciation and investments in Invested Capital. For consistency, these value drivers should feedback to the detailed line items of the income statement and balance sheet. They should also mirror the most recent management forecast, e.g. the top-management approved strategic business plan. Given the projections of the balance sheet and income statement line items and by computing revenue, growth, EBITDA margin, and Invested Capital the FCF forecasts could be determined. Fig. 3.8 shows explicitly such a FCF and DCF projection: Continuing Value Short- to mid-term each line item of the financial statements as well as value drivers and FCFs are explicitly calculated. But beyond a certain time-horizon, in most cases beyond 5–7 years, yearly forecasts on such a level of granularity might be difficult. Therefore, the projection of FCFs beyond this business plan horizon point does not make sense and might be substituted by applying a Continuing Value (CV) formula. The CV formula timing should be in line with a steady-state, long-term performance of the company’s value drivers like RoIC and growth.

3.1 Valuation

131

A couple of Continuing Value formula exist, but here the Key Value Driver formula, as proposed by Koller et al. (2015a) is applied. The Key Value Driver formula links ­long-run FCFs to their growth and ROIC performance of new investments but also addresses reinvestment needs. A CV calculation requires as inputs a forecast of the steady-state NOPLAT performance in the year following the end of the explicit forecast period, the long run forecast for the Return on Newly Invested Capital RONIC, an estimate of the WACC, and the long run growth (g):   g NOPLATt + 1 1 − RONIC CVt = WACC − g The CV is computed at the end of the planning period, therefore it has finally to be discounted back to today’s present value. WACC For the final computation of the Operating Value the forecasted FCFs within the planning horizon, as well as the CV, have to be discounted by—in terms of risk and methodology -appropriate cost of capital. As the Enterprise DCF uses the FCFs available to all investors, the discount factor for FCF must represent the blended cost of capital. This is represented by calculating the Weighted Average Cost of Capital (WACC) as the investor’s required rates of return for debt kd and equity ke weighted by the market value of Debt D and Equity E based on their relative weights within the company’s financing mix. As interest expenses are tax deductible and this advantage is addressed within the cost of capital in the Enterprise DCF model, the cost of debt is reduced by the marginal tax rate t. This mirrors the interest tax shield (ITS) as the tax advantage of debt funding.9

WACC = kd

D D (1 − t) + ke , V V

with V = E + D

whereby the cost of equity is determined by the Capital Asset Pricing Model (CAPM):   ke = rf +β rm − rf , with rf = risk free rate, rm = market return Applying a constant WACC throughout the forecasting period, it is implicitly assumed that the company maintains a fixed financing mix—debt-to-equity ratio -. The

9The

impact of the company’s financial structure, foremost its interest tax shield (ITS), must be addressed by the valuation. Enterprise addresses this impact in the cost of capital, as the tax shield reduces the WACC and increases DCFs. By moving ITS from FCFs to the WACC, FCFs are computed as if the company is entirely equity financed. Therefore, by benchmarking FCFs, the operating performance across peers without being biased by capital structure and financing side effects, could be evaluated.

132

3  Transaction Management

WACC can be adjusted to accommodate a changing capital structure. However, as the process is complicated, in such circumstances the APV model, as an alternative, will be recommended. Operating Value The Value of Operations is simply the sum of the DCFs within the planning period plus the present value of the CV, whereby the latter presents the value of the company’s expected FCF beyond the explicit forecast period of the business plan horizon:

Operating Value =

∞  t=1

(DCFt ) =

∞ 

(FCFt )/(1 + WACC)t

t=1

Workstream 3: From Operating Value to Enterprise Value to Equity Value The flow from Operating Value, which mirrors the pure operating performance of the company, to Enterprise Value and finally to Equity Value involves two steps (Fig. 3.9): From Operating to Enterprise Value: Identifying Non-operating Cash and Equity like Items Many target companies own assets that have value but whose Free Cash Flows are not part of the target’s Business Design and are addressed neither by NOPLAT nor Invested Capital, as both have a pure operational view. Therefore, excess cash and other ­non-operating assets are not covered by FCF and must be valued separately. Examples for other non-operating assets might be excess cash, equity investments, nonconsolidated subsidiaries or tradable securities.

Operang Value

Non-Operang Assets

Enterprise Value

Debt & Debt like items



Tradional definion of Debt: Interest bearing liabilies like bonds and loans



Debt like items:  Pensions (underfunding)?  Tax liabilies?  Off balance financing (Leasing, Factoring,…)?

Fig. 3.9   Walk from Operating Value to Enterprise Value to Equity Value

Equity Value

3.1 Valuation

133

From Enterprise to Equity Value: Identifying Debt and Debt-like Items The Enterprise DCF derives the market value of equity, the Equity Value, by deducting debt and debt-like items from Enterprise Value. Equity is according to the absolute priority rule a residual claimant, receiving FCFs only after the company has fulfilled all its other contractual claims, like: – Debt: Any kind of interest-bearing liabilities, like bonds or loans, fixed versus floating rate debt or foreign currency debt at their market value. – Underfunding of pension liabilities: Companies with defined benefit pension plans and promised retiree medical benefits may have underfunded their obligations. The underfunding proportion should be treated as debt. – Operating leases: Operating leases are in multiple industries like logistics, automotive or industrial goods common forms of off-balance-sheet financing. Under certain conditions, companies can avoid capitalizing leases as debt on their balance sheets. As those assets are still necessary parts of their Business Design their off-balance sheet pattern has to be undone and in parallel mirrored as a debt-like item on the funding side of the Balance Sheet. – (Off-balances-sheet) Contingent liabilities: E.g. IP disputes and lawsuits in the tech industry or customer claims in the automotive industry. – Minority interests of other investors in an affiliate, where the target is majority shareholder have to be treated as debt. – Preferred stock: The pattern of preferred stock is often closer to unsecured debt than equity as dividend policies of incumbents in mature industries are often sluggish and mimic therefore more interests. For the Enterprise Value to Equity Value conversion, those debt and debt-like items have to be deducted from Enterprise Value. Workstream 4–6  The workstream 4–6 would be identical for all Income Approaches. Within workstream 4 the indicated Equity Value should be stress tested by a set of selected  scenarios and framed by a suitable Multiple assessment. The Transaction Value Add for the acquirer is then simply the difference between the indicative Standalone Value of the target plus the NPV of all synergies minus the purchase price of the target company, including all means of payment. Adjusted Present Value (APV) Model  Within an APV context, just workstream 2 with the calculation of the Operating Value would be different in comparison to the Enterprise DCF approach: Although the Enterprise DCF model is widely applied and is straight forward in its calculation, it has also a couple of limitations and drawbacks. By discounting the forecasted FCFs with a constant WACC an implicit assumption is taken, that the company does not change its financing structure or that it keeps is debt-to-equity ratio at a given target ratio. This might be a valid approximation for mature companies with

134

3  Transaction Management

steady FCFs. In other cases, it would be a naïve assumption. E.g. in cases of VC or PE transactions, where the acquisition might be funded and fueled by a significant proportion of debt, thereby increasing the target’s debt-to-equity ratio, the current standalone WACC of the target would understate the to be expected tax shield.10 Also, during a financial-crises like in 2007/2008 or in case of a company specific restructuring the debt-to-equity ratio might in the first years increase and after a turnaround or restructuring decrease. By applying a periodic-specific WACC, which adjusts the blended cost of capital year-by-year to accommodate a changing capital structure, the volatility of the tax shield could be addressed. However, these yearly adjustments of the WACC are quite time demanding. The alternative approach of the Adjusted Present Value (APV) method might be a relief: The APV is a simple valuation framework to model more complex financial structures. In cases where the financing mix is expected to change significantly the explicit modeling of the valuation impact of the capital structure might reduce the complexity of EV valuation. The APV model applies this basic idea by separating the value of operations into two components: 1. The value of operations under the assumption of an all-equity financial structure and 2. The valuation impact of the financial structure, whereby the APV model does focus on the first order effect of the tax shields arising from debt financing.11 The APV method calculates the Enterprise Value of an indebted company (APV) simply as the sum of a debt-free company plus the net valuation advantage of a higher indebtedness by explicitly evaluating the interest tax shield (ITS) year-by-year.

APV = PV of debtfree enterprise + PV of ITS The debt proportion is thereby assumed as given and dependent on the forecasted financing and debt retirement plan. The APV valuation uses the same FCFs as the Enterprise DCF model, but discounts these FCFs at the unlevered cost of equity instead of the WACC as in a first step the value of a theoretically purely equity financed target is calculated:

PV of debtfree enterprise =

∞ 

(FCFt )/(1 + kue )t ,

t=1

10According

the Modigliani & Miller theory the second order effect of increased leverage would counterbalance this primary ITS value advantage of increasing debt: Increased leverage will increase a company’s financial risk, drop its debt rating and therefore increase its cost of debt & equity. 11The traditional APV neglects the second order effect of increasing costs of financial distress driven by a higher debt burden.

3.1 Valuation

135

with kue as unlevered cost of equity. To this value of a pure equity funded enterprise the NPV contribution of debt financing benefits, like the Interest Tax Shields (ITS), is added. Interest tax shields could be in principle discounted at either the unlevered cost of equity or the cost of debt, depending on the assumed risk of being able to exploit the tax shield. To evaluate the ITS in a first step the expected interest payments are calculated by multiplying the prior year’s net debt by the expected yield on the company’s debt payments. The ITS for each year is then equal to the resulting interest payment multiplied with the marginal tax rate of the company in any specific year. For calculation of the NPV of the total tax shield the discounted tax shields of each year in the planning period have to be added to the continuing value of interest tax shield beyond the planning horizon. The latter is calculated by applying again a perpetuity model for the ITSs, using unlevered cost of capital and growth in NOPLAT.

PV of ITS =

∞ 

(ITSt )/(1 + kue )t

t=1

The APV, mirroring the value of operations, is simply the sum of the NPV of the FCFs and the NPV of ITSs, by applying the cost of unlevered equity kue for both NPV calculations.

3.1.3.2 Multiple Approach A careful analysis of Transaction Multiples, based upon in recent transactions paid prices for peers, and Trading Multiples, based upon actual stock market prices of peers, are adequate cross-checks for the plausibility and robustness of Income Approach based intrinsic valuations but are no substitute.12 Also, in case of subjective decision values or for a first indicative offer for a target company a multiple comparison could serve as a first rough indication for the likely pricing of a transaction. Furthermore, multiples might be applied for the identification of the value drivers of a company, for benchmarking a company’s performance with peers or for assessing—form a stock market perspective—which companies are believed to possess a competitive advantage which converts into a value outperformance on the stock market. Last not least, Multiples might assist for sum-of-the-parts valuations of a corporate portfolio by providing an overview of the value contribution of the different SBUs. The concept of the Market Approach intends to derive the likely, but unknown price of a target company out of a comparison with a peer group. It applies the basic idea that similar companies—the peer group—should sell for similar prices in efficient capital markets. The indicative Enterprise and Equity Value of a dedicated target company

12E.g. German accounting setter standard IDW S1: If stock market prices of comparable enterprises are available they have to be used as a cross check for the valuation.

136

3  Transaction Management

are based on actual market values or, more precisely, prices. The Market Approach wants to price an enterprise under the principle of a “apples-by-apples” comparison. The unknown price of the target company is derived out of the prices of: – Comparable listed companies (peer group): Trading Multiples or – Recent comparable transactions: Transaction Multiples Multiples like the Enterprise-Value-to-EBITDA or -EBITA ratio compare the relative valuations of companies. The Multiples normalize the Enterprise or Equity Value as given by the capital market by revenues or profits before or after interests. For the assessment of the indicative market price of the target company the mean or median value of the specific Multiple of the peer group is multiplied with the target’s performance indicator which fits to the specific Multiple, e.g. in case of an Enterprise Value-to-EBITDA Multiple with the actual or forecasted EBITDA performance of the target company (Fig. 3.10): The Multiples of the Market Approach could be based on: – Comparable transactions or stock market prices of comparable companies and – Either on an Enterprise Value—indirect way to deduct the Equity Value as in the Enterprise DCF Approach—or Equity Value perspective The design options of the Multiple Approach are pinpointed in Fig. 3.11: Trading versus Transaction Multiples The Trading Multiple concept is based upon the assumption, that share prices mirror the fair value of comparable listed companies. Therefore, share prices are also believed to be best approximations for the pricing of the target company. Recent share prices represent the valuation at a given point of time, thereby incorporating all latest market and industry trends, as assessed by the capital market participants. Trading Multiples incorporate no control premia. The target of the analysis of comparable stock listed companies is the calculation of industry specific Multiples for a rough indicative valuation of the target company. The idea of the Transaction Multiples is, that prices, which were paid in past, comparable transactions, are a fair approximation of the actual value of a target company.

Equity- / enty price (value)

=

of Target Co.

Fig. 3.10   Multiple approach—the concept

Performance indicator of Target Co.

*

Mulple Peer Group as reference point

Valuaon Approach

3.1 Valuation

137

Mulple concept

Comparable Companies

Comparable Transacons

Trading mulples

Transacon mulples

Market approach

Equity mulples

Enty mulples

Income approach

Equity Valuaon

Enterprise Valuaon

Naonal / Banks

Internaonal

Concept Applicaon Fig. 3.11   The multiple matrix

In contrast to the Trading Multiple concept the Transaction Multiples mirror prices paid for the majority ownership within past transactions and therefore incorporate strategic control premia. The ultimate target of Transaction Multiples is identical to Trading Multiples. By assessing industry specific Multiples, here including premia, the indicative value of a target is derived. Enterprise Value versus Equity Value Multiples A second pairing is Enterprise Value based Multiples versus Equity Value based Multiples. The first uses as a denominator an earning’s indicator before interest, as the Enterprise Value covers all investors of a company, whereas the latter takes earnings after interest into account, as just the equity holders are addressed by Equity Value based Multiples. Typical multiples applied in practice are described by Fig. 3.12, whereby the selection of the best fitting multiple will be covered later in the Multiple Design description. Besides, to derive the Equity Value of the target company by Enterprise Value based Multiples, the net-debt of the target company has to be deducted, whereas Equity Multiples provide, per definition, straight the Equity Value. The Design of a Suitable Multiple Assessment  A couple of design principles might support a sensitive Multiple based indicative pricing or framing of a valuation (Koller et al. 2015a):

138

3  Transaction Management

Peer Group P&L Turnover EBITDA

Enterprise mulples to

Enterprise Value

EBIT

Equity Value Target Co.

NOPLAT

EbT

Equity mulples to

Equity Value

EaT / net income

Fig. 3.12   Multiples based on Enterprise versus Equity Values

1. Forward looking Multiples To be consistent with the principles of valuation, forward-looking estimates of earnings before interest, like EBITDA or EBITA in case of Enterprise Value Multiples, or after interest, like Earnings before Tax or Net Income in case of Equity Value Multiples, are more applicable than Multiples based on actual or last year’s performance. As ­forward-looking Multiples indicate, at least partially, expectations about a company’s future performance, they are more in line with the principles of corporate valuation than the latter. Also, forward-looking financials should be normalized and therefore avoid misinterpretations due to one-time effects, like restructurings or patent litigation costs. Finally, Multiples based on performance forecasts have typically a lower spread across a defined peer group, narrowing thereby the valuation bandwidth. How far forward-looking Multiples should be designed depends on context and is in line with the Continuing Value discussions within the Enterprise DCF model. For start-up companies, digital businesses, platform strategies or patent valuations the Multiple should be based on a longer-term perspective, taking a forecast of earnings in a steady state ROIC and growth scenario into account. On the other side, for more mature businesses already the next year’s EBITDA or EBITA forecast might be suitable. 2. Most applicable Multiples Multiples have to be designed consistently, meaning that the value (numerator) and earnings (denominator) must be based on the same underlying assets. For instance, if an Enterprise Value Multiple is used only an Earnings before interest denominator is acceptable or if excess cash is excluded from value, also interest income has to be excluded.

3.1 Valuation

139

15 4,5 10,5

Corp. Y 15 2,5 12,5 3,75 8,75

Bond at 5% interest rate Equity Enteprise Value

100 100

50 50 100

P/E Rao EV to EBITDA Mulple

9,5 6,7

5,7 6,7

EBITDA Interest Expenses EbT Taxes (30% tax rate) EaT

Corp. X 15

Fig. 3.13   EV-to-EBITDA Multiple versus P/E ratio

The Price-to-Earnings (P/E) ration, defined as market capitalization divided by prior year’s or the actual year’s forecast of earnings after tax is the most widely applied relative valuation metric on capital markets. Nevertheless, P/E-ratios mix up operating performance with capital structure impacts and non-operating items. Enterprise ­Value-to-EBITDA ratios, for example, are much better suited for peer group comparisons and Multiple assessments as they are not dependent on non-operating or capital structure impacts. The following example in Fig. 3.13 highlights how differences in capital structure distort the P/E-Multiples whereas Enterprise Value-to-EBITDA multiples are independent of the financing side-impacts. Therefore, the latter might be more reliable and robust for a peer-group assessment: Two corporations X and Y should be comparable with respect to their operating performance with an EBITDA of $15 m and an Enterprise Value of $100 m, therefore both trading at an EV-to-EBITDA Multiple of 6.7 times. The only difference is that corporation X is fully equity funded whereas corporation Y is by 50% levered. Since both companies trade at a low EV-to-EBITA Multiples in comparison to Interest-to-Debt Multiples, the P/E Ratio decrease for the company which uses more leverage, here corporation Y. The P/E Ratio decreases in this case due to leverage, despite both companies have the same operating performance.

140

3  Transaction Management

3. Multiples and value drivers Koller et al. (2015a) also stress the close tie between Enterprise Value-to-EBITDA or -EBITA Ratios to the core value drivers of FCF and a company’s operational performance, like NOPLAT, ROIC, and growth: The EBIT(D)A Multiples increase with a lower tax rate or cost of capital, but these two factors are more exogenous given by the national tax regime or the specific industry risk pattern. Therefore, these two factors should not differ in case of peer group comparisons. The company’s specific business performance indicators are its ROIC performance and growth momentum. The ­EBITDA-Multiple will increase in line with a higher ROIC, whereas growth will only be value contributing, if the company’s competitive advantage translates into a positive spread, meaning that ROIC outperforms the WACC. 4. Tailored peer group. The peer group is decisive for the Multiple Design. A first round selection of peers might apply Standard Industry Classification (SIC) codes, or Global Industry Classification (GIC) codes to identify companies from the same industry. Peers from the same industry should typically trade at roughly similar Multiples. Nevertheless, due to differences in their operating performance concerning growth and ROIC, they should show some variance. For a sensible Multiple assessment, therefore, the peer group should be additionally narrowed down to competitors with roughly comparable performance metrics. Comparison of Multiples Approach with Income Approach  An Enterprise DCF model might be the most detailed and accurate method for valuing a company. Nevertheless, a sensitive Multiples analysis might be useful for the framing and stress-test of Enterprise DCF-based valuations. Both approaches have their specific advantages and disadvantages and might, therefore, be used more as complements than as substitutes: The most fundamental advantage of the Income Approach models is, that they are based on the future performance of the to be evaluated company, and are therefore in line with the core principles of corporate valuation. Additionally, by using FCFs, they incorporate, besides the operating earnings performance of a company, also its investment needs like capital expenditure and working capital. Additionally, by applying sensitivity analysis, scenario-based valuations and simulations, a robust valuation bandwidth of a company could be defined and linked to the underlying value drivers of the company’s strategy and its industry. Besides, the valuation could be run on a standalone basis or including synergies. Last not least, the Enterprise DCF model is the internationally most accepted valuation method. Nevertheless, the Income Approach has also certain limitations. First, it is only as accurate as the forecasts of its underlying FCFs it relies on, being fully dependent on the quality of those forecasts. Additionally, these valuation models are very sensitive to the applicable cost of capital as denominator of the FCFs and to the Continuing Value which covers the value contribution after the explicit planning period. A sensitive analysis of

3.1 Valuation

141

those two factors are “mission-critical” elements for a high-quality Income Approach based valuation. The advantages and disadvantages of the Multiple Approach are more or less ­flip-sided to the Income Approach. One plus of the Multiple Approach is, that the derived prices are based on very recent market prices in perspective to a specific, dedicated peer group. As the Multiple Approach is based on two selected, but necessarily consistent financials, only a limited set of data and efforts are necessary. Additionally, Transaction Multiples might indicate strategic premia paid in recent transactions. The simplicity of the Multiple Approach comes with a set of disadvantages. The most severe criticism of Multiples is, that they are in the end no true intrinsic valuation, but mirror “just” recent prices of the stock-market or transactions. Additionally, the comparability of transactions or peer groups of comparable companies might be limited. The Multiples are also limited for valuation purposes, as they do not address a company’s specific strategy, value drivers and performance level.

3.1.4 Valuation Summary

MULTIPLE (Market Approach) VALUATION

ENTERPRISE DCF (Income Approach) VALUATION

For the definition of a reasonable valuation bandwidth the final valuations of the Income Approach, based on an Enterprise DCF or Adjusted Present Value methodology, and the different Multiple Approaches could be summarized in one chart, like in Fig. 3.14. This valuation canvas might get even more powerful if it might include as well different

in m $

DCF w/o synergies DCF with synergies

EBITDA-Mulple (2019 – 2020) EBIT-Mulple (2019– 2020) Normalized EBIT-Mulple (adjusted 2019 – 2020)

Fig. 3.14   Valuation Canvas

Valuaon bandwidth “worst” case

“realis c” case

“worst” case

“best” case

“realis c” case

“best” case

142

3  Transaction Management

valuation scenarios (best, worst, most likely cases) and valuations with and without the NPV of synergies: Such a valuation canvas might also be used for the board discussions with respect to final purchase price discussions and decisions.

3.2 Due Diligence The Due Diligence is, in essence, the process whereby the potential acquirer back-tests, meaning verifies or falsifies, the investment thesis. The indicative stand-alone value and the assumed synergies, as well as the target’s competitive advantage, might be of special interest. Nevertheless, the Due Diligence has to dig deep in legal, financial, strategic and business matters of the target company to detect potential risks and upsides of an acquisition.  Definition The Due Diligence intends a consistent, robust and stress-tested proof-of-concept of the investment thesis concerning the target company. High-level questions might be: How sound is the standalone valuation based on forecasted FCFs? How likely are assumed synergies and how realistic are their estimated volumes and timeframes to capture them? How have the Business Designs of the acquirer and target to be adjusted to realize those synergies and how could the Joint Business Design lever all upsides of the transaction? How could a sensible Joint Culture Design realize talent retention and avoid culture clashes? What are the crucial legal, financial and business risks of a potential transaction? Such a Due Diligence process is highly complex and consists of multiple activities like site visits of the most important factories, sales outlets and R&D centers, the assessment of the most critical documents in a virtual or physical data room, as well as management presentations and discussions. Therefore, the management of the Due Diligence is of paramount interest for a successful transaction. The following subchapter will first highlight the Due Diligence targets, before assessing the overall management, the organization, the processes and the tools of a Due Diligence. After this overview, the specifics of the Strategic and the Financial Due Diligence, as two decisive traditional parts of the overall Due Diligence, will be analyzed. The last part does focus on the Proof-of-Concept of the Standalone Business and Culture Designs as well as the Redrafting of the Joint Business and the Joint Culture Design within the Due Diligence framework.

3.2  Due Diligence

143

3.2.1 Due Diligence Targets The Due Diligence is from an E2E process flow view perspective the follow on step after the indicative valuation of the target company. This assumes, that the potential seller is satisfied with the indicative offer and agrees to “open his books”. In benchmark M&A processes the valuation and the Due Diligence are strongly intertwined: The indicative valuation of the target company and synergies is the starting point and could be interpreted as an investment thesis. This investment thesis has to be proven in the Due Diligence. The outcomes of the Due Diligence have to be feed-back into the update of the valuation and synergy estimates. The origin of the Due Diligence lies in the information asymmetry between the buy and sell side. The entrepreneur and the management team of the target company might know the company inside-out. The potential acquirer, on the other side, has in most cases a very limited information level concerning the target company prior to the Due Diligence (Gole and Hilger 2009, pp. 7–9). This information deficit has to be bridged by a focused and intense Due Diligence in a very limited timeframe, typically of three to six weeks. Before providing sensitive and confidential data the seller will request the signing of a nondisclosure agreement, which protects data leakages and allows the use of the accessed data of the target by the acquirer only for Due Diligence purpose. The reliability of the Due Diligence data is for the quality and robustness of the Due Diligence outcomes essential. Acquirers use therefore a wide set of sources, as pinpointed in Fig. 3.15 and run multiple cross-checks. The latter are levered by newest digital Due Diligence tools, especially within the Legal and Financial Due Diligence.

    

Strategic Business Plan Strategy Projects Interviews with management Workshops with selected employees Internal data of the company…

Target internal sources:

 Site visits  Interviews  Management presentaons  VDD documents of the target

IB reports Web reports Customer surveys  Expert interviews  Competor & supplier inquiry  Benchmark studies  Secondary stascs  Consultant analysis 

Target external sources: Interviews of people outside the target company, reports…

 

Reliability of the informaon independent

qualified

robust

clear

Fig. 3.15   Information sources of a reliable Due Diligence assessment

144

3  Transaction Management

Acquirers use the Due Diligence typically for multiple targets, like: – The verification of the investment thesis, especially of the stand-alone value and the synergies as estimated prior to the Due Diligence – To stress-test assumptions and to get a sound understanding of the business model, the strategy, the sources of the target’s competitive advantage and the value drivers of the target company – The benchmarking of high-level financial indicators and operational indicators with the best in class competitors – The assessment of the financial, strategic, Business Design and Culture Design fit between the acquirer and target – The identification of the essential strategic, legal, financial, operational, and cultural risks of the specific transaction as well as its potential upsides – A proof-of-concept of the Integration Approach, especially the intended JBD and JCD, as well as a first draft of essential integration topics and the integration design which have to be detailed within the Integration Masterplan The outcomes of the Due Diligence will be feed-back in the update of the valuation and therefore in the final purchase price discussions. Besides, in the Due Diligence identified risks will determine the structure of the purchase agreement and potential integration needs.

3.2.2 Due Diligence Management and Process In today’s world of business model variety and tectonic shifts in ecosystem boundaries, a tailored Due Diligence is mandatory. The Due Diligence has to be adjusted concerning the size and complexity of the intended transaction, the Business Design, as well as the cultural and international footprint of the target company. A holistic Due Diligence management framework incorporates not only the design of the Due Diligence process but also the selection of a highly-capable Due Diligence team, the design of the Due Diligence modules, and the development of suitable tools for efficient Due Diligence  assessments.

3.2.2.1 Due Diligence: Overall Process Management The timeframe of Due Diligence processes is in most instances limited to 3 to 6 weeks to avoid information leakages. On the buy side, the necessary information for an in-depth assessment of the likely chances and risks of the potential transaction has to be gained within this very limited timeframe. Therefore, a highly efficient process design, which keeps the balance between the necessary depth but gets not lost into too many details, is mandatory.

3.2  Due Diligence

145

3rd Round 2nd Round 1st Round



Generic Data Room strategic and financial informaon foremost excluded

 Crical

Possibly large number of bidders (20-30)

More detailed informaon is presented  Management presentaons, discussions and on site DD might be conducted  Selected Interviews



Limited number of bidders (5-8)

 Further on site

DD may be conducted crical informaon is disclosed shortly before signing (e.g. license agreement with competors, IP, terms and condions of key customer contracts)  Foremost 1:1 situaon

 Mission

Exclusive for final bidder

Fig. 3.16   Multi-round Due Diligence process

To manage the trade-off between the confidentiality interests of the sell side and the information needs on the buy side, multistep Due Diligences are nowadays standard practice, especially within M&A auction processes (Fig. 3.16): The potentially interested parties on the buy side will get in a first-round access to generic information, like audited financial statements or the general business plan of the target company. This first-hand information is for ease of use and scalability frequently bundled within a so-called information memorandum. Such an orchestrated process allows the target company on the one side to approach many potential buyers without having to be afraid of the leakage of confidential information, on the other side to initiate a bidding contest. Besides, due to a professional preparation of the separate steps, a higher quality of data in comparison to physical data rooms is frequently realized. Especially in international M&A projects are Virtual Data Rooms (VDRs) state-of-theart where the data are structured and stored within a password protected cloud. This enables a cost-efficient, web-based, secure process design, where multiple interested parties around the world might access at the same time the VDR. For the preparation of the second round, the seller selects the most attractive bidders by requesting an update of their indicative valuation. The selected bidders of the second round will be then provided a much wider database, multiple assessment possibilities, on-site visits and management discussions. In the last, third round, final purchase price discussions and contract negotiations will be initiated with a hand-picked number of final bidders. In this round very sensitive information on customers, IP rights, or financials might be released shortly before closing. The seller should be the orchestrator of such a multi-round Due Diligence process, as this offers the chance to avoid any surprises on the buy side. To tackle the multiple critical topics of the Due Diligence and the massive amount of information, the acquirer

146

3  Transaction Management

has to use an interdisciplinary and highly qualified Due Diligence team, which has all the necessary capabilities to assess the target company:

3.2.2.2 Due Diligence: Project House, Modules and Teams The selection of the Due-Diligence team (Herndon 2014, p. 66) is by itself a challenging task, as it involves not only the selection of internal team members but also the targeted insourcing of consulting services for specific Due Diligence subjects where the internal capabilities might be missing or limited. The project lead of the Due Diligence has to safeguard a proper steering and coordination of the different Due Diligence modules. Besides, the orchestration of the external resources like consultants and investment banks has to be assured. Detailed tasks of the Due Diligence projects house are the timing, the steering and the monitoring of the different Due Diligence modules, as well as the integrated processes with the dedicated focus to answer the core questions of the Due Diligence. The key challenge of the DD project house lies in the integration of the different Due Diligence tasks to an overall picture of the true risks and upsides of the potential transaction. In addition, the project lead has to coordinate the information needs from their own Due Diligence teams at the interface to the target company and has to ensure a transparent and permanent communication of the interim results between the modules and the top management. Therefore, general management and communication capabilities might be as important as specialist M&A know-how for the Due Diligence leadership team. In most instances where the potential acquirer has an in-house M&A team, one of the members of this team might be the most suitable project leader for the Due Diligence (Gole and Hilger 2009, pp. 93–97) (Fig. 3.17). Due Diligence Steering Commiee

Module

Due Diligence project lead and project house

     

Key issues

Legal Due Diligence

Strategy & Financial Due Diligence

      

Strategy documents Business plan Enterprise valuaon FCF and value drivers P&L and drivers, incl. fix vs. variable cost Balance sheet (equity, debt, assets, liabilies) Audits Exchange-rate risks IC-relaons Tax effects Accounng policies Non-recurring revenues & expenses Sales & EBIT per product



Valuaon & scenarios, Value drivers and FCF Likelihood of synergies Strategic raonal



         

Customer contracts Employment contracts Company contracts Warranes Liabilies Claims IP Rights, patents Property rights (incl. real estate) Shareholders Antrust issues Change of control clauses

Business Design Due Diligence Core Assets & Market, Compeon Capabilies and Sales           

Quality standards Trademarks, IP Factory layout & process Product concept and overview Technical posioning Technologic chances and risks; Distribuon & logisc concept R&D competencies IT architecture Product quality Exisng product porolio

        

Business Definion (incl. boundaries) Market and customer use case analysis Competor analysis Sales development & planning High runner and Return assessment Customer analysis Order planning and structure Order backlog …

Culture Design, Management & Organizaon

… 

Standalone Culture Diagnoscs and JCD proof-of-concept o Regional o Corp. values o Management



Wages and benefits Core competencies and qualificaons Organizaon Chart Employee structure Employee contracts Working hours Working Pensions et al Management team …

       

   

Clear picture of legal risks

Detailed understanding of Business Design

Fig. 3.17   Due Diligence project structure and project house



Transparency of management risks

3.2  Due Diligence

147

3.2.2.3 Due Diligence: Workstreams and Stage Gates An efficient and effective Due Diligence addresses the core questions within dedicated workstreams. The later might be decomposed in working packages and subprocesses: Due Diligence Stage-gates and Workstreams  overall Due Diligence processes could be structured along the following five work streams and stage gates (Fig. 3.18): Workstream and Stage Gate 1: Definition of Due Diligence Strategy As a starting point, the Due Diligence strategy has to tailor the common targets of the Due Diligence for the specific target company, like: – What kind of competitive advantages should be assessed? – What are the most important value drivers and synergy potentials which should be analysed? – Which potential core risks should be screened? Besides the specification of these targets, the rough timetable for the Due Diligence has to be defined and agreed upon with the top management of the sell side. Last not least the project house has to select the specific Due Diligence modules for the target assessment.

Due Diligence Process: Work streams

Valuaon

• Rough • Outside-in perspecve

Negoaons

• First contacts • Outside-in perspecve

DD-Strategy and set up of key foci

Define DD Team

Due Diligence

Valuaon

• Thorough • Informaon from inside

• Back-tesng investment thesis • Gathering detailed informaon for further valuaon • Searching for „hidden“ risks • Synergy proof • Gaining insights for integraon & negoaons

DD preparaon and preliminary invesgaon

Deal Closure • Aer detailed negoaons • Based on final valuaon and DD

Execuon of detailed DD Dataroom

Fig. 3.18   Due Diligence workstream and stage-gate model

Management interviews

DD summary and wrap up Onsite visits

148

3  Transaction Management

Workstream and Stage Gate 2: Design of Due Diligence Teams and Capabilities After the definition of the Due Diligence strategy, targets and rough timeline, the management team on the buy side has to select the project leader for the Due Diligence endeavour. The latter has to define the necessary resources and capabilities for the specific target assessment. Based on this first screen, an appropriate organizational Due Diligence structure with according core modules, like strategic, financial, legal, Business Design and Cultural Design Due Diligence, has to be defined. By mirroring the internal capabilities with the mandatory competencies to assess the target risks and upsides competency gaps and therefore necessary external resources, which might have to be hired from consultants, Big4 companies or investment banks, could be identified. In case of more complex and international Due Diligences, the establishment of a project house which supports the project leader is common use. The tasks of this project house are the coordination of the different modules, the enhancement of the smooth communication between the three layers management team, Due diligence project lead and project managers, the definition of work packages and timelines, the development of suitable Due Diligence tools as well as the definition of consistent reporting standards. The project house has as well to coordinate all activities and timelines with the sell side. Workstream and Stage Gate 3: Preparation of the Due Diligence In the third workstream, all Due Diligence team members should be brought onto the same information level. The project management can achieve this by providing a first set of information on the target company based on an outside-in assessment and the intended timeline of the Due Diligence. Besides, the mission-critical outcomes of the Due Diligence assessment and potential deal breakers, like hidden facts, financials, potential liabilities or significant management issues, are addressed. Also, the tasks, responsibilities and competencies for each module and team member have to be clarified at this stage. Workstream and Stage Gate 4: Execution of Due Diligence Workstream four, the operational execution of the Due Diligence, is the most intense and complex sub-stream. It covers virtual or physical data room assessments of legal, commercial, financial and other important documents or contracts, management interviews and presentations as well as site visits. These three layers should assure a high qualitative assessment for the strategic, financial, operational, legal, management, Business and Culture Design Due Diligence. The operational part of the Due Diligence might be supported by tailored Due Diligence tools which will be discussed in the next subsection. Workstream and Stage Gate 5: Due Diligence Summary In the final workstream five, the core outcomes of the Due Diligence are described and summarized. This might be even more challenging than stream four, as a significant amount of documents and findings has to be consolidated and the most crucial ones

3.2  Due Diligence

149

selected. For the top management summary the following questions might be used as a guideline: – Based on the Due Diligence information and findings: Should the intended transaction still be realized or are there crucial deal breakers? – In line with the Financial and Strategic Due Diligence: What are realistic estimates for the synergies and the stand-alone value of the target company? Are synergies likely? What is, therefore, the upper limit for the purchase price? Are the competitive advantage of the target and the transaction rational verified? – Based on the Due Diligence risk assessments: Which kind of risks have to be addressed in the purchase agreement, for example by using representations and warranty clauses, and what might be the ideal deal structure (asset versus share deal)? – Along with the overall Due Diligence findings: what should be the priorities for the Integration Management? – Is the intended JBD robust and does it address the transactional rational? – Could culture clashes and talent drain avoided by a sensitive culture transition?

3.2.3 Due Diligence Tools An efficient management of the workstreams requests a standardized and digitalized Due Diligence toolset. This toolset has to assure that even under time pressure the most important risks will be identified and the fair value of the target company, as well as the synergies, assessed. The Due Diligence tools will be discussed along the five defined workstreams (Fig. 3.19): Due Diligence Tools for Workstream 1 Before setting up the Due Diligence, a Non-Disclosure Agreement (NDA) is signed by the potential acquirer and the seller. Standardized NDAs intend, as described, the protection of sensitive target company data, but should as well enable a smooth execution of the Due Diligence. A second tool prior to the ramp up of Due Diligence efforts are Letter of Intents (LoIs). Those LoIs cover, besides the indicative, non-binding offer, the crucial assumptions on which the offer is based, necessary board approvals prior to a final transaction and proposed next steps of the Due Diligence process. A one pager, which describes the most important targets within the core fields of the Due Diligence assessment, summarizes briefly the Due Diligence strategy. The summary might be used as a guideline throughout the overall Transaction Management to avoid getting overcrowded during the later execution of the Due Diligence.

150

3  Transaction Management

responsibility

Due Diligence Process (con’t): Deliverables DD-Strategy and set up

Kick-Off Meeng   

acons







results

Define DD Team

DD Project Manager Regional MD Business MD DD strategy & Deal architecture (share vs asset deal, earn out,…) Definion of DD framework & key / focus areas Precise definion of value, synergy and investment thesis

NDA Leer of Intent

   

  

DD Project Manager Regional MD Business MD Definion of teams, sub teams and team members Definion tasks & responsibilies Define guideline for communicaon First design of work streams based on focus points

NDA for team members

DD preparaon & preliminary invesgaon       



DD Project manager Sub Teams DD-team members

Execuon of detailed DD Dataroom

Informaon memo Time and resource planning Contact details Preparaon packages (DD quesonnaire & request list, templates…) Data room preparaon

Team details

Short info-package about target

Definion of DD framework / work streams

Management interviews          

DD summary and wrap up Onsite visits

DD Project manager Sub Teams DD-team members



Site visit Management interviews Analysis of documents in the data room Idenficaon deal breakers and risks Verificaon success factors, value and synergy thesis In depth analysis acc. work streams Cross checks



DD- guidelines, Handbook + DD-quesonair + DD-request list

 

 

DD Project manager Sub Teams MD´s Mgt. report Mgt. presentaon Mgt. discussion

Management Summary Management Presentaon

Fig. 3.19   Due Diligence responsibilities, tasks and tools

Due Diligence Tools for Workstream 2 The tools of the second workstream focus on the organizational preparation of the Due Diligence, the insourcing of necessary capabilities and the setup of the project structure. The starting point are NDAs for the individual team members to avoid within the acquirer’s organization a leakage of information. The organizational setup of the project team might be supported by standardized and digitalized templates and reporting standards, as well as by Due Diligence module concepts. These standards have to be adjusted according to the needs of a specific transaction design, the transaction rational and the Business Design of the specific target company. With the support of an info-memo the most important information about the target company, based on outside-in assessments, will be summarized. This info-memo serves as a first-hand information for the full-fledged Due Diligence team. Due Diligence Tools for Workstream 3 Within workstream three the project leadership team might initiate a kick-off session with an intense briefing about the target company as well as the timing, the process flow and the intended outcomes of the Due Diligence efforts. This meeting must also frame the responsibilities and deliverables of the different modules and team members as well as mandatory reporting standards. The project house might also provide a short-hand training of the Due Diligence tools to be applied in workstream four and might prepare a cloud-based platform, where the tools could be downloaded.

3.2  Due Diligence

151

Due Diligence Tools for Workstream 4 Workstream four covers the execution of the Due Diligence. A broad variety of tools focus on this workstream, like data room request lists, data room assessment tools, and tools which support the site visits and the management discussions:13 – A module specific, digitalized Due Diligence question-list frames the core questions which have to be tackled by the individual modules and which have to be assessed and answered during the course of the Due Diligence execution phase. – A Due Diligence data room request-list serves as a preparation of the Due Diligence efforts and VDR content as it describes the crucial legal, financial and further documents requested by the buy side from the sell side to gain a sound understanding of the target company. Additionally, the Due Diligence data room request-list is used to have a permanent transparency in which documents have been provided by the target company, which have been assessed by the Due Diligence teams and which ones are still missing. The last point is in so for important, as information loopholes have to be early detected and addressed by the buy side. – A site visit guideline assures that a maximum of information is achieved by the in-person visits of the factories, sales outlets or R&D centre of the target company. The site visits are of special interest to gain further insights for the valuation of assets and processes of the target company and serve as a blending for the information achieved by the screening of the documents in the virtual or physical data room. Together with the later a holistic view of the target company should be achieved. – Last not least, a management interview-guideline is used for the design of the management interviews. It ensures  a maximum outcome of those interviews, fosters a cross-check between Due Diligence findings and enables a valuation of management capabilities and qualities within the target company. Due Diligence Tools for Workstream 5 The challenge of workstream five is to summarize the massive amount of data and outcomes of the Due Diligence and to crystallize the most crucial risks and upsides of the potential acquisition of the target company. Tools which might support within this workstream are standardized management reports and presentation templates which keep the balance between a detailed discussion of the Due Diligence findings and a focus on the most crucial transaction topics.

13Detailed

Due Diligence checklists are provided, for example, by Gole and Hilger (2009, p. 108).

152

3  Transaction Management

3.2.4 Core Parts of the Due Diligence As Due Diligence processes are complex and heavily content-driven, they are structured in modules. A couple of overall modules, like the Financial or the Legal Due Diligence, have to be addressed in more or less any Due Diligence, but the detailed structure within those modules has to be tailored for the specific transaction. Other modules, like the Business Design Due Diligence and Diagnostics, are from the very beginning dependent on the target company, its ecosystem and its strategy. Besides, new developments, like platform and digital Due Diligence questions renewed classical Due Diligence matters. The latter are addressed in the following within the design of the Due Diligence. Typical Due Diligence modules are: – – – –

Strategic Due Diligence (SDD) Financial and Tax Due Diligence (FDD) Legal and Compliance Due Diligence (LDD) Business Design Due Diligence (BDD), which covers the traditional commercial, the management and HR, the organizational, the digital and platform and other operational Due Diligence fields – Culture Design Due Diligence (CDD) The later gained in the last couple of years in importance as more and more transactions are cross-border deals or involve different corporate value systems, like in cases where a large corporate buyer acquires an agile start-up company (Fig. 3.20).

Strategic Due Diligence • Target porolio diagnoscs • SBU strategies and compeve advantage • Ecosystem trends and boundaries, SWOT • Core competencies • White Spots • Competor Profiling • Strategy & innovaon projects

Legal Due Diligence • • • • • •

Corporate charters IP and patents Employment contracts and terms Claims Change of control …

SDD FDD CDD • Regional culture embeddedness • Corporate value architecture • Tone-of-the-top

LDD BDD DD Modules Fig. 3.20   Due Diligence modules

Financial Due Diligence • P&L Diagnoscs: ROIC and growth assessment, decomposion of top-line in value drivers • B/S diagnoscs: Debt & debt like items; PP&E, CapEx and working capital • FCF diagnoscs: Cash conversion, … • Synergies: Likelihood, volume, ming, robustness

Business Design • • • • • • •

CO: SBUs, value chain, HR & management CV: Core products, services, web-offerings CM: Core markets, use cases, segments CR: Relaonship model CH: Distribuon channels and logiscs CA: Factory footprint, IP,… CC: Core capabilies, e.g. reserach,..

3.2  Due Diligence

153

In the next subchapters the mission-critical Due Diligence modules will be discussed, whereby the focus will be on the Strategic (SDD), the Financial (FDD), the Business Design (BDD) and Culture Design Due Diligence (CDD):14

3.2.4.1 Strategic Due Diligence The ultimate target of the Strategic Due Diligence (SDD) is the identification and verification of the competitive advantage and standalone attractiveness of the target company as well as of the transaction rational. The following five questions and building blocks of an SDD might foster this understanding: – How are the corporate portfolio and the SBUs with their unique ecosystem designed? How would the target company’s portfolio fit with the acquirer’s one? What are the strategic synergy levers between the acquirer’s and the target’s portfolio? – What are the outstanding and unique advantages of the target company on a corporate level, its parenting advantages, and on strategic business unit levels, its competitive advantages? How strong are the competitive advantages in comparison to the most capable competitors of its peer group? – How might the attractiveness of and the trends within the different ecosystems of the target company, which include the competitive environment, the customers, use cases and core technologies, evolve? – What are the unique capabilities within the target’s Business Design and how might they be renewed or endangered by business model innovations? – Do the corporate and the business unit strategies of the target company address the crucial developments in the ecosystems and create unique, defendable and ­long-lasting competitive advantages? (Fig. 3.21) Corporate and business unit strategies, as defined in Chap. 2, address different topics: The corporate strategy answers the question “where to compete”, while business unit strategies address the question “how to compete”. Therefore, both strategy levels have to be assessed separately within the SDD. Within the corporate strategy, the priority is to achieve an understanding of the target’s portfolio of business activities (SBUs), of the core portfolio strategies, how the target portfolio fits with the acquirer’s and if the acquirer offers parenting advantages for synergy leverage on portfolio level. The evaluation of portfolio strategies involves also the discussed Business Model Innovation strategies, like internal business innovation strategies, accelerator and incubator models, M&A activities, or JV and partnering strategies of the target.

14Herndon applies a higher granularity of Due Diligence fields to be investigated (Herndon 2014, pp. 59–61).

154

3  Transaction Management

Strategic Due Diligence Submodules

Corporate Porolio Diagnoscs • Corporate porolio architecture • Overview of SBUs within the corporate porolio • Porolio strategies • Strategic Fit with acquirer’s porolio (synergies) and parenng advantages

SBU Strategies & Compeve Advantage • Segmentaon of SBUs according products, markets, regions, customers, competors • SBU strategy and compeve advantage • SBU compeve posion (best-in-class benchmark) • Strategic Fit with acquirer’s SBUs (synergies)

Ecosystem Aracveness

Core Competencies

• Evaluaon of (future) ecosystem aracveness

• Assessment of each SBUs core competencies: o Uniqueness o Lasng o Defendability o Value impact

• Assessment of mega trends: o Technology o Markets & white spots o Use cases

• Complementarity with and renewal of acquirer’s capabilies

Strategic Programs • Strategic Programs mirrored against compeve posion and SWOT • … link to valuaon and financial DD

• Matching with parenng advantages (synergies)

Fig. 3.21   Strategic Due Diligence (SDD)

SBU strategy assessments start with the segmentation of the SBUs products, services, served markets, customers and use-cases. Each SBU has its own specific ecosystem, which describes not only the specific environment of an industry but as well the needs of the customers, underlying technologies and trends. Based on this understanding of the specific ecosystem the SDD can assess the strategic position and competitive strength of the target company in each of its SBUs. This involves the assessment of the regional footprint, the unique selling proposition of its products, and a benchmark with ­best-in-class competitors with respect to its relative competitive positioning. By combining the assessment of the future attractiveness of the ecosystem and the strategic positioning of the target company within its ecosystem a sound strategy evaluation is possible. Within this step, also the analysis of how the SBUs fulfill the characteristics of Michael Porter’s competitive strategies, like cost leadership, differentiation or niche strategies, might be valuable. Besides, the SDD has to assess the SBD concerning its differentiating, unique and lasting core capabilities. These capabilities could be benchmarked with best-in-class competitors. To get a final, holistic view of the strategies of the target company the strategic programs on the corporate and the SBU levels are assessed. This offers the possibility to analyse if and how the acquirer might improve the standalone positioning of the target company. The SDD serves also as a back-drop for a sound judgment of the valuation and investment thesis by assessing how the competitive advantages of the target company fit the acquirer’s portfolio, capabilities and strategies and how they enable value

3.2  Due Diligence

155

levers? Secondly, it supports a detailed judgment on the “fair”, in the sense of realistic, ­stand-alone value of the target company and its strategic levers to improve the standalone value. Last not least, it prepares the assessment which synergy potentials on the corporate as well as on the strategic business unit levels might exist between the acquirer and seller.

3.2.4.2 Financial Due Diligence The quality of the Financial Due Diligence (FDD), and in the end as well the valuation, could be improved by an intertwined FDD and SDD, as both serve different time horizons. The FDD is more backward and the SDD is more forward oriented, as described by Fig. 3.22: The traditional understanding of the FDD is based on the verification and assessment of the audited financial statements of the target company for the last 3–5 years. This should provide an in-depth understanding of the value, reliability and robustness of the target’s financial reporting system. Besides, the target’s assets, liabilities, its historical earnings and cash performance is evaluated. But, as the valuation of the target company is based on the future FCFs and not its past performance, the year-to-date development of the target company, as well as the plausibility check of the forecasted future earnings and FCFs, must be as well analysed. Tseng (2013, p. 1) describes the target of the FDD: “It considers the reasonableness of financial forecasts to the current business model and detects risks and opportunities prior to closing the deal. It obtains necessary information to investigate trends and fluctuations in the operating performance of the target and assist clients in their investment and financing decisions.”

Value & Cash Flow Past Performance:    

CF & ROIC performance Earnings performance Turnover performance Cost, investment and working capital development

YTD performance and planning assumpons:  Cash flow & ROIC development  Earnings development  Turnover development  Fit with strategic iniaves

ROIC, Turnover (growth)

Fig. 3.22   Link between Strategic and Financial Due Diligence

FC Future Performance:    

Focus: CF, ROIC, IC Scenarios Simulaons Value drivers

Strategic Due Diligence

Financial Due Diligence

From strategic to financial DD

156

3  Transaction Management

The ultimate targets of the FDD might be therefore described by: – Gain a deeper understanding of the competitive advantage and Business Design of the target company, its profitability and CF drivers, including the probability of synergies – Assess the quality of earnings, profitability and FCFs by normalizing past performance – Determine the investment, working capital and financing requirements of the business – Assess net debt and identify further net debt like items – Defined price limits, deal breakers and integration priorities The FDD is the module with the most standardized toolset. The reason might be, that transaction services, as well as Big4 companies with their standardized reports, are frequently involved in FDDs. Nowadays a Financial Due Diligence report frames the following parts:15 – The first part of an FDD report is the judgement on the quality of the financial statements, the management accounts and the reporting system, the so-called quality of earnings assessment. This includes as well the analysis of the applied accounting principles and a detailed description of the financial reporting processes. The judgement about the quality of financial reports might be based on criteria like functionality, reliability, speed, suitability, robustness and compliance. – In the next section the historical and actual asset values, earnings performance and financial performance are analysed and interpreted. This is one of the core parts of FDD and includes a detailed analysis of the balance sheet, income statement and cash flow statement as well as of the most important line items. Within the balance sheet assessment, the financing structure of the company will be decomposed in equity, debt and hybrid capital. Besides, debt-like items, like a pension underfunding or potential liability claims, must be identified as they must be subtracted as well in the walk from the Enterprise to the Equity Value. On the assets side, capital expenditures and investments as well as working capital items like accounts receivables, inventory and accounts payables—and in case of project businesses prepayments—might be on the top priority list. Within the income statement analysis, the performance development will be broken down into the detailed assessment of the most important revenue and cost drivers. Also, their impact on cash flows will be analysed, the so-called ­earnings-to-cash flow conversion. In the final part, tax impacts will be described. – The normalization of earnings for the past years is a separate step. It distinguishes operating performance from one-time effects like periodic specific costs (e.g. restructurings) which have to be stripped out and any non-operating items. This section

15A

more detailed overview of the Financial Due Diligence content is provided by Tseng (2013).

3.2  Due Diligence

–

–

–

– –

157

intends to generate a consistent long-term view on the earnings potential and FCF development of the target company. In the section on the year-to-date performance, sometimes also called actual performance, deviations from the long-term trend in earnings and FCFs are of interest. This will be framed by an assessment in how far the actual performance deviates from the intended plan performance. The latter is described in most instances by budget targets and might be the underlining benchmark for the management incentive system. In the YTD assessment, the granularity is typically increased from a yearly perspective to a quarterly or even monthly perspective. In a further part of the FDD, the equity and debt structure will be analyzed. This is as well a very substantial part, as the bridge from the Enterprise to the Equity Value is built by the net-debt position. The sensitive assessment of the net-debt position incorporates not only excess cash and interest-bearing liabilities, like bonds and loans, as net-debt but as well debt-like items, as described. The conversion rate from earnings (NOPLAT) to FCFs is as well a crucial input for the valuation of the target company as it assesses how much of the realized NOPLAT flows into the cash performance of the company and how much is plowed back (retained earnings) into the target’s business. In most cases the Tax Due Diligence is as well incorporated in the FDD. The management summary of the FDD report will frame the most important findings and risks of a potential transaction. A high-quality report will select and address the crucial findings always from an investor or the acquirer’s top management point of view (Fig. 3.23).

The corporate valuation, as well as the valuation of the synergies, is not an integral part of the FDD. This is a separate task which has to be performed by the M&A department Quality of financial informaon Accuracy and robustness of financial reporng, accounng and planning.

Historical & current trading Detailed break-down on line items and assessment of P&L statement, B/S and financing

PAST PERFORMANCE Quality of earnings & normalizaon

YTD PERFORMANCE

Budget & forecast Assessment of budget and YTD performance. Comparison of YTD with management plan.

Valuaon FCF performance, decomposion and conversion

Fig. 3.23   Financial Due Diligence (FDD)

FUTURE PERFORMANCE

Normalizaon of historical ROICs, NOPLATs and FCFs. Idenficaon of sources of one-offs.

Net Debt, Working Capital & FCF conversion

Idenfy debt, debt-like items (off-balance) and leverage. Assessment of invested capital items and development.

158

3  Transaction Management

of the acquirer, as described in the valuation subchapter. Nevertheless, the FDD has still important implications for the identification of the true value drivers of the target company as well as the definition of the purchase price limits, potential deal breakers, closing requirements and integration needs.

3.2.4.3 Legal Due Diligence The core targets of the Legal Due Diligence (LDD) are the transparency on the target’s most crucial contracts as well as the identification of key legal transaction risks. The ­mission-critical contracts might include shareholder rights, patent and IP rights, employment contracts or legal disputes. The challenge of the LDD is to avoid getting lost in the massive amount of the target’s legal documents. The guiding principle is the materiality of the contracts. Therefore, priorities have to be set, for example by using thresholds like revenue hurdle rates in customer contracts. The LDD by itself frames multiple subjects. A first part of the LDD is the clarification of shareholder rights and assessment of corporate charters and contracts. This might include important change of control clauses, minority shareholder rights, potential restrictions of dividend policies or liabilities on corporate level. The target of this part is to clarify potential risks on the corporate group level of the target company. A second subject of the LDD, which has to go hand-in-hand with the FDD, is the analysis of the contracts with respect to important assets and liabilities as those might have an immediate impact on the value of the target company. Examples might be factoring or leasing agreements for important assets. The outcome of the legal assessment of balance sheet items might also impact the design of the potential purchase agreement as a share or asset deal. In case of customer contracts, the financial parts, like volumes, prices and price adjustments in case of delivery delays or for certain purchasing volumes, as well as the pure legal parts, like non-competes, guarantees or change of control clauses, have to be reviewed. The customer contracts are typically prioritized by an ABC analysis concerning their size. A further high priority LDD topic is the assessment of management and employment contracts. These have to be reviewed with respect to working hours, compensation and benefits, pensions and healthcare costs, leave agreements and further topics. Already the analysis if the pension scheme is based on a defined benefit or contribution schedule shows the financial importance of these assessments. In case of a defined benefit structure, the potential underfunding of pensions has to be mirrored in the valuation as a ­debt-like item. Digital Business Designs and platform companies in industries like media, automotive, telecommunication, high-tech as well as pharmaceuticals and healthcare shifted the competitive advantage from tangible to intangible assets, like brands, patents, IP rights or network effects. Therefore, the analysis of the according rights, patents or trademarks became more and more important within the LDD. An aligned subject are legal disputes. Here, the LDD has to assess potential worst-case scenarios in case of lost disputes and the likelihood of such scenarios to materialize.

3.3  Blending of SCDs and SBDs and Redrafting of JCD and JBD

159

Besides, there might be a bunch of special LDD issues and investigation needs specific to the target company and industry.

3.3 Blending of SCDs and SBDs and Redrafting of JCD and JBD The SDD, FDD and LDD are supplemented by Due Diligence efforts concerning the Standalone Business Design. The Business Design Due Diligence analyzes the operating mode vivendi of the target company. Besides, a thorough understanding of the target’s Business Design is mandatory to understand the viability, time needs, volume and likelihood of potential synergies. The Business Design view, as discussed in Chap. 2, offers a holistic assessment of the operational target business. It integrates thereby the traditional commercial, business, operations, technical, management and HR Due Diligence tasks, besides newer subjects like digital and platform or cyber-security Due Diligence by applying one consist framework throughout the E2E M&A Process. The Corporate Strategy and Corporate Finance part of the Due Diligence have been already frontloaded due to their importance for the overall Due Diligence outcome. The Business Design Due Diligence intends, in the end, a proof-of-concept of the SBD Blue Print of the M&A Strategy phase:

3.3.1 Business Design Due Diligence: Blending of SBDs and Redrafting of JBD Blue Print The Business Design Due Diligence (BDD) is highly target specific as it depends on the market footprint and value chain of the target company. Obviously, the BDD of a service company is substantially different than one of a pharmaceutical, media or manufacturing company. Accordingly, the BDD has to be adjusted and tailor-made for the specific target Business Design. Therefore, only the framework and a broad overview of the substantial parts of the BDD will be provided here. The BDD will be structured along the 10C model and covers the so far not discusses Due Diligence parts, as described in Fig. 3.24: The Business Design Due Diligence includes the Due Diligence of the target’s core products & services (CV), its addressed markets and use cases (CM), the distribution, sales and communication (including marketing) channels (CH), the critical customer relationships including sales and aftermarket approaches (CR), the core assets like manufacturing footprint or technology platforms (CA), the target’s unique core capabilities (CA), the key relationships with its ecosystem (CE) and last not least the organizational, management and HR Due Diligence (CO): The products, services and web-offerings are often the true transaction rational of an acquisition. The BDD has to address this within the CV part by identifying the core products and services of the target company, assessing their core advantages and USPs including a benchmark with the key competitors. For the latter product and service

160

3  Transaction Management

CS Separately discussed and carved out in Strategic Due Diligence (SDD)

CP

CA

CR

CV

• Global manufacturing • Core products & • Direct sales • Core suppliers and footprint benchmark • Web-sales services relaonships • Investment levels • Product advantages • Aermarket • Purchasing ABC • Technology plaorm relaonship and characteriscs assessment • R&D plaorm (incl. benchmark) • University network • IPs, patents, … • Success factors • VC network • Product volumes • Partnering network… (ABC) & profitability

CC

CM

• Served markets & boundaries • Market segmentaon & use cases • Market trends • Regional footprint • Market share (incl. competors) • Distribuon channels: • Customer analysis and profitability volumes, profitability • Value and cost • Logiscs: costs drivers (ABC) • Sales orga & costs • Core customers & • Markeng mix share of wallet

CH

• R&D pipeline & capabilies • Digital capabilies • Brand management • HR management

CF

Separately discussed and carved out in Financial Due Diligence (FDD)

CO• Organisaonal structure (SBUs), layers, (de-)centralizaon

• Management team, key talent and retenon, employee structure • Compensaon, benefit policies, leave rates, employment contract

Fig. 3.24   Business Design Due Diligence (BDD)

characteristics like pricing, quality and reliability, revenues and profitability on product and service level (ABC analysis) might be assessed. Besides, the market and customer trends impacting the product and service attractiveness of the target’s offerings are of interest. Hand-in-hand with the Value Proposition goes the market and customer Due Diligence (CM). The starting point is a detailed description of the served markets, market segments and use cases by indicators like market size, market growth, segment and customer margins or share of wallet. But, as the valuation is forward looking, also the trends in the target’s markets and the threats from substituting technologies have to be evaluated. The assessment of core customers, their purchasing volumes, profitability and the target’s share of wallet increases the granularity of the CM Due Diligence. The customer relationships (CR), play a central role for the Due Diligence, but also the later integration. Due to their direct customer exposure, they are very sensitive to changes and have a direct top-line impact. The analysis of the primary sales approach, the use of mass versus individualized offerings, the degree of digital technologies for sales as well as one term vs long term client services are of essence here. The channel assessment (CH), also described under the term supply chain Due Diligence, frames distribution channels, logistics, sales channels and the marketing mix. This might be one of the broadest, but also most Business Design specific parts of the

3.3  Blending of SCDs and SBDs and Redrafting of JCD and JBD

161

BDD. The analysis of channels references typically to profitability, cost, efficiency, quality (e.g. order fulfillment), flexibility and time indicators. The core assets (CA) depend on the competitive advantage of the target company. As the necessary investments directly impact the Free Cash Flows their analysis it ­top-priority for the BDD and the FDD: – For manufacturing companies, the Due Diligence of the global manufacturing footprint including utilization levels and optimization potentials, the overlaps with the acquirer’s operations, the capital expenditure and investment programs, as well as the flexibility of the manufacturing setup have to be assessed. The analysis of manufacturing processes is typically based on indicators like efficiency, costs, time and quality. It might even become more insightful, if this manufacturing Due Diligence is supplemented by the benchmark of best in class competitors and the proof of applied quality improvement techniques, like TQM, Kanban or Lean Manufacturing principles. – For a pharma or biotech incumbent, the detailed CA analysis of the R&D pipeline, R&D investments and intended product launches might be more important – Whereas for a technology company the applied digital platform, IPs and patents might be of paramount interest in the CA Due Diligence Closely aligned with the core assets is the Due Diligence of core capabilities (CC). Like the products and services (CV) they are nowadays one of the most important reasons why of a transaction and are deeply ingrained in the Business Design of the target. For start-ups, it might be the innovation, digital and platform design capabilities or for luxury good companies brand management excellence. The Due Diligence of the target’s ecosystem (CE) involves the assessment of its core suppliers and relationships, its university network or, as a start-up, its VC and partnering network. Traditionally, the analysis of the sourcing strategy and key suppliers plays a dominant role in the assessment of the bill of material (ABC). Besides, low-cost country sourcing approaches or cost efficiency and saving potentials in purchasing due to economies of scale and scope might provide further insights. The CO part of the BDD analysis the organizational structure of the target company from three perspectives, the corporate, the regional and the business unit view, which involves the definition of the degree of (de-) centralization. Besides, the assessment of the target’s management team, key talent and retention as well as the overall employee structure, compensation and benefit policies, leave rates and employment contract play centre role. As nowadays the acquisition of capabilities and talent are core advantages of most transactions the management & HR Due Diligence will be discussed in more detail. The later has an impact on mission-critical transaction questions, like how key employees and talent may  be kept onboard or how core competencies could be retained. Management appraisals provide an overview of leadership skills and gaps, which are of

162

3  Transaction Management

special interest for the later integration of the target. Concerning employment-related issues, indicators like working hours, leaf rates, and others have to be assessed. Based on this overview the employment structure, the compensation and benefit system, as well as more soft issues, like employee development and learning programs, might be analysed. Benchmarks with best-in-class competitors offer, once more, even more insights. The HR and Management Due Diligence is in most instances a mix of desk research, interviews, but also newer digital tools, like LinkedIn or Glassdoor.com assessment. Within the desk research, the contracts of the most important employees are analysed with respect to details like compensation and benefits, exit clauses, incentive systems, or noncompete clauses.

3.3.2 Culture Design Due Diligence: Blending of SCDs and Redrafting of JCD Blue Print In the past Culture Due Diligence (CDD) questions have been not or at least underrepresented within Due Diligence matters as management teams focused more on strategic fit evaluations and synergy capture (Schweiger and Goulet 2000). Nevertheless, this changed in the last couple of years. The assessment of the cultural perspective and potential gaps between the potential acquirer and target has three dimensions, a regional, a corporate value architecture and a top-management perspective. The first Standalone Culture Design (SCD) Diagnostics of the M&A Strategy have to be verified by a tailored proof-of-concept approach within the CDD. This might be achieved by a detail culture profiling of the two companies. A set of tools, like top management interviews, employee surveys, the observation of management behaviors and LinkedIn or Google-Search web-research based culture profiling offer such a deep-dive and cross-checks of the SCDs. This will provide a much higher granularity for the culture assessment. Based on this detailed understanding of the individual SCD culture similarities and differences, the Blueprint of the JCD could be tested concerning its robustness and refined.

3.3.3 Due Diligence and Verification of Integration Approach Due Diligence findings are highly valuable sources for the validation of the Integration Approach, especially the targeted Joint Business and Culture Design, and the verification of synergy estimates. Furthermore, a smooth transition of the information and insights gained in the Due Diligence from the transaction team to the integration team assures that valuable information, as well as the transaction rational, are retained. Besides, the integration could be head-started and scaled from Day-One onwards. This holds true especially for the Due Diligence as it includes mission-critical insights for the integration, like the proof and refinement of the Joint Business and Culture

3.4  Valuation and Due Diligence of Digital Business Designs

163

Design, the identification of the business-specific value drivers, the verification of the assumed synergies, and the identification and investigation of the transaction risks. The latter might be especially valuable, as the early involvement of the lead integration management, meaning those integration team leads which will focus on the realization of the core value drivers of the transaction, levers the sensitivity to potential integration hurdles. Furthermore, the Integration Project House (IPH) may be pre-structured already along with the Transaction Management. The early blueprint of the post-closing governance structure and workstreams, of the reporting and tracking processes, of the escalation resolution mechanisms, as well as of Integration Scorecards and key performance indicators ensure Day-One readiness and smooth integration processes. Also, a first prioritization of integration tasks along with criteria like value impact, risk impact, feasibility, and time span could be derived. This keeps the focus on value-add activities throughout the integration journey.

3.4 Valuation and Due Diligence of Digital Business Designs The valuation and Due Diligence of digital targets and Business Designs is even more demanding than transactions within traditional industries. The challenges start already with the evaluation of the target’s stand-alone attractiveness, especially the target’s Business Design and capabilities. The valuations of incumbents are typically built around a worst-best-realistic-case based Enterprise DCF model and the evaluation of cost synergies. This traditional valuation view does not address the specific pattern of digital acquisitions with their  focus on revenue scaling and digital capabilities (Fig. 3.25). For the valuation of digital start-ups and targets their unique Business Design must be taken into consideration: They are built on fast growing, but foremost unproven BDs, lacking historical evidence. The strategic intent of digital innovations is to create new markets and user experiences, which are described by the strategy literature as riding Blue Oceans (Fig. 3.26). On top of the valuation challenges in such untested waters, the competitive advantage of digital BDs is built on intangible assets like IPs, patents, know-how, platforms, digital brands or digital customer access and data. These intangible assets are much harder to predict and evaluate as industrial businesses built around tangible assets. The financial pattern of such Business Design is most likely characterized by high, but volatile revenue growth rates, early start-up losses and, at least initial, high cash burn rates. Additionally, due to the focus of intangible assets, they have typically a Balance Sheet-light business model, like in the case of digital platforms or social media networks.

164

3  Transaction Management

The End-to-End M&A Process Design for Digital Business Designs Embedded M&A Strategy

#1

• Ecosystem Scan with focus on: − Digital disrupve technologies (IP scan and VC investment flow) − Use-cases: White spots detecon • Embedded M&A Strategy: Idenficaon and assessment of future digital competeve advantage and capability needs • BMI-Matrix for tailored growth strategy • JBD and Integraon Approach Blue Print • Fit Diamond focus on digital targets and capabilies

#4 • • • •

#2

Transacon Management

• Valuaon and (F)DD addressing the unique CF paern of digital BDs: − High growth rates, but risky and volale FCFs − Foremost B/S light BDs, therefore focus on P&L − JBD & synergy model based on revenue scaling • Applying advanced DCF methods − DCF scenarios and simulaons (Monte Carlo) − Reverse DCF and VC valuaon for back-tesng • Verificaon of Integraon Approach − SBD Blending and JBD Proof-of-Concept − SCD Blending and JCD Proof-of-Concept

Integraon Management

• Tailored Integraon with balance of − Leveraging defined parenng advantage to scale targets SBD − Sustaining targets standalone momentum and BD success factors • Retain and develop crical talent • Implement necessary compliance • Scale targeted culture transion • Back-track integraon progress

Synergy Management

Idenficaon of digital synergy levers • Back-tesng Synergy Scaling model Parenng advantages to scale target SBD • Back-tesng parenng advantage Revitalize buyer’s SBD by target capabilies • Synergy-valuaon blending Tailored Synergy Scaling Model

#5

#3

• Rapid scaling of target’s SBD • Focused implementaon of Synergy (revenue) Scaling Model

M&A Project Management & Governance Digital M&A playbook

Fig. 3.25   Tailored E2E M&A Process Design for digital transactions: Transaction Management

Paern of digital Business Designs • Most successful innovaons and plaorms built in “winners takes all markets” on white spots (riding building oceans) • Digital Start Ups and Business Designs with foremost unproven performance and therefore hardly to predict FCFs • True compeve advantage built on intangible assets, like IP, patents, know how, plaorms or brands • Digital Business Design most likely with: − High revenue growth rates (scalability!) − Early start up losses − High cash burn rate (pre-investment in plaorm and digital Business Design) − Oen B/S light model and plaorms

… and their FCF & valuaon impact • Unproven Business Design with high risk paern: − High volality of Cash Flows − Addressed by simulaons and cost of capital approach − Business Design specific investments • Due to riding Blue Oceans true peers most likely not available − Mulple Aproach not applicable − VC method (pricing) limited applicable − Oen B/S light model and plaorms • Synergies: Scaling of Business Model and revenues (e.g. by building a plaorm) more important than cost synergies • Financing structure and therefore cost of capital might change significantly through out the digital business life cycle

Fig. 3.26   Pattern of digital Business Designs: Cash flow and valuation impact

3.4  Valuation and Due Diligence of Digital Business Designs

165

The combination of these financial patterns with an unproven, risky Business Design has lasting valuation and FCF impacts: – FCFc might be significantly negative in early years as in any start-up or seed stage – By establishing new, untested markets revenues and Free Cash Flows are expected to grow exponentially in early years, but also bear a high volatility and therefore risk – The start-up characteristics also impact the cost of capital, as the financing architecture might change significantly along the digital target’s life cycle – Investments needs are sensitive to the specific digital Business Design and it’s intended competitive advantage – For the synergies, the scaling of the Business Design, e.g. building a platform, and therefore revenue synergies are typically much more important than any cost synergies. The latter point will be specifically addressed in Chap. 5. Therefore, a couple of traditional valuation techniques are not or very limited applicable in digital Business Design environments. By riding Blue Oceans true peers are hardly available. The Multiple Approach is, as a consequence, only limited applicable. Typically applied VC-methods with their simplistic view on exit multiples and long run earnings are as well too short-cut. Also, the traditional DCF approach, beginning with the assessment of the companies past performance, then designing in detail future FCFs and adding last not least a Continuing Value once the company achieves the steady state growth, will not address digital business needs. Digital Business Design specific valuation approaches have to mirror the volatility of their FCFs. As well they should mirror and quantify the implicit uncertainties. The target must be the valuation of the true sources of digital competitive advantage, the value drivers and synergies, including the parenting advantage to scale the digital Business Design by the parent company (Fig. 3.27). Suitable Valuation Approaches in such a digital start up environment could be: – DCF models based on scenarios as “pictures of the future” – DCF simulations built on Monte Carlo approaches – Real option models, especially for multiple stage investments and decision points within the built up of the BD, like in case of bio-pharma or technology start-ups – Using VC-methods and multiples as price-earnings ratios, Enterprise ­Value-to-revenue, or Enterprise Value-to-EBITDA only as a rough cross-check for the valuation, but not as standalone valuation approach for digital Business Designs – Reversed DCF approach by starting the valuation by defining the endpoint in the sense of a scenario of an established digital Business Design, based on a 10C model, and then modeling FCFs backward from this endpoint to the current performance (Fig. 3.28).

166

3  Transaction Management

Valuaon Approaches for digital Business Designs

• Applicaon of tailored porolio of Valuaon Approaches for a sensive valuaon of Digital Business Designs

• DCF applicaon mirroring volality of digital Business Designs − DCF scenarios “pictures-of-the-future” − DCF simulaons (Monte Carlo) − APV (carve out and separate valuaon of financing impact) • Reversed DCF combined with 10C Business Design for FCF backward modelling • VC-method as cross-check • Idenficaon of true value drivers of compeve advantage and likely revenue and capability synergies (on parent and target side) mandatory • Digital Valuaon Tool Fig. 3.27   Valuation approaches for digital targets and Business Designs

Reverse DCF

Reverse DCF

Scenario 1

10C Business Design Model #1 CS

#8 CP

CA #6 CC #7

CV #3 #9 CF CO

CR #4 CH #5

Scenario 2

#2 CM

Scenario 3

#10

E V = ∑ t=1 (1+r )tt ∞

DCF

Boom-out period

Fig. 3.28   Reversed DCF and 10C Business Design approach for the valuation of digital targets

3.4  Valuation and Due Diligence of Digital Business Designs

167

Reversed DCF and 10C Business Design Approach for the Valuation of Digital Targets  The starting point of the Reverse DCF Valuation Approach is flip-sided to the traditional approach: Beginning with the modeling of the future steady state performance and FCFs based on a multiple, detailed scenario setting and a description of the targeted future 10C Business Design, the FCFs will then be modelled backward. Starting point for building the future scenarios should be a detailed assessment of the future Business Design and ecosystem, meaning how the future markets, customer needs and competitors could look like, as well as how digital technologies and platforms might develop. Only by such a detailed understanding of the future Business Design, how the company fulfills customer needs (CVs) and monetizes those (CF) a sensible valuation of digital targets is possible. Digital Business Designs bear the additional complexity, that they are often built on double- or multi-sided platforms, like the Google search engine or the Spotify and Netflix streaming Business Designs. For the long-term scenarios a bandwidth of key financial metrics, like the potential size of the future market, likely user and use cases, penetration and saturation rates, the company’s realistic and sustainable market share, share of wallet and pricing power per user or application are estimated. Besides, the potential technology driven costs to build the digital business and ROIC performance within the expected future competitive arena will be modelled for each of a set of highly likely scenarios. In a second step the transition from early-stage high-growth rates in revenues into the more moderate growth, steady state scenario world is modelled by interpolating the scenario’s picture of the future backwards to its current performance. For building this bridge between today and the future end-point also the time period of hypergrowth and the tipping point where growth might be petering out to a stable and sustainable ­long-term rate has to be assessed. This transition period might be substantially longer than the typical 5 up to 7 years horizon of traditional DCF models before entering into the Terminal Value period. This means that the FCF pattern and CAGRs might have to be modelled up to 12–15 years out. But even more demanding  than modelling this growth tipping point might be the analysis of how the start-up business might convert high growth rates into high FCFs, as only the latter are in the end decisive for the valuation. Therefore, the understanding and modelling of the disruptive 10C Business Design are paramount. This might involve in the case of double-sided platforms to model the conversion from free to paid services or new ownership models, the customer lock-in of the digital platform by economies of scope or user advantages, and forecasts of revenue per user or client or business in B2B markets. Combining conversion-driven paid services with forecasts on price per service leads to revenue estimates. Given a sound revenue forecast the ROIC and Free Cash Flows can be modelled by analyzing the necessary core assets and capabilities in the 10C Business Design and according to likely technology-based unit costs. Additionally, investment needs in platforms have to be assessed, but might have less impact as most digital models are based

168

3  Transaction Management

on a pay-at-order model with low capital intensity, meaning capital expenditure and investment needs. Benchmarks and companies with somehow comparable Business Design, if available, might provide just an indication to frame performance forecasts as they might look substantially different within a today’s high growth rate environment. For the backward design of FCFs to current performance, given these steady state estimates of long-term market size and use cases, investment intensities, ROICs and margins the speed of transition from current performance levels to those long-term scenario performance levels has to be modelled. This must be in line with the development of the digital Business Design and its ecosystem. The scenarios will then be probability-weighted, depending on a consistent view of how the market, competition, customer use-cases and, most crucial, digital technologies might evolve and how fast and successful the targets SBD could be scaled within the assumed ecosystem scenarios. The sum of equity valuations of each scenario weighted by their probabilities of appearance might provide a rough indicator of the likely value bandwidth of the digital target based on today’s best knowledge. Additionally, this valuation approach might prepare an open mindset of uncertain and multiple likely outcomes by designing different scenarios. But, a detailed understanding of the target’s value drivers—like market and use case developments, technological tipping points or conversion rates and revenue per user — and potential synergies might be even more valuable than the indicative valuation band-with by itself.

3.5 Summary of Transaction Management 3.5.1 Critical Cross-Checks and Questions of Transaction Management

Questions

Valuation Once the valuation is finalized it should be back-tested if the model is robust and consistent. Besides, it must be questioned if it is built upon reasonable assumptions, especially with respect to assumed value drivers and if the valuation bandwidth is plausible: – Valuation technique questions, like: Does the B/S indeed balance every year or are Net Incomes correctly split into dividends and retained earnings? – For the comparison of the Equity with the Enterprise Valuation Approach: Are EBIT and NOPLAT identical when calculated top-line from revenues or are ­bottom-line built up from Net Income?

3.5  Summary of Transaction Management

169

– Does the valuation mirror Standalone and Joint Business Design realities? Are the assumed synergy patterns robust concerning likelihood and timing and reasonable with respect to their volume? Due Diligence The Due Diligence target was broadly defined as a proof-of-concept of the investment thesis. Crucial cross-checks for the Due Diligence are: – How are the primary E2E M&A processes as well as the core Transaction Management modules, the Due Diligence, the valuation and the negotiations, intertwined? Do Due Diligence outcomes flow back to valuation and is a smooth flow into the integration assured? – Are the transaction rational, the valuation and the synergy potentials verified? Have the key strategic and financial risks been identified? What would be the consequences of the acquisition? – Are the Business Design and critical capabilities clearly understood? – Are culture issues and gaps identified to avoid culture clashes within the integration and strategies to retain talent defined?

3.5.2 Key Success Factors of Transaction Management The Due Diligence is intertwined with the valuation of the target company and the purchase agreement: The indicative valuation is based on the assumed value drivers of the target company and therefore might help to prioritize Due Diligence tasks and deliverables. The Due Diligence outcomes, vice versa, are feed-back into the update of the valuation. The most important risks identified within the Due Diligence have to be either addressed in the purchase price or the purchasing contract, especially the deal structure, or in the integration priorities. Core tasks of the Due Diligence are: – The verification of the investment thesis which is described in the indicative offer and of the potential synergies, as those two components together define the transaction rational and purchase price limits. – Gaining an in-depth understanding of the strategy, the Business Design, the Culture Design, the competitive advantages, and the value drivers of the target company. – Besides, the evaluation and verification of the strategic fit between the target company and the acquirer, especially with respect to the SCDs and SBDs, is of essence. – The identification of essential strategic, legal, financial, operational, management and cultural risks of a potential transaction. These have to be addressed either within the purchasing agreement or within the  integration concept to avoid integration hurdles. – Additionally, potential upsides and additional value drivers should be identified.

170

3  Transaction Management

To fulfill these multiple tasks the Due Diligence is built upon a couple of intertwined modules, like the Financial, the Strategic, the Legal, the Business Design and the Culture Design Due Diligence. Due Diligence quality is dependent on a qualified Due Diligence team with clear tasks, responsibilities and communication, as well as structured sub-process. A couple of Due Diligence success factors could be identified: – An early prioritization of questions and topics which should be addressed within the Due Diligence might support to sustain the focus along the execution of the Due Diligence on the crucial value drivers of the target’s business, the transaction rational and on the most important risks. This also might avoid getting lost within highly complex and time demanding Due Diligence processes. – The Due Diligence project leadership or project house should establish clear roles and responsibilities for the Due Diligence teams. Besides, communication principles, on the one side between the DD leadership team and the different Due Diligence modules, and on the other side between the IPH DD leadership team and the top management, should be established. The latter might be essential, as within Due Diligence processes often fast management decisions are requested. – In an E2E view, the Transaction Management has also to safeguard that the Due Diligence outcomes are feed into the update of the valuation and Synergy Management.  The latter is especially important for the proof of the likelihood and volume of synergies. – The identified risks in the Due Diligence have to be addressed in the purchase agreement, the transaction structure and in the draft for the Integration Management. – Especially for serial acquirers the step-by-step build-up of Due Diligence capabilities and tools to foster learning effects and quality improvements for future M&A processes is recommended.

References Brealey, R., Myers, S., & Allen, F. (2020). Principles of corporate finance (13th ed., pp. 863–885). New York: McGraw-Hill Education. (Chapter 31: Mergers). Clark, P. J., & Mills, R. W. (2013). Masterminding the deal – Breakthroughs in M&A strategy & analysis. London: Kogan Page. Coates, J. C. (2017). The mergers and acquisition process. Core curriculum finance of Harvard University. Cambridge: Harvard Business. Damodaran, A. (2006). Damodaran on valuation – Security analysis for investment and corporate finance (2nd ed.). New Jersey: Wiley. DePamphilis, D. M. (2015). Mergers, acquisitions, and other restructuring activities (8th ed.). Oxford: Elsevier. Fernandes, Nuno. (2012). Note on company valuation by Discounted Cash Flows (DCF). Lausanne: IMD note.

References

171

Goedhart, M., Koller, T., Wessels, D. (2016). Valuing high tech companies. McKinsey & Company. Retrieved from: https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/ our-insights/valuing-high-tech-companies. Gole, W. J., & Hilger, P. J. (2009). Due diligence – An M&A value creation approach. Hoboken: Wiley. Herndon, G. (2014). The complete guide to mergers & acquisitions – Process tools to support M&A integration at every level. San Francisco: Jossey-Bass. Koller, T., Goedhart, M., & Wessels, D. (2015a). Valuation – Measuring and managing the value of companies (6th ed.). New Jersey: Wiley. Koller, T., Dobbs, R., & Huyett, B. (2015b). The four cornerstones of corporate finance. New Jersey: Wiley. Ruback, R. S. (2000). Capital cash flows: A simple approach to valuing risky cash flows. Boston: Harvard University Graduate School of Business Administration. Schweiger, D. M., & Goulet, P. K. (2000). Integrating mergers and acquisitions: An international research review. In S. Finkelstein & C. Cooper (Eds.), Advances in mergers & acquisitions (pp. 61–91). New York: JAI. Sirower, M., & Sahni, S. (2006). Avoiding the “Synergy Trap”: Practical guidance on M&A decisions for CEOs and boards. Journal of Applied Corporate Finance, 18(3), 83–95. Tseng, A. J. (2013). M&A transactions: Financial due diligence from zero to professional. New Jersey: GreateSpace.

4

Integration Management

Contents 4.1 Integration Strategy and Approach . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1.1 Integration Strategy. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.1.2 Integration Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2 Integration Masterplan: Planning the Transition. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.1 Integration Framework. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.2.2 Integration Masterplan Modules: Planning the Transition to the JBD . . . . . . . . . . 4.2.3 Culture Transition Program: Planning the Transition to the JCD . . . . . . . . . . . . . . 4.3 Transition Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.1 Integration Principles. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.3.2 Implementing the Integration Masterplan. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4 Integration Monitoring, Controlling and Learning . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4.1 Integration Tracking and Scorecards. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4.2 Integration Controlling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.4.3 Integrational Learning: Post Mortem Report and Learning Platform. . . . . . . . . . . 4.5 Integration Management for Digital Targets and Business Designs . . . . . . . . . . . . . . . . . . 4.6 Summary of Integration Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4.6.2 Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_4

179 179 185 197 198 203 222 225 225 228 232 233 236 236 237 238 238 239 242

173

174

4  Integration Management

Abstract

The history of M&A is littered with transactions which collapsed under the weight of integration issues and culture clashes. The Integration Management has to address these challenges as the third primary E2E M&A Process Design module which complements the M&A Strategy and the Transaction Management. The term “Integration Management” instead of Post-Merger Integration is used by purpose, as the E2E approach demands that integration issues are thought about from the very beginning of a transaction to avoid typical M&A pitfalls at a later stage. The Integration Management consists of four submodules: The Integration Strategy, based on the originally intended transaction rational and targeted synergies, provides a sketch of how the integration should be tackled. It includes as well the targeted Joint Business Design (JBD) and the intended transition to the Joint Culture Design (JCD). The Integration Masterplan (IM) builds upon the Integration Strategy and breaks it down into specific integration-modules, -initiatives and workstreams. Besides, the IM defines the dedicated culture transition program, defines the Integration-Project House (IPH), assesses the integration capabilities and establishes a suitable integration toolkit, including Integration Scorecards. The Integration Masterplan has to be mirrored and integrated with the Synergy Management and supplemented by a transparent and continuous communication flow. The JBD and JCD are the guiding principles for the Transition Management which takes care of the short-, mid- and long-term implementation of the Integration Masterplan. The IPH and change agents make this transition happen, but also top-management guidance and commitment are mandatory for a successful integration. Last not least, the Integration Monitoring and Controlling intends an early identification of potential gaps between actual and projected integration performance, and defines suitable counter-measures, if necessary. It closes with a summary of the lessons learned to professionalize the inhouse M&A capabilities and redefines integration levers to scale the full value potential of the JBD and JCD even beyond the integration horizon. A transaction  is only successful, if the forecasted synergies and the intended transaction rational are realized, and if the former two independent organizations of the acquirer and the target achieved the transition to the intended Joint Business Design (JBD) and a new winning Joint Culture Design (JCD). This is still nowadays a challenging task, as multiple studies show (Mercer Bing and Wingrove 2012) and integration hurdles are one of the primary reasons for M&A failures. One explanation might be, that most transaction processes focus on Due Diligence and valuation matters and therefore not addressing integration issues from the very beginning (Davis 2012, p. xi) (Fig. 4.1). Besides, a significant number of M&A showcases highlight where integration efforts ended in disaster, under-delivering on synergies, frustrating shareholders, neither retaining talent nor core-capabilities and deteriorating employee morale. Well-known

4  Integration Management

175

examples of M&A failures, based on poor integration efforts, are Daimler’s acquisition of Chrysler (Edmondson et al. 2005), where the latter was at the end sold off to Fiat, the merger between Time Warner and AOL (Joyce 2013), the merger between Citicorp and Travelers, or Kraft’s acquisition of Cadbury (Lucas and Rappeport 2011). Galpin & Herndon assessed that more than 50% of interviewed companies from a cross-industry sample had only average, pure or even very pure capabilities with respect to critical integration skills like M&A communication, effective decision-making, integration planning, Day One Readiness preparation, employee onboarding, integration tracking, successful integration leadership, or culture integration (Galpin and Herndon 2014b). These skills are even more demanded nowadays, as transformational and cross-border deals increase the complexity and risks of the integration process. A latest tri-annual M&A integration survey of PWC at least indicates that companies might get step-by-step more mature concerning their integration skills and achieve greater financial and operational success by applying best-practices for M&A integration. But, there seems to be a disconnect, as many companies still struggle with respect to their strategic and transformational integration targets, especially in go-to-market goals (PWC 2017a). A couple of core question must be addressed, to assure integration success within an E2E framework, like: – What are the key targets of the Integration Strategy? How to balance strategic, financial and operational targets?

#1

• • • • •

Embedded M&A Strategy Embedded M&A Strategy Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond & Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

#2

Transacon Management

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − JBD blending and JBD Proof-of-Concept − Culture blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

#3

Integraon Management

• Integraon strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan • Transional Change: Implement JBD • Culture Transion • Integraon tracking and controlling • Integraonal Learning & Best Pracce

Synergy Management

#4 Synergy Diagnoscs and Blue Print of Synergy Scaling Approach

Synergy Paern and Scaling Approach Proof-of-Concept

Synergy Capture: Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and M&A Toolkit M&A playbook

Fig. 4.1   The E2E M&A Process Design: Integration Management

M&A Knowledge Management

176

4  Integration Management

– How to freeze and implement the targeted JBD? What are different suitable Integration Approaches to achieve this JBD? How to seamlessly combine the two SBDs to one JBD at the defined touchpoints? – How “deep”, how broad, how intense and how fast should the target be integrated into or merged with the acquirer’s Business Design? – How to assess, blend and integrate—maybe vastly diverse—cultures? How to initiate and foster cultural and organizational change? – What are the crucial submodules of a holistic Integration Approach and Masterplan? Which tools could be applied? How to design a powerful project organization with strong integration capabilities and robust integration processes? – How to use lessons learned of integration projects to improve integration capabilities and to avoid pitfalls? The goals and understanding of the Integration Management within an M&A process underwent several changes and developments. One of the very first, broad definitions was created by Lindgren: “The concept of integration refers to the process through which changes in various systems in the acquired subsidiary are undertaken (Lindgren 1982)”. This view dominated most M&A integration processes in the 1990s. Nevertheless, it was too shortcut. It neither addressed that besides the integration of systems and processes quantitative synergies have to be achieved as well as sensitive cultural integration issues have to be solved. Nor it mirrored that not only the target has to be integrated into the acquirer’s organization, but also the new parent might have to adjust and foster the integration of the target, or as Lajoux described “the term M&A integration refers primarily to the art of combining two or more companies (not just in paper, but in reality) after they have come under common ownership (Lajoux 2006, p. 4)”. A further pitfall of multiple integration processes was a pure inside orientation within the integration process. A holistic integration process has to avoid such a narrow focus by also integrating the needs of all external stakeholders, like customers, suppliers, shareholders, analysts or regulatory entities. An integration strategy has to be tailor-made to address the specific integration needs on the acquirer and target side. A one-fits-all approach for integration does not exist (Galpin and Herndon 2014a, p. 10). Nevertheless, a structured Integration Approach with defined milestones and which addresses the transaction rational (Siegenthaler 2009, p. 27) and synergy targets of a transaction is mandatory for a successful E2E M&A Process Design:

4  Integration Management

177

 Definition The Integration Management complements the Embedded M&A Strategy and the Transaction Management as an integral primary E2E M&A Process Design module. The Frontloading of important integration matters, like the design of a Blue Print of the Joint Business and Culture Design, into the prior parts of the M&A Process Design should ease and speed up the integration initiatives. The core subprocesses of the Integration Management are: – The Integration Strategy: Applying an E2E view, the Integration Strategy builds upon the Due Diligence outcomes and the assessment of the value and synergy drivers of the underlying acquisition as well as on  its transaction rational. The Integration Strategy starts with the definition of the overall integration vision and mission as the “northern star” of the integration process. It describes the ­transaction-specific Integration Approach, thereby defining integration speed and depth. Last not least, the Blue Print of the Joint Business Design (JBD) and the intended Joint Culture Design (JCD) are finally frozen for kicking off the integration. – The Integration Masterplan (IM): The IM defines the integration modules and workstreams for the transition to the targeted Joint Business and Culture Design. Detailed Integration Scorecards (ISC) specify the dedicated integration projects and workstreams per module. They frame the targets, timelines, milestones as well as responsibilities and resource needs for each integration project and enable a standardized reporting. The IM also designs the culture change program to achieve the targeted culture transition and the implementation of the new principles and values for the joint company. Last not least, the organizational integration principles and enablers, like the Integration Project House(IPH) and team, the responsibilities and the necessary Integration Toolkit (ITK) are important pillars of the IM.1 – The Transition Management: The Transition Management makes the integration happen. It specifies the responsibilities and fosters transparency and communication along the integration process. The true implementation relies on an intense culture change management and the implementation of the IM along the underlying timeline of Day One Readiness, short and mid-term integration  as well as the long-term scaling of the full potential leverage of the JBD. – The Integration Monitoring, Controlling and Learning: The integration has to be tracked and controlled to safeguard that the transition to the JBD and the

1The

215).

need of careful integration planning is also underlined by DePamphilis (2015, pp. 212 and

178

4  Integration Management IntegraonMasterplan (IM)

Integraon Strategy (JBD & JCD freeze) 



Integraon needs and priories defined on  Strategic raonal  Valuaon & synergies  Due Diligence blending  Integraon risk analysis Integraon-Strategy Design Integraon vision & mission  Integraon Approach  Integraon targets  Integraon intensity  Alignment with Synergy Management  Speed and ming



JBD & JCD refinement and freeze

Design of IM, modules , workstreams & -scorecards



#1 CS #8 CP

CA #6 CC #7

CV #3 #9 CF

CR #4 CH #5

#2 CM

#10 CO





Transion Management



Culture Change Program



Design of IntegraonProject House (IPH) and built up of necessary integraon capabilies



Design of and training on integraon toolkit



Coordinaon with Synergy Management

Integraon guidelines  Definion of responsibilies  High degree of transparency  Focused, aligned communicaon



Culture Transion Management



Implementaon of Integraon-Masterplan  Day one readiness  100 days plan  Mid term plan  Full potenal leverage plan

Integraon Monitoring, Controlling & Learning 



Integraon tracking Integraon controlling Gap assessment Definion of counter acons

 





Integraonal learning 

Lessons learned and Post Mortem Report



Integraonal Learning & Best-Pracce Plaorm (IL&BPP)

Redefine core areas of Integraon & Synergy Management for longterm full-potenal value leverage

Fig. 4.2   Structure and flow of thoughts of Chap. 4 on Integration Management—sub-processes

JCD will be achieved and the transaction rational finally realized. Therefore, an in-time identification of deviations and the launch of counter-initiatives, if necessary, is mandatory. Especially for multiple acquirers, integrational learning loops offer substantial potentials for the improvement of their integration capabilities. This could be achieved by implementing standardized post-mortem reports and by creating an Integration Learning & Best Practice (Il&BP)-Platform, which includes external benchmarks besides the closed inhouse M&A projects (Fig. 4.2). Each integration project has its own challenges. A tailor-made Integration Strategy is therefore mandatory. Figure 4.3 adds a timeline to the Integration Management and the overall E2E M&A Process-Design.2 It also shows how the Frontloading of crucial integration tasks, like the Diagnostics of the SBD and SCD as well as the definition of the Blue Print for the JBD and JCD, enables an integration head start at Day One and increases transparency. Further, an intense coordination and alignment of the Integration Management and the Synergy Management might also improve M&A performance.

2Compare

the timeline as defined by Davis (2012, p. 11), who uses different process steps and milestones, but addresses the same idea of an early start of integration planning.

4.1  Integration Strategy and Approach #1

M&A Strategy

M&A Strategy

Transacon Management

Due Diligence

Integraon Management

#3

Signing

Closing 100 Day Program

Manage 100 day IM

Deliver on mid-term Scale IM

Joint Business Design (JBD)

Assure Day One Readiness

SBD Diagnoscs & JBD Blue Print

SCD Blending & JBD Stress Test

JBD Freeze

Joint Culture Design (JCD)

Integraon vision

Sign off integraon

Full flagged integraon

SCD Diagnoscs & JCD Blue Print

SCD Blending & JCD Robustness

JCD Freeze

Implementaon

JCD Tracking

Controlling

Synergies

Strategic raonal

#2

179

Synergy idenficaon

Synergy proofof-concept

Synergy Model

Implementaon

Synergy Tracking

Controlling

#4

Implementaon

JBD Tracking

Controlling

M&A Synergy Management

Fig. 4.3   E2E design for the Integration Management

4.1 Integration Strategy and Approach The Integration Strategy defines the ultimate targets of the integration and the guiding principles for this transition process. As the Transaction Management, especially the Due Diligence, fosters a detailed understanding of the risks and upsides of the potential transaction, the Integration Strategy should build upon, in the sense of a true E2E approach, on those findings and outcomes. But as well the valuation and Synergy Management, by identifying the value and synergy drivers of the intended transaction, provide multiple inputs for the definition of integration targets and priorities. The Integration Strategy allows the acquirer to refine and tailor its own original assumptions and estimates about the valuation (DePamphilis 2015, p. 215), the intended FCFs, the synergies and the best fitting Business and Culture Designs before freezing them for the draft of the IM.

4.1.1 Integration Strategy The pillars of the Integration Strategy are the definition of the integration vision and mission, the specification of the integration targets, as well as the final adjustments on the

180

4  Integration Management

Integration Approach. The latter involves final decisions on and freezing of the intended JBD and JCD.

4.1.1.1 Integration Vision and Mission One crucial cornerstone of the integration strategy is the definition of the integration vision and mission of the joint company. Companies, which have to adopt permanently their corporate and business strategies, as being exposed to an ever-shifting ecosystem, may use their vision and mission, understood as a brief description of their core values and purpose, as navigation system (Collins and Porras 1996, p. 65). As integration processes are times of significant change, not only for the external but as well for the internal stakeholders, the leverage of a joint vision and mission as integration tool seems even more applicable. Within a transaction context the vision and the mission have to address and clarify a set of high-level questions for their stakeholders: – What will be the ultimate value proposition of the joint company? – What are the “mission-critical” elements of the targeted Joint Business Design? – What will be the lasting, differentiating and unique competitive advantage of the joint company? – What are the future value drivers of the targeted Joint Business Design and what are the core synergy levers for the integration? – What will be core capabilities and how to address culture and employee issues? – How to initiate a change program that assures a seamless JBD and JCD transition? Starting with this set of reference questions the targets of an integration vision could be derived, as described by Fig. 4.4: The purpose of the integration vision is to provide a lasting orientation in times of transformational change and therefore act as a “northern star” along the integration process. The integration vision should be a focused, consistent, and reliable massage which motivates employees to become part of this integration journey and to build the new company. A consistent vision building process uses the advantages of the E2E characteristics of the M&A Process Design as it builds upon the strategic rationale of the M&A Strategy and takes care that the latter not get lost during the ups and downs of an integration process. This implies, that the integration of a luxury goods conglomerate acquiring another brand and leveraging global sales will have a significantly different integration vision than an automotive acquisition built on scale, like in the Peugeot and Fiat-Chrysler merger, or a pharma deal, which is built on capabilities and avoiding the patent cliff. The integration vision should also address soft issues as it could leverage the creation of a new joint winning culture and may support to overcome potential culture clashes

4.1  Integration Strategy and Approach

181

Purpose: Integraon Vision as the “northern star” for the integraon process: Builds upon the transacon raonal and keeps it alive along the integraon process

Fosters the creaon of one joint winning culture and overcomes culture clashes. Provides employees and other stakeholders orientaon during mes of change.

Integraon Vision

Has a touch point to the Joint Business Design approach

Enables a consistent communicaon including the top-management and external stakeholders

Fig. 4.4   Targets of the integration vision

between the acquirer’s and the target’s employees. Additionally, the vision might provide, especially for the employees, orientation during those times of change. Besides, the integration vision enables consistent communication not only on all levels of the organization but also with external stakeholders, like customers, suppliers or shareholders. The vision supports the communication strategy of the top management by providing a consistent and focused view on the ultimate goal of the integration. As both top-management teams work together on a joint vision, this might improve a shared understanding of the origins of the transaction partner and where both companies would like to go together. One-voice-from-the-top is essential for guiding a successful integration process. The top-management could use the vision as a sketch of the end-point of the joint integration journey by walk the talk throughout the organization. Such a ­co-operative vision building approach would also foster a supportive culture and on-boarding of both companies’ employees. For the creation of the Integration Vision, the 4A-principle might be used: The vision should be on the one side ambitious, meaning setting ambitious targets which might be only achieved by out-of-the-box thinking, but must be on the other side attainable, which separates the vision from utopia. Furthermore, the vision should be appealing for all employees—on the target’s as well as on the acquirer’s side—as well as for stakeholders and should be well articulated (Fig. 4.5). The integration mission, as a more detailed supplement of the integration vision, describes the mid-term strategy and architecture of the joint company for all stakeholders. It describes the intended strategic position of the combined company, the value creation model and the most important synergy levers, the cornerstones of the targeted

182

#1

4  Integration Management

Embedded M&A Strategy

Create a joint integraon vision & mission

Transacon Management

#2

Top-down communicaon strategy

INTEGRATION VISION 





Purpose: “Northern star”; providing orientaon and movaon along the integraon process

Communicaon on all levels

Review of vision & mission

Vision & mission scaling beyond integraon

INTEGRATION MISSION 

Close link to the strategic raonal of the transacon Describes the midterm intended joint value proposion, as well as the unique and differenang compeve advantage in a very brief way

Integraon Management

#3



Describes the mid-term strategy and architecture of the joint company for all stakeholders (external and internal): • Intended strategic posion of the combined company • Value creaon model and synergy levers • Corner stones of the targeted JBD • Core values of the JCD Addresses especially the value added levered by the transacon for the different stakeholders, like shareholders, customers, and employees

Fig. 4.5   Process and content of integration vision and mission

Joint Business Design, like the decisive capabilities of the new joint company and the value proposition for the customer, and, last not least, the core values of the Joint Culture Design. In each of those parts, the focus must be on the value-added levered by the transaction for the different stakeholders, like shareholders, customers, and employees. The process for the built-up of a consistent vision and mission is a top-management responsibility. The ultimate target is the creation of an appealing and demanding vision and mission. Important is thereby, that already at this definition stage a joint process should be established which integrates besides the acquirer’s management and employees as well the acquired company’s management and employees. Only then the vision and mission will be accepted also by the target’s employees. As the vision and the mission should give orientation along the integration process, a detailed communication strategy has to be defined in the second step. This communication strategy has to address what will when to whom communicated. The rollout of the communication strategy has to be run consistently and on all levels of the joint organization. At a later stage of the integration process, most likely between the finalization of the mid-term plan and before the leverage of the full potential plan, a review of the integration vision and mission on top management level might be sensible. The updated vision and mission could then be used for scaling the JBD, the JCD and the strategy beyond the integration process.

4.1.1.2 Integration Targets and Priorities The integration vision and mission provide long-term orientation for the integration process. They serve as well as a framework for the more specific midterm integration targets and priorities. Where vision and mission should be even valid for the past-integration horizon, integration targets and priorities explicitly focus on the integration period of the

4.1  Integration Strategy and Approach

183

post-closing 18–24 months. Besides, the integration targets address also the core integration risks, as pre-assessed within the Due Diligence. The integration targets could be split on the one side into overall or  transaction-specific targets and, with respect to the stakeholder, into inward or outward—ecosystem—oriented targets. Overall integration targets  Overall integration targets are those which are valid for more or less any transaction and are therefore less specific. Inward oriented targets intend foremost an efficient transition to the defined JBD on all organizational layers. Typical examples are: – Leverage on the joint value creation and deliver on synergies – A smooth and efficient transition to the target JBD by executing the chosen Integration Approach as later detailed by the IM – The transition of the two standalone cultures to a new JCD with a consistent value architecture, which is accepted on the acquirer’s and the target’s side – Retaining and developing key talent and capabilities On the external side, a minimal disruption of the day-to-day business and the ­on-boarding of ecosystem partners concerning the transition is intended. This includes: – to retain key customers and to leverage the acquirer’s and the target’s joint share-of-wallet – to strengthen core supplier ties and double down on research and other important ecosystem partners – to gain shareholder support and alignment on the transaction rational and synergy leverage As these general integration targets are, per definition, vague, they have to be supplemented by the transaction specific targets: Transaction specific integration targets The transaction-specific integration targets are closely linked to the integration vision and mission by making them more touchable. They have to address questions like: – what will be the core products and services of the joint company to fulfill the strategic rationale and intended customer value proposition – what will be the mission-critical parts and drivers of the JBD – what are the core synergies which have to be realized along with the milestones of the integration for achieving the promised value accreditation of the transaction

Integration priority identification and matrix  Especially cross-border, high-tech or mega deals bear the risk to get lost in complex integration goals and processes. Therefore, the mission-critical targets of the integration have to be identified and prioritized. The

184

4  Integration Management

Short Term

“Day-one” plan

Time for implementaon of integraon module

HR integraon

Long Term

180-day IM Cross selling

Joint Customer Base Joint R&D plaorm

Midterm IM

Joint manufacturing footprint

low

high Lever of integraon modul on overall integraon success

Fig. 4.6   Integration priorities and integration matrix

identification of the AAA-integration issues enables the buyer’s and target’s management team to decide on which integration efforts to focus on (Fig. 4.6): For this identification of high priority integration tasks an integration matrix could be used, which is based on the two criteria “time pressure to implement the specific integration module” and “importance of the specific integration module for the overall integration success and synergy capture”. Three specific integration patterns allow a detailed structuring of the overall integration process and the IM. Each integration project has to fulfil short-term a couple of integration needs, which might not have a high-level impact on the overall success, but are nevertheless important for the day-to-day operations. This might include the integration of HR and payroll systems, financial reporting integration, IT system integration or customer communication and billing processes. The second cluster of integration tasks might evolve by combining high importance with time criticality. These should be the integration priorities for the 180-day IM. The leverage of cross-selling opportunities might be a good example, as they will have most likely a strong impact on the top line revenue development, especially for technology, IP or start-up acquisitions, and are exposed to competitive retaliation, therefore being under time pressure to be captured. A third, last pattern might be a combination of high impact integration issues, but which might be not as exposed to time pressure. Examples might be the transition to a joint manufacturing footprint. These are typically the mid-term integration priorities.

4.1  Integration Strategy and Approach

185

Project Risks

JCD Risk

 Unclear objecves or communicaon  Lack of leadership / top mgt. involvement  Lack of integraon capabilies or resources CULTURE RISKS  Too less coordinaon between  SCD Cultural Gaps: regional,  target & acquirer values, management style  different hirarchies PEOPLE RISKS  Negave impacts on day-to project and top management  Loss of key employees day business  Demovaon / uncertainty  IT-plaorm incompability  Employee resistance  Drain of core customers  Decreasing loyalty / commitment  Too large gap between  Limited know how transfer acquirer’s and target’s SBD INTEGRATION  Talent risk & loss of intellectual architecture capital  Differences in organizaonal RISKS  Unclear Target / Mgt. structure principles (SBUs, profit centres)  Legal / Environmental Risks  

JBD Risk

Missing focus on key value drivers of JBD Undershoong synergies  Inadequate capture  Insufficient ming  …

Synergy Risks

Fig. 4.7   Integration risk assessment

This categorization of integration tasks in Day One, 180-days and mid-term priorities will also be later used for the development of the IM.

4.1.1.3 Addressing Integration Risks Besides this integration target setting, the most important risks, as identified in the Due Diligence, have to be addressed. The analysis of the integration risk portfolio and the prioritization of the most crucial risk might use a clustering of risks into a project, JBD, JCD or synergy risks, as pinpointed in Fig. 4.7:

4.1.2 Integration Approach As the integration vision, mission and targets describe what should be achieved by the integration, the Integration Approach describes how these targets should be achieved. The Integration Approach has to answer thereby two questions: which activities of the target company and the acquirer—meaning which parts of the JBD—should be integrated and how they should be integrated. Two organizational layers have to be separated: – On the corporate level, the JBD has to define the joint business activities of the new corporate portfolio. This involves as well decisions on potential divestments of businesses which might have only a limited fit with the targeted portfolio or might not offer a high attractiveness of the future ecosystem due to competitive moves, technology trends or shifts in customer use cases

186

4  Integration Management

– On strategic business unit level, the approach of integration describes which parts of the SBD of the buyer and the target should be merged and which ones should be run on a stand-alone basis post-closing. Besides, the Integration Approach also defines the intensity and speed of integration. The transaction rationale (Davis 2012, p. 5), the necessary autonomy of the targets Business Design for its successful development, the strategic interdependencies and intended synergies between the target and the acquirer, and the targeted JBD have a substantial impact on the selection of the best-fitting Integration Approach. A specific Integration Approach mirrors the necessary intensity, depth and speed of integration.

4.1.2.1 Freezing the Integration Approach Integration approach: Degree of integration The level, also described as the degree of integration, determines how far the acquirer and the target company integrate their pre-transaction SBDs into one JBD post-transaction.3 A ­one-fits-all approach does not exist. Within the integration literature and research especially the trade-off between absorbing a target company to maximize synergy and value capture versus leaving the target company preserved to prevent its autonomy for maximum standalone value delivery is widely discussed (Haspeslagh and Jemison 1991; Puranam et al. 2006). If the acquirer, based on his assessment of the trade-off between coordination and autonomy, concludes that the benefits of coordination are prevailing, the acquirer would choose an integration by structural absorption, in which activities of both sides would be integrated into one JBD allowing the acquirer to realize synergies by economies of scale or scope as well as by the sharing of resources and capabilities between the two companies (Zaheer 2013). But, the debate on the best-fitting, transaction-specific Integration Approach in the 20s will be based on a multitude of factors, like on the chosen growth pattern, the specific transaction rational and the intended synergies of the transaction (Galpin and Herndon 2014a, p. 40), the gaps between the SBDs, the necessary independence of the target to preserve its competitive advantage as well as the given boundaries of the wider ­eco-system of the new, joint company. The close relationship between the chosen growth strategy based on the distance to the core and the specific Integration Strategy is shown in Fig. 4.8. Transactions close to the core of the acquirer’s SBD most likely demand a One-Company Approach, whereas transactions in adjacent markets might demand a more collaborative, loose knit Integration Approach:

3The

concept of the degree and different levels of integration in M&As was originally developed by Thompson (1967) and later underlined by multiple authors (Shrivastava 1986; Napier 1989, p. 277).

BMI distance from core

(touch points with respect to value proposions, technologies and markets)

4.1  Integration Strategy and Approach

187

Venturing (Inhouse VC)

New corporate “touch points”

COLLABORATION INTEGRATION APPROACH

Business Incubaon

Adjacent “touch points”

Alliances & partnerships

M&A

ALLIGNMENT INTEGRATION APPROACH Joint Ventures

Core business

Minority & cross shareholdings, ONE COMPANY INTEGRATION APPROACH divestments Inhouse business model innovaon

Short term

Time needs for Implementaon

Long term

Fig. 4.8   Growth strategy and Integration Approaches

The definition of the degree of integration is more of a gradual decision. As described in the Embedded M&A-Strategy chapter, three principal Integration Approaches, which define the intensity of integration, could be distinguished: – Collaborative Integration Approach: Within this approach, the two companies retain more or less the autonomy of their pre-transaction SBDs. Minimal, but tailored changes in these two SBDs are requested for synergy capture and value creation  of the transaction. Despite a loose-knit Integration Approach, the acquirer will align the financial reporting and accounting principles, as well as the business model and strategy development process. This could be achieved by introducing common guidelines and compliance principles, management reporting and approval standards. Besides, the expected parenting advantage will define the necessary resources on the acquirer’s side to scale the target’s SBD and to create the intended value-add (Puranam et al. 2009). – Alignment Integration Approach: This approach integrates clearly defined, specific parts of the SBDs of the acquirer and target within the JBD. The intent is to leverage dedicated synergies, whereas other parts of the two SBDs are kept autonomous post-transaction.

188

4  Integration Management

Degree of Integraon

Need of Autonomy

Strategic Interdependencies and Synergies

Collaboraon Approach  Limited

synergies and interdependencies parenng advantages have to be clearly defined (incl. governance)

 Selecve

 Limited

 Focus foremost

on early-stage investment

 Target

Integraon Approach Characteriscs

Alignment Approach

keeps it’s SBD

 Integraon

focused on governance: Acquirer implements investment, reporng & governance guidelines

 Limited

management & capability transfer



One-Company Approach Target transion Best-of Both

synergies and interdependencies, idenficaon and realizaon of synergies key

 Significant

Selecve parenng advantages and capability transfer

 Especially

Target with defined autonomy

 One-company



 Idenficaon

and footprint of JBD interfaces

 Tailored

integraon: Integraon of defined modules of the SBDs into JBD

 Mulple

SBD interdependencies

and deep pool of synergies

 Full JBD and JCD integraon

for leveraging synergies and realizing strategic raonal in case of horizontal M&As

approach: Full flagged integraon of SBDs and SCDs

 Joint

reporng & governance guidelines

Target

SBD transion on acquirer’s SBD

Target

autonomy lost

 Best-of-Both

JBD by blending SBDs

 Both SBD blended

and transion on new JBD and JCD

Fig. 4.9   Comparison of patterns of Integration Approaches

– One Company Integration Approach: The two SBDs of the acquirer and the target will be fully integrated. This approach involves the highest complexity for the integration process, but as well the highest synergy potentials. This approach is typically used for horizontal M&As, where the acquirer and the target company compete in the same industry and have therefore strong similarities in their pre-transaction SBDs. Cost synergies might be primarily the value driver of such transactions. Applying the two contradicting criteria of needs concerning the organizational autonomy of the SBDs and the strategic interdependences between the SBDs, the tailored pattern of the Integration Approach is described in Fig. 4.9: As the sensitive selection of the best fitting Integration Approach is a core success factor of for the overall transaction a couple of further details will be highlighted in the backup information before the freezing and implementation of the Integration Approach will be described. Background Information An Integration Approach which also mirrors the needs and characteristics of a specific transaction depends foremost on two criteria, the needs of the SBDs of the acquirer and the target with respect to their “organizational autonomy” for a successful business development and the “strategic interdependencies” between the acquirer and the target to lever business models and synergies.

4.1  Integration Strategy and Approach

189

Based on the peculiarities of both criteria four different patterns of Integration Approaches could be specified. Strategic Interdependencies The leveraging of strategic interdependencies, in the sense of a transfer of strategic capabilities between the acquirer and the target, is a precondition to realize intended synergies (Haspeslagh and Jemison 1991). As the value add  is the ultimate target of any transaction, the question of the “ideal” transaction specific degree of integration depends on the pattern and intensity of those strategic interdependencies, which are fundamental for the  synergy potentials, between the buyer and the target. Especially horizontal and vertical M&As close to the acquirer’s core business are based on intense strategic interdependencies, as the acquirer and the target either come from the same industry or are linked to each other through the vertical value chain in upstream and downstream markets. For example, in case of inner-industry consolidation plays, economies of scale in purchasing and manufacturing as well as the merging of manufacturing footprints or other tangible assets, might be the true value drivers of a transaction. In such cases, a very tight alignment or even a full merger of the two SBDs might be recommended. Former business boundaries between the companies might be fully wiped out post-transaction. In case of knowledge-based acquisitions or more adjacent market-driven M&As, the transfer of capability depends on the question if the underlining knowledge is codifiable or not. In the primary case, for example, IP rights in technology-based industries or patents in the pharma industry, knowledge as an intangible asset might be transferred between companies like a tangible asset. In the latter case, when knowledge is embedded in personal capabilities, the transfer of capabilities might be more demanding and request personal interaction and communication. This might request to overcome, maybe even non-visible, organizational boundaries (Nonaka 1994) to realize strategic interdependencies. Less strategic interdependencies might exist in case of the transfer of general management capabilities. The transfer of management and controlling systems, budgeting or compliance processes from the acquirer to the target could also be realized by softer integration strategies based on selected and limited interdependencies. This kind of integration strategies are often applied in financial holding or private equity acquisitions. In the latter case, the strategic interdependencies between the private equity and the target company might be extremely limited. All in all, the intensity of strategic interdependencies is strongly correlated with the need for a high degree of integration and the breakdown of organizational boundaries between acquirer and target. Business Design and Organizational Autonomy That the leverage of synergies demands the transfer of strategic capabilities is clear-cut, as organizational boundaries have to be overcome. Nevertheless, to sustain the competitive advantage and capabilities of the target company, a certain degree of autonomy of the latter might be necessary. This is typically the cases where a huge conglomerate acquires a start-up company. A too tight Integration Approach would be at risk to destroy the unique characteristics and advantages, like speed and entrepreneurship, of the target company and might endanger the retention of key talent. The need to maintain the autonomy of the target might be the more necessary, the more the strategic capabilities and competitive advantage of the target are ingrained in its culture and Business Design, especially its organizational structure and processes. Therefore, the necessity of organizational autonomy of the target is the second important selection criteria for the degree of integration and a tailored Integration Approach. The trade-off between the necessity of the transfer of strategic capabilities to realize intended synergies on the one side and the need for autonomy of the target company to capture its unique

190

4  Integration Management Targeted synergies

low

high low

Stand-alone approach (Financial holding, PE)

Paral integraon – symbiosis (Management holding)

Preservaon

Absorption (“One company concept”)

low

Degree of integra on

Necessity of organiza onal autonomy of target

high

high low

Strategic interdependencies

high

Fig. 4.10   Integration approach: Organizational autonomy versus strategic interdependencies

competitive advantage on the other side have to be addressed by the specific Integration Approach. Figure 4.10 describes this trade-off. A matrix using a low vs. high scale for these two criteria of the necessity to realize strategic interdependencies and the necessity of organizational autonomy of the target company defines 4 specific Integration Approaches and was developed by the landmark book of Haspeslage (Haspeslage and Jemison 1991). Standalone A standalone “integration” concept is suitable for transactions where the target’s Business Design and competitive advantage might demand a high degree of organizational autonomy to keep its unique core also post-transaction and where limited strategic interdependencies and synergies between the two organizations might exist. This is typically the case, where financial investors acquire a successful independent target company, where the strategies and Business Designs of the target and the buyer are highly diverse, or where an early-stage investment in a startup with a high-risk profile should be kept legally separated from the new parent company. The advantage of this integration concept is the limited organizational change and risk of culture clashes, the disadvantage of the very limited amount of potential synergies and parenting advantage spillovers, as well as the missing Joint Business Design and Culture Design. A pure standalone approach—from a corporation point of view—was therefore not addressed in the above Integration Approaches of the E2E M&A Process Design. Preservation Transactions with a limited need of the target to stay independently ­post-transaction combined with only minor strategic interdependencies would fit best with a holding concept. Within this holding concept integration efforts are again not of major concern and may focus on the transfer of general management capabilities, like financing, budgeting or reporting guidelines, or HR policies from the acquirer to the target. But, as in the case of the standalone approach, the missing strategic rational of a transaction due to missing strategic interdependencies might limit the applicability for the E2E M&A Process Design.

4.1  Integration Strategy and Approach

191

Partial Integration (symbiosis) A partial Integration Approach is characterized by significant strategic interdependencies and high organizational autonomy needs. Strategic interdependencies and synergies have to be scaled, but tailored around dedicated parts of the JBD, not to destroy the SBD of the target company. The detailed identification of synergies, parenting advantages and therefore the to be integrated parts versus the independently kept parts of the Business Design are the success factor of this integration concept. The symbiosis concept is comparable with the Alignment Integration Approach of the E2E M&A Process Design. Full Integration (absorption) A full integration concept, comparable with the “One-Company” Integration Approach of the E2E M&A Process Design, fits best for a target company that does not need to stay necessarily independent, and where significant strategic interdependencies and synergies exist. This integration concept intents a full integration of the two independent SBDs into one JBD. Limitations of this approach might be the time need for merging two maybe highly complex organizations and potential cultural hindrances. The upsides might be high synergies potentials. For a successful new JCD the before discussed integration vision and mission might become for this Integration Approach a paramount concern.

4.1.2.2 Freezing the Joint Business Design (JBD) Applying the E2E M&A Process Design, the final decision on the intended JBD builds upon the detailed SBD Diagnostics and Blending as well as on the Blue Print of the intended JBD as part of the Embedded M&A Strategy. The Proof-of-Concept of this Blue Print of the JBD along the Due Diligence process of the Transaction Management is a final preparatory step for the Integration Management, as detailed in Fig. 4.11. Within the Integration Strategy, the intended JBD has to be finally decided upon and frozen. The latter is important for having a reference point along the integration process (DePamphilis 2015, p. 215). The different elements of the 10C JBD, as discussed in Chap. 2, will be used for the structuring of the IM in Sect. 4.2. After the freeze of the JBD, the integration tasks, projects and workstreams could be defined and described by Integration Scorecards (ISC) and the overall IM. Besides, the timeline for the integration and its milestones have to be finalized. Last not least, the integration projects might be mirrored against the integration risk to identify if the latter are fully covered by the integration initiatives. The impact of the Integration Approach on the ultimate intended JBD and the implicitly necessary SBD changes on the acquirer’s and target’s side are described in Fig. 4.12. – By evaluating: – the fostering of strategic interdependences and parenting advantages – the scaling of similarities in the SBDs versus capturing the standalone competitive advantage of both SBDs – the limitation of culture integration risks and the leverage of management and talent retention – the capture of standalone value and synergies typical Joint Business Designs patterns for the different Integration Approaches could be identified:

192

4  Integration Management

Embedded M&A Strategy (Pre-transacon) SBD Diagnoscs

JBD Blue Print

Transacon Management

Integraon Management

JBD Proof-of-concept

JBD freeze and implementaon

Integraon Approach

Acquirer‘s SBD

CS

CS CA CC

CP

CV

CR CH

CS

Blue Print

CM

CA CP

CF CO CS CA CC

CP

CV

CV

CC

BackTest

CR CH

CM

CF CO

Masterplan

CR CH

•

CM

CF CO

• •

Target‘s SBD

Definion of Integraon Masterplan: integraon modules, tasks, workstreams and scorecards Definion of meline and milestones Definion of integraon risks

Fig. 4.11   Integration Management and JBD: Final adjustments, freeze and implementation

Collaboraon Approach

Alignment Approach

CA CC

CP

CP

CA CC

CV CF COCS

One Company Approach

CS

CS CR CH CR CH

CV CF CO

CP

CM

CM

CA CR CV CC CH CA CM CO CS CA CR CV CC CH CP CF CO

CS

CM

CA CC

CP

CV

CR CH

CM

CF CO

CM

Integraon Strategy: Foster strategic interdependencies and parenng advantages

1

2

3

JBD: Capturing standalone compeve advantage

1

2

3

JCD: Minimizing culture integraon risk

1

2

3

Valuaon: Capture standalone value

1

2

4

5

4

5

4

6

5

6

5

6

7 7

synergy potenals

versus

3

7

build JCD

versus

4

6

scaling SBD similaries

versus

Fig. 4.12   Comparison of patterns of different integration approaches

7

4.1  Integration Strategy and Approach

193

Example

The transaction-specific answers on those four criteria will give an indication which Integration Approach and JBD might fit best for the integration and beyond. For example, the pattern for an incumbent OEM in the automotive business acquiring a startup to get access to critical technologies in autonomous driving systems or raid-hailing services as a supplement to the traditional core business might look like the canvas in Fig. 4.13: Most likely the SBDs of the incumbent and the start-up pre-transaction are substantially different and therefore offer limited possibilities of leveraging similarities between the SBDs. Synergy potentials might be as well limited, but the scaling of strategic interdependencies partially necessary to have a spillover of the technical capabilities of the start-up on the incumbent’s business. The capturing of the ­stand-alone unique competitive advantage of the start-up, it’s unique technical capabilities, might be of utmost importance. Due to the innovative technology integration risks might loom and differences between an entrepreneurial start-up culture and more hierarchical, process and efficiency-driven incumbent’s culture have to be addressed by a JCD which minimizes those integration risks. A Collaborative Integration Approach, meaning only slight, but precisely defined alignments of the acquirer’s and target’s SBDs seem to be the most appropriate approach in this case. ◄ The final definition of the transaction-specific JBD and which parts of the acquirer’s and target’s SBDs should be merged depends significantly on the value levers of the joint activities and intended synergies:

4.1.2.3 Alignment of Joint Business Design and Synergy Management The pattern and volume of the intended synergy capture have a significant influence on the required level of Business Design alignment and integration (Galpin and Herndon Integraon Strategy: Foster strategic interdependencies and parenng advantages Low

1

2

3

JBD: Capturing standalone compeve advantage Low

1

2

3

JCD: Minimizing culture integraon risk High

1

2

1

2

5

4

3

4

5

4

7

High

6

7

High

build JCD

5

6

7

Low

7

Low

synergy potenals

versus

3

6

scaling SBD similaries

versus

versus

Valuaon: Capture standalone value High

4

5

6

Fig. 4.13   Integration approach for a potential startup acquisition by an automotive incumbent

194

4  Integration Management

2014b). The estimated synergies from the Embedded M&A Strategy phase, which have been validated within the Due Diligence, serve as a baseline and reference point. Nevertheless, the buyer should actively seek new synergy opportunities while running the integration process. The sensitivity of the Integration Approaches on the intended synergies is interwoven with the dominant pattern of synergies: – Focus on cost synergies driven by scale: If the primary lever of the synergy concept is based on cost synergies, like in industry consolidation plays, the Integration Approach is most likely intense—Alignment or One-Company Integration Approach—and should focus on speed and execution. Integration Synergy Scorecards, how the cost targets could be achieved, should be verified within the Due Diligence and detailed already between signing and closing. This enables, that the implementation of cost synergies, like the realization of efficiencies, the design of new “best-of-both” processes or the merging of organizational footprints, could be rapidly executed. – Focus on revenue synergies driven by scope: Revenue synergies have a more strategic touch-point. It has to be defined how new business opportunities could be scaled or adjacent marketes will be explored. Also, implementation challenges must be addressed, like how parenting advantages could be levered and dynamic, entrepreneurial targets aligned. The most likely Integration Approach will be Collaborative or Alignment. Therefore, a prolonged integration time span with an intense coordination of product development, marketing, sales and aftermarket activities, but a looser touchpoint in other modules of the Business Design might be the most sensitive approach. – New skills and capabilities: In case that the transaction rational is focused on the combination of different, but complementary capabilities, the Integration Approach will be most likely more strategic and long-term. Capabilities and talent have to be developed and the new Business Design  to be designed. The new vision has to be communicated permanently by the management to foster the engagement of the employees and to direct the integration efforts. An Alignment Approach might fit best (Fig. 4.14).

4.1.2.4 Freezing the Joint Culture Design (JCD) Within the Integration Strategy phase the JCD blue print, as defined in the Embedded M&A Strategy and stress-tested during the Culture Due Diligence, has to be finalized and frozen. The JCD mirrors the intended joint culture post-transaction. The intended culture has to be based upon the purpose, as articulated in the integration vision, the targeted post-closing joint core values and management norms. If the JBD is the heart of the Integration Approach and Masterplan, the JCD is its soul. The implementation of a JCD understood as the new joint values, norms, guidelines, management behaviours, and practices of the new entity, which are accepted by the employees of two prior to the transaction independent companies, must be made a central plank of the overall Integration Approach (Chakrabarti et al. 2009). This is especially

Integraon Approach

Main synergy pool

4.1  Integration Strategy and Approach

Cost synergies (scale)

195

Revenue synergies (scope)

Capability synergies (skills)

• One Company or Alignment Integraon Approach

• Alignment or Collaboraon Integraon Approach

• Alignment or Collaboraon Integraon Approach

• Detailed cost synergy assessment mandatory

• Balance of sound Integraon Masterplan and speed of integraon

• Capability and talent retenon as well as development of essence

• Mission crical to define which parts of the SBDs should be merged and which part should be kept autonomous

• Sensivity on keeping capabilies and Business Design of target alive posttransacon

• Core: Development of new business opportunies and revenue scalling

• Building enrely new Business Designs

• Clear definion of JBD Blue Print • Thorough Integraon Masterplan • Trade-off: Integraon speed of essence, but broad scope of JBD implementaon

Fig. 4.14   Linkages between Integration Approach and synergy focus

true for transformational deals, where new and partially unknown capabilities and growth are acquired (PWC 2017a). Culture has a significant and long-term impact on the way employees interact, communicate, make decisions and get their work done, individually or within a team. In a best case, the culture transition fosters the integration process by promoting the new purpose of the joint company as described within its integration vision and the integration strategy. On the other side, a missing cultural integration or even culture clash could derail a transaction (Lajoux 2006, p. 118). Following the 4-step process for the transition to a new JCD, as described within Sect. 2.7, the breading of the integrated and new joint corporate values, norms, believes and behaviours involve two phases: First, the transition from two SCDs to one JCD. Second, the long-term scaling of the JCD beyond the integration process by fostering a long-term winning culture and its values (Siegenthaler 2009, pp. 147–149) (Fig. 4.15): The transition to the JCD involves the definition of a dedicated culture change program which has to be sensitive to the pre-transaction SCDs, the existing culture gap between the acquirer and target as well as cultural integration hurdles, like employee resistance to change. The culture transition has also to balance the new joint value architecture with the preservation of desirable culture differences between the formerly independent companies. Two organizational layers are in charge to drive the culture transition. The culture change has to be initiated and orchestrated by change champions as ambassadors of the transition and is built upon test runs and sequenced rollouts. As “the-tone-ofthe-top” signals the employees the new intended corporate values, management attitudes and norms, for the rollout of the JCD and especially for its communication, the

196

4  Integration Management

SCD Diagnoscs Assessment of (pretransacon) SCD of target & acquirer

JCD scaling Foster winning culture values and measure culture integraon success

Joint Culture Design

JCD Blue Print Definion of the intended „new” JCD and value architecture

JCD transion Blending and transion of SCDs to new intended JCD

Fig. 4.15   Culture integration: Transition to and scaling of the Joint Culture Design

top management plays a central role for a successful culture transition. The definition of management initiatives to communicate consistently the intended culture change and to foster the joint values are a substantial part of the culture transition program. Additionally, culture change has to be measured, to get a real-time understanding, if the transition to the new culture is well understood, supported and in the end realized by all employees and on all organizational layers or if there are necessary adjustments. The last step, the scaling of the JCD beyond the integration process, builds upon the measured and reassessed culture change and transition to the intended joint values, norms and behaviours. The final target is, after the maybe necessary readjustment of the JCD, the leverage of the core values of a joint winning culture—which is closely tied with the competitive advantage of the joint company—on all organizational levels (Fig. 4.16): The culture transition program is the enabler of the implementation of the JCD. At the beginning of the culture transition program, the change champions have to be chosen and their responsibilities to be defined, as change champions orchestrate and drive the culture change initiatives. Besides, the detailed work streams, test runs and sequenced rollouts have to be defined. Thereby a broad set of tools, like face-to-face meetings, tailored management e-mails, intranet campaigns and web pages, top management letters, social media initiatives, press releases, newsletters, round tables and management presentations might be designed for the intended culture transition. The definition of top management initiatives to drive cultural change and adoption is an integral part of the culture transition program.

4.2  Integration Masterplan: Planning the Transition

SCD Diagnoscs & Gap Assessment Mapping of SCDs of buyer and target on 3 levels: • Regional value archetypes • Corporate value system • Management style





Assessing values, norms, believes and their roots



Mapping the culture gap: similaries vs. differences between the standalone value maps

JCD Blue Print

197

Transion to “new” JCD



Definion of consistent set of core values and norms for JCD



Blending culture context, especially integraon vision, mission, approach and intended synergies



Test JCD within Due Diligence on applicability and robustness



Idenficaon of potenal culture clashes and embed in overall integraon approach

Transion to JCD by culture change program • Balancing joint value architecture with… • preservaon of desirable culture differences





Definion of culture change program: change champions, test runs and sequenced rollouts



Definion management iniaves to fosters JCD



Measuring culture change (pulse checks,…)

Scaling of JCD Leverage JCD beyond integraon process by • Measuring culture change • Reassessing JCD • Adjusng JCD





Fostering core values on all organizaonal levels

Intent   

Create holisc, consistent, powerful Joint Culture Design with clear set of joint core values Align new JCD with reason why of acquision and core synergies Avoid culture clash and keep core capabilies and talent ”on-board”

Fig. 4.16   Implementation steps of the joint culture design

4.2 Integration Masterplan: Planning the Transition The Integration Masterplan (IM) is fundamental for the transition from the SBD and SCD footprint of the target and the acquirer to the JBD and JCD. Before designing the IM, any intended integration module and workstream should be based on revalidated data collected during the Due Diligence and best-practice approaches from benchmarks of the relevant peer-group. Besides, the IM must go hand-in-hand with the Synergy Management, especially the realization, monitoring and controlling of synergies. The IM’s key target is to precisely define what should be done by whom at which point of time along the integration process (DePamphilis 2015, p. 217). By doing so, the IM frames implicitly also the targeted financial performance of the combined entity and aligns therefor all integration steps with synergy realization. Besides, the IM has a high granularity, as it is, in essence, a breakdown of the integration goals into individual integration processes, work streams and integration teams for each function and business unit. The IM does focus foremost on the JBD and must be therefore supplemented by a Culture Transition program. The IPH and team, as well as the change agents, will drive the transition process and support the overall integration team with the necessary tools and capabilities. The core tasks are addressed in Fig. 4.17:

198

4  Integration Management Integraon Strategy (JBD & JCD freeze)





Integraon needs and priories defined on  Strategic raonal  Valuaon & synergies  Due Diligence blending  Integraon risk analysis Integraon-Strategy Design Integraon vision & mission  Integraon Approach  Integraon targets  Integraon intensity  Alignment with Synergy Management  Speed and ming

IntegraonMasterplan (IM) 

JBD & JCD refinement and freeze



#1 CS #8 CP

CV #3 #9 CF

CR #4 CH #5

#2 CM

#10 CO





Design of IM, modules , workstreams & -scorecards CA #6 CC #7

Integraon Monitoring, Controlling & Learning

Transion Management



Culture Change Program



Design of IntegraonProject House (IPH) and built up of necessary integraon capabilies



Design of and training on integraon toolkit



Coordinaon with Synergy Management

Integraon guidelines  Definion of responsibilies  High degree of transparency  Focused, aligned communicaon



Culture Transion Management



Implementaon of Integraon-Masterplan  Day one readiness  100 days plan  Mid term plan  Full potenal leverage plan





Integraon tracking Integraon controlling Gap assessment Definion of counter acons

 





Integraonal learning 

Lessons learned and Post Mortem Report



Integraonal Learning & Best-Pracce Pla†orm (IL&BPP)

Redefine core areas of Integraon & Synergy Management for longterm full-potenal value leverage

Fig. 4.17   Planning the integration: The integration masterplan

4.2.1 Integration Framework Before defining a suitable set of integration modules as part of the IM, the integration framework, defining the speed, the horizon and the guidelines of integration, are discussed.

4.2.1.1 Integration Speed The speed of integration is interwoven with the length of the integration process, starting from Day One and ending with the closing of the integration project or post-mortem report. The ideal speed of integration is, as the Integration Approach, dependent on the specific transaction. Therefore, no general statement is possible if a faster, revolutionary or slower, evolutionary integration process is, in general, more successful. A high-speed Integration Approach might realize synergies earlier (DePamphilis 2015, p. 214), which implies in a NPV perspective a positive valuation impact. Also, a smooth and faster integration might influence which and how much of the anticipated synergies are captured. Besides, a fast integration might support a more seamless transition to the new integration vision, mission and the new joint strategy. This might be especially relevant in a transformational deal environment. A fast clarification of the management leadership might speed up decision processes, signal transparency from Day One and may reduce uncertainty amongst employees. Also, the dynamics of change might be leveraged by a faster integration style. A last argument in favour of revolutionary approaches is, that they enable an early (re-) concentration of employees and resources of the new joint

4.2  Integration Masterplan: Planning the Transition

199

company on the day-to-day business to avoid customer losses and retain key talent. Latest studies also seem to underline that companies accelerated their speed of integration (PWC 2017a). But, on the other side, also arguments for a lower speed integration could be found. For example, the new top-management would have more time to define a detailed joint strategy and to identify the true value drivers and synergy levers, which might be a significant advantage in highly complex integration projects. As well, a less ­time-constrained integration offers the possibility to realize a higher acceptance and motivation by the acquirer’s and target’s employees to participate in the integration process and therefore to minimize organizational and cultural resistance. More time may also make it easier in handling the integration of two different cultures and to transform both to the intended new, joint culture and value footprint. If a longer timeline for the integration is intended, it should be based on the decision to spend more time on a sensitive integration planning, and not as an excuse for slow mode or sloppy execution (Davis 2012, p. 13) (Fig. 4.18). Especially four drivers have a decisive influence on the transaction specific integration speed. In tendency the integration will need a longer timeframe: – the higher the target’s and acquirer’s SBD complexity, especially in their organizational footprint, – the higher the diversity between the acquirer and the target concerning their SBD and SCD, – the longer the time horizon and the higher the complexity for synergy capture, and – last not least, the higher the intended depth of integration of the JBD and JCD

Acquirer and target SBD & SCD diversity

 Size of acquirer and target  Organizaonal layers  Complexity of target’s and acquirer’s SBD footprints  Regional diversity

 Acquirer-target diversity in SBDs (especially, but not limited to organizaonal structures and processes)  Buyer-target diversity in SCDs (especially regional and corporate values as well as management style)

Integraon Approach (depth of integraon) Complexity of SBDs

Fig. 4.18   Drivers of integration speed

Time horizon and paern of synergies

 Intended me horizon for synergy capture and full scale integraon  Paern of synergies  Volume and diversity of intended synergies

200

4  Integration Management

Nevertheless, most recent studies favor a faster than a slower integration process. On the one side, fast integrations seem to outperform financially wise (Bacarius and Homburger 2005), on the other side, they might signal their employees a clear strategic direction and management (Mercer Bing and Wingrove 2012), therefore increasing employee acceptance and motivation as well as talent retention. The combination of a more short-term oriented 180-day IM and a mid-term IM allows a best-of-both approach where the necessary short-term integration issues are embedded in the first, and the important long-term integration tasks in the latter:

4.2.1.2 Integration Horizons and Milestones To structure the integration efforts and workflows as well as to set priorities for the integration four separate horizons are proposed for the Integration Masterplan: – Day One Readiness – The more short-term 180-days IM – The midterm IM – The full potential long-term plan, which goes beyond the integration process (Fig. 4.19) Overall, the IM has to balance in each step day-to-day operating and integration needs. The IM describes in detail the frozen JBD and JCD, as these serve as reference points for the overall integration process. The JBD modules are as well ideal to frame and structure the dedicated integration modules of the 180-day short-term and the mid-term

Post closing

Pre closing

IM Design and Day One Readiness

Midterm IM

180 day IM



Descripon of Integraon Targets, JBD and JCD



Implementaon of IPH and project organisaon



Definion of IPH (project team & management)



Ensuring value creaon focus



Definion of IM modules and workflows:



CS CA CC

CS

CR CO

CH

CA

CI



Definion of integraon tracking and controlling concept Plan Day One readiness and business connuity

CP

CC

CH

Ensuring consistent integraon management as well as tracking and controlling

CH

CI



Permanent monitoring, tracking and controlling of integraon success



Early counter iniaves in case of deviaon from IM



Lessons learned data base

CI

CO



CR CO

CO

CR CO

CC

CM

CM

CO



CS

CV

CV CP

CM

Implementaon of full scale IM within all modules: CA

Implement top priories of 180 day IM within modules

CV CP



Full scale

Fig. 4.19   Integration Masterplan: Integration horizons and milestones

4.2  Integration Masterplan: Planning the Transition

201

integration. Besides, the IM has to define the organizational structure for the integration process, specifically the Integration Project House (IPH) with the dedicated project team and management.4 To keep consistency, speed and transparency from Day One of the integration onwards, the tracking, monitoring and controlling concept of the integration process have to be decided upon also at the beginning of the integration process. After the design of the IM the sequenced rollout of the short-term 180-days integration, of the more mid-term integration, which should not last longer than two years, and of the full-scale leverage post transaction have to assure that the JBD and JCD are implemented and synergies are captured.

4.2.1.3 Integration Masterplan Design Principles The integration guidelines are the framework for the execution of the IM. Content-wise the main areas of integration are given by the targeted JBD. The JBD involves the internal operating activities of the Business Design like purchasing, manufacturing, sales and marketing, R&D, IT, finance or HR, which typically are addressed by traditional integration concepts. But besides, the JBD approach takes also care about the integration impact on external constituencies, like customers, suppliers, cooperation partners, competitors and other players of the ecosystem of the company, as described by Fig. 4.20: The development of the IM is based on four design principles: At the Core of the E2E M&A Process Design: Final Revalidating and Freezing of JBD & JCD Blue Print  The IM is built upon the JBD and JCD Blue Print of the embedded M&A Strategy. The blending of the two SBDs and SCDs and the verification and robustness check of the JCD and JBD within the Due Diligence offer further critical insights and adjustment needs of the first Blue Prints. But, the Due Diligence is a snapshot and not a “full picture”, especially of the target’s BD. It is much more a draft of the potential joint business. After the closing, the buyer has access to the full dataset and first integration results. This offers the opportunity to blend Due Diligence results with the first insights of integration initiatives before the freezing of the final IM as a reference point for the overall integration process (DePamphilis 2015, p. 223). Best-of-Both Best-Practices and Peer-Group Benchmarks A second integration principle is to leverage the JBD by applying a best-of-both approach between the target and the acquirer. Further valuable reference points for defining the final targets and the layout of the IM are best-practice processes and benchmarks within the industry peer-group of the target. Other sources for benchmarks could be ISO 9000 standards, quality awards, or consulting reports (Fig. 4.21).

4Compare

Chap. 6 on the details of M&A project management and the role of the Integration Project House (IPH).

202

4  Integration Management External Integraon Complements Suppliers

Strategy Systems

Structure

Internal Integraon

Operaons / Processes Communicaon

Customers Financial Integraon & Synergies Organizaon / Management Core Capabilies

Ressources Culture

Communies

Business Partners

Competors Fig. 4.20   The integration ecosystem: External and internal stakeholders

Integration initiatives and workstreams

End-to-end Revalidang & Freezing JBD & JCD

•- Identification, evaluation and priorization of core

- Focus on intended JBD, capabilies and JCD

• integration initiatives and synergies

- Ensure fit between JBD and JCD

•- Workstream process model with Integration

- Freezing aer robustness check of JBD & JCD

• Scorecards and close tracking process

and integraon risk idenficaon

Design principles for JBD & JCD Smooth transition SCDs < JCD & SBDs < JBD by

Best pracce beyond best-of-both integraon

•- Applying best practices (beyond best-of-both)

- Best pracce processes for JBD implementaon

•- Development core competencies &

- Winning JCD along the 3 culture levels and

•- Retaining core talent

- Close knit integraon & synergy capture

Fig. 4.21   Design principles for the integration masterplan

Smooth Transition from SBDs to the Intended JBD and from SCDs to the Intended JCD Also, the smooth transition from the SBDs to the intended JBD should always be guided by the implementation of best practices beyond a simplified best-of-both optimization. The same holds true for the transition from the stand-alone cultures to the Joint Culture

4.2  Integration Masterplan: Planning the Transition

203

Design. Two important core design principles are the development of core competencies closely linked to the integration mission and the intended strategic rational as well as the retention of critical core talent. Integration Initiatives and Workstreams The Integration Masterplan frames the identified, evaluated and prioritised core integration initiatives and synergies. Based on these core initiatives, a dedicated workstream process model with Integration Scorecards and close tracking process could be designed.

4.2.2 Integration Masterplan Modules: Planning the Transition to the JBD Following the consistent progression along the E2E M&A Process Design, from the Embedded M&A Strategy through the transaction phase up to the integration, the ten modules of the 10C Joint Business Design seem to be perfectly suited for the structuring of the IM. The combination of the frozen 10C modules of the JBD could be defined as the targeted “end-state” Business Design. The latter might be used as guiding light for the overall integration process (Fig. 4.22).

#1

CS-Integraon • Built unique, aracve, differenang CV CA-Integraon #6 • Address uniqueness by capabilies and • Joint R&D plaorm differenaon by compeve advantage • Joint manufacturing and best-in-class CV footprint • Integrang digital approach & • Joint logiscs network BD innovaon iniaves • Joint, seamless support funcons as enablers CE-Integraon #8 • Retain and develop core ecosystem partners: Key suppliers Universies and research Instutes … other stakeholders

− − −

#3

#4

CS CA

CR CV

CP

CC

CH CO CF

CO

#7

CV-Integraon • Define joint offer with maximum CV and user experience • Scaling enlarged product-servicedigital plaorm beyond standalone potenal

CM

CR-Integraon • Customer retenon program • Sales & aermarket program for share-of-wallet exploitaon • Best-of-both markeng mix

#2 CM-Integraon • Consistent and joint CM segmentaon (use-cases) • Define untested white spots and blue oceans • Scale user experience by joint CV

#5 CH-Integraon CC-Integraon #10 • Blend brand, markeng & communicaon strategy • Establishment of leadership team • Coordinaon and scaling distribuon channel and organizaonal footprint strategy • Retenon of core capabilies and • Establish joint sales and aermarket network development of core talent CF-Integraon #9 • Integraon of digital capabilies • Synergy capture and full value leverage • Leverage of core capabilies for JBD • Integraon of management and financial reporng guidelines • Consistent shareholder communicaon Fig. 4.22   The modules of the integration masterplan

204

4  Integration Management

The IM addresses the 10C integration modules, thereby assuring a consistent process from the assessment of the SBDs up to their integration into one JBD. The IM covers the bundle of the most important integration topics and workstreams: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10.

Corporate Strategy (CS) integration module Customer and Market (CM) integration module Core Value Proposition (CV) integration module Customer Relationship (CR) integration module Channel (CH) integration module Core Assets (CA) integration module Core Capabilities (CC) integration model Cooperative Ecosystem (CE) integration module Cashflow & Financial (CF) integration module Corporate Organization integration module

How the 10C Business Design could be deployed in detail for integration processes is discussed in following:

4.2.2.1 Corporate Strategy (CS) Integration Module The core target for the Corporate Strategy (CS) of the joint company is to build a unique, attractive, and differentiating competitive advantage by providing a compelling offer for the joint company’s customers. The question of the long-term and joint competitive advantage within M&As is addressed by the transaction rational. The key questions are here “what is the value add for the customer by combining the capabilities of the target and acquirer?”, “could innovative customer use cases be addressed by scaling the JBD innovation strategies and capabilities?” and “how does the transaction strengthen the competitive advantage and capabilities in comparison to best in class competitors?”. Therefore, the CS integration module is closely intertwined with the CM and the CV integration module. But, as a CS is built upon the core capabilities and assets of a company, it is also closely tied with the CA and, especially, the CC module. The reference point for the CS integration module is the integration vision and mission. The CS integration module goes beyond the integration vision and mission, by clearly addressing the uniqueness of the joint company’s capabilities and customer offers in comparison to key competitors and substitutes by a detailed competitive profiling and best in class comparison concerning competitive advantage and the competitor’s CVs. On a higher level, this offers also a starting point for integrating digital approaches and Business Design innovation initiatives to renew or lever the corporate strategy of the joint company. On a lower level, it helps to decide on the future market-product-brand portfolio, what also includes the decision, which brands, products or markets should be covered. Additionally, the technology and platform strategy might be defined with

4.2  Integration Masterplan: Planning the Transition

205

respect to efficiency and innovativeness. The CS integration module is also a snapshot of the most important, aligned strategic initiatives post-closing. Besides, a joint strategic planning process, with all the details like responsibilities, timelines, milestones, contents and deliverables, has to be set up midterm for the joint company.

4.2.2.2 Customers & Markets (CM) Integration Module A thorough analysis and specification of which markets and customer segments, as well as dedicated use-cases, should be addressed post-transaction is a core ingredient for any integration project. This involves not only those markets which have been served by the acquirer and seller on a stand-alone base but as well the definition of untested white spots and blue oceans. The latter might be especially important for transformative deals, which intend a business model (re-)innovation (Lajoux 2006, pp. 357–359). There exists a close link to the CV module, especially due to this mission-critical question of how to scale the user experience by a joint CV offering. Applying a synergistic view, the joint offer should go beyond simply adding the pre-transaction products, services and digital applications of the independent companies by defining new use cases and addressing holistic customer solutions. As customers are sensitive to changes at their suppliers or business-partners and customer retention and gains are crucial for the synergy capture of a transaction, a series of Day One activities are mandatory for any transaction: – Assurance of customer retention and continued commitment by customer loyalty strategies and programs – Installation of a transparent customer communication, addressing the value add of the transaction for the customers (for each segment, region, use-case and key customer) – Smoothing the transition of any customer exposed business activities within the integration process like the integration of sales and marketing operations and processes. A swift execution of customer mission-critical issues within the short-term integration plan is mandatory. The implementation of the CM integration module is closely tied to other “customer parts” of the JBD and Integration Masterplan, like the CV, CR, and CH. Besides, CM integration has a lasting and significant impact on the value creation of the transaction as the revenues within the CF module are closely intertwined with the customers’ perceived value add of the joint company’s offerings. The early detection of customers at risk, the potential reasons for defection and the management of key relations are additional important tasks to be defined within the IM and have to be coordinated with the Synergy Management.

206

4  Integration Management

4.2.2.3 Core Value Proposition (CV) Integration Module The definition of the joint Core Value Proposition (CV), meaning the products and services, as well as the digital applications of the combined company solving a distinct customer use-case, is the centerpiece of the JBD (Osterwalder and Pigneur 2010, pp. 22–23). The intend of most transactions is the scaling of the enlarged product, service and digital platform for tailor-made customer use cases beyond the simply added standalone solutions. Within nowadays M&A markets, many transactions focus on the re-innovation of their own product portfolio or, even more aggressive, to innovate their whole Business Design by the acquisition of or merger with a target company. The value-add of the transaction from a CV standpoint is in those cases foremost based on (Osterwalder and Pigneur 2010, pp. 24–25): – Newness, in the sense that the joint VP satisfies entirely new customer use-cases or needs—very often by applying new digital technologies and solutions – Customization, meaning a tailoring of product and service portfolios to the distinct needs of a defined customer segment, including customer co-creation, like in the case of multi-sided platforms – Accessibility, by making products and services available 24/7 by scaling digital channels and platforms or by business model innovations, e.g. by robo-advisors in the FinTech market, which offer retail clients Investment-Banking like products and services which have been in former times limited to high-net-worth individuals or corporate clients. – Convenience/Usability, as in the case of streaming solutions in the music and film industry which drove an M&A fancy in the last years. Show-cases for the latter are the 21st Century Fox acquisition by Disney, the transaction between AT&T and Time Warner, or Comcast’s acquisition of Sky Europe. Streaming offers an unprecedented convenience, by making a huge film library and variety available 24-h every day at home.

4.2.2.4 Customer & Client Relations (CR) Integration Module During to the ups and downs of integration processes, there might loom the risk of a high customer churn rate post-transaction, reflecting uncertainties on the customer side with respect to on-time deliveries, missing customer attention, deteriorating service quality due to decreasing employee motivation, missing product quality, or due to aggressive post-merger pricing initiatives of competitors. Or customers might become simply confused by not knowing who will be their future interface or key-account manager. Therefore, a robust and detailed Customer Relationship (CR) integration model, focusing on the core customer segments, regions and use-cases, as defined within the CM module, is a mandatory part of the IM:

4.2  Integration Masterplan: Planning the Transition

207

Integration of Sales Structures, Teams and Establishment of Best-Practice Processes  For a seamless customer transition into the post-closing world and new customer wins the customer use cases and attention must be always at the center point of the integration efforts. A sensitive CR integration balances cost savings, which might result from reducing overlaps of sales representatives or key accounts at specific customers, with the retention of existing customers by implementing dedicated customer retention programs. Besides, they leverage cross-selling synergies. Especially the latter will demand an extensive training program of the sales teams with respect to the enlarged product portfolio and service offerings of the joint company. The degree of integration of sales and marketing organizations is sensitive to the specific product and service offering post-transaction, the regional and customer footprint of the target and the acquirer pre-transaction, as well as the original strengths and weaknesses of both companies’ sales and marketing capabilities. Especially in cases where the sales team of the target plays an intimidate role for the customer solution fulfillment, like in industrial product markets, where iterative customer interactions might be necessary for a successful client solution, the sales teams of the target and the acquirer might be kept independent, at least for the mid-term. Nevertheless, the tasks and processes on the back-end, which have no direct customer contact, like technical support, automated services, billing and shipment services, might offer significant optimization and cost synergy potentials already short-term, without the risk of disruptive customer interferences. Along with the integration of sales structures and teams also customer interfaces should be optimized and any customer confusion limited by offering one clearly defined interface (key-account manager) to the customer. A tailored set of marketing and sales KPIs of the joint teams might help to establish this one-face to the customer approach by fostering a consistent sales and marketing behavior and footprint. Customer Retention Program and Sales Program for Share-of-Wallet Exploitation Besides these post-closing sales structure optimization addressing  the trade-off between cost-synergies and customer retention, a dedicated customer retention program might limit the risk of customer drain. Customer retention programs have to identify in a first step the most important clients from a volume and customer profitability point of view by applying ABC assessments. Knowing customer needs and priorities concerning dedicated products, pricing, services, quality and other USPs, a dedicated customer communication and retention strategy could be designed. As the customer retention is a more passive strategy avoiding customer losses, it should be supplemented by a more progressive customer-win and share-of-wallet extension strategy and program to leverage the full market potential of the transaction. This must be supplemented by internal integration initiatives to streamline and coordinate the two companies’ incentive and bonus systems, especially for key accounts.

208

4  Integration Management

4.2.2.5 Channels (CH) Integration Module Channels (CH) cover all marketing, especially communication and distribution, as well as logistics activities, which a company applies to reach out to its core markets and clients (CM) (Osterwalder and Pigneur 2010, pp. 26–27). The CH integration module is a mission-critical element, as channels have a direct interface to the customers, are decisive for delivering the CV and enable also add-on aftermarket and service potentials. Even more nowadays, as the strategic rational of many transactions is based on the targeted transition from indirect channels, like wholesalers or partner stores, to direct, foremost web-based channels. Best-of-Both Marketing Mix and Blending of Brand Portfolio  The integration of marketing, especially the transition of the brand management of the target and the buyer, is a delicate task. Continuity and consistency in the brand image and positioning are substantial challenges within integration processes. Brand and potential re-branding strategies, triggered by integration processes, might exist on two levels, the company level and the product level. On the company level, the key question will be, if the target’s company brand should be kept, repositioned or skipped, meaning substituted by the acquirer’s brand(s), or even, as in a couple of merger processes, a totally new brand name and design launched. This decision should be coordinated with the strategic rational and the integration vision of a specific transaction. The degree of integration and necessary brand re-positionings or co-branding initiatives on product level might depend on: – the importance and strength of the brands in the specific markets and – the below discussed channel strategies for the product and service deliveries – and customer value propositions The CH related marketing and brand portfolio integration are therefore closely tied with the CV and other CH integration modules. For the transfer of customer sensitive data, leveraging of CRM initiatives or customer data mining, coordination needs also with IT (CA) arise. As sales and marketing are front end issues, integration initiatives in sales and marketing might trigger changes in multiple other integration parts, like CA or CC. Integration and Scaling of Distribution Channel Strategies Especially for the integration of two B2C businesses, which use overlapping distribution channels on wholesale or retail level, or in case of the acquisition of a digital target with direct customer access by an acquirer delivering its products or services through more traditional wholesale distribution channels, the coordination of the distribution strategy post-acquisition is key. This involves also strategic decisions, like using own sales channels with direct customer interface, selling via retailers, wholesalers or agents, or extending digital

4.2  Integration Masterplan: Planning the Transition

209

f­ ootprints. Mapping of supply channels, how they have been used pre-transaction, where there have been overlaps of the pre-transaction SBDs and how the joint distribution and channel approach should look like, might support this decision process. Establishment of Joint Sales and Aftermarket Networks  In more and more markets the value add is shifting from pure one-time product sales to long-term customer-client relationships supported by a complex bundle of services accompanying an initial product purchase, but also beyond by offering aftermarket sales. As these services are decisive for the perceived performance the establishment of a joint sales and aftermarket network with global reach might offer a substantial benefit and trigger, therefore, for top-line revenue synergies. As this might involve organizational and process changes, the implementation of such a joint sales and aftermarket network is more a long-term endeavor.

4.2.2.6 Core Assets—Operations and Processes—(CA) Integration Module The integration of core assets (CA) is of essence for all time horizons of the integration process and does focus on the inner-organizational integration of the JBD. More or less any business function within a dedicated Business Design is affected by an integration process, at least within transformative transactions. A smooth transition and retention of CA  assure operational business continuity and Day One readiness. Mid-term, the integration of CA  serves as the overall platform for the internal process and organizational integration. Besides, the CA integration drives a substantial part of synergies, especially within transactions where the value creation is based on cost and efficiency gains. The integration of core assets must, therefore, mirror these cost and efficiency driven synergy targets by merging internal structures and optimizing processes. But these cost synergies should be well-thought and should reflect any side effects, not to endanger core elements of the joint company’s competitive advantage. The dedicated core assets and their importance are dependent on the targeted JBD. The main primary operations to be integrated might be research and development, manufacturing, logistics, and from the secondary value chain activities finance, HR or IT. The market exposed functions are already covered by the CR and CH integration. Establishment of a Joint Development Platform  One the one side, the integration of the R&D pipeline is in most industries decisive for the long-term competitive advantage of the joint company, as in pharma, automotive, media or high-tech transactions. Besides,  it will define the long-term top line development. On the other side, and especially in cases where both organizations’ R&D departments have overlaps in prioritized R&D projects, the streamlining of R&D activities and teams might offer substantial cost savings. Due to this trade-off and the intangible characteristics of R&D, as in the end, the employees

210

4  Integration Management

and their skills define the R&D core capabilities, such integrations have to be designed sensitively. A good starting point for the integration of R&D functionalities and departments might be to bring together R&D teams and portfolio managers of both companies to share their work. Additionally, the joint R&D priorities for the years to come might be defined by applying a transparent and consistent R&D scoring model. Also, the relative importance of R&D for the overall JBD and intended competitive advantage must be decided upon. Based on this priority setting, a dedicated joint R&D portfolio and program, mirroring these priorities, can be designed, relevant capabilities refined and employees staffed or recruited (Lajoux 2006, pp. 307–311). To assure and lever the R&D integration, the transfer and exchange of technological and innovative knowledge between the two companies have to be initiated, enabled and motivated. This can be done by job rotations between the combined firms’ employees and managers, the design of joint R&D project teams, especially for highly important R&D projects, and the strengthening of decision-making processes and capabilities on the R&D level (Galpin and Hendorn 2014a, p. 48). Therefore, a dedicated R&D integration team is mandatory for most transactions (Grimpe 2007). Optimizing the Joint Manufacturing Footprint  If and how important the manufacturing (integration) is, depends on the specific Business Design. The first step within the manufacturing integration workstream is regularly to get a more detailed and granular view of the global manufacturing footprint of the target than the first overview achieved within the Due Diligence. This optimized picture could then be blended with the acquirer’s footprint for designing and freezing an optimized joint manufacturing layout. The latter might be based on a rich set of data like capacity utilization rates, cross-product manufacturing possibilities due to platform strategies, aging patterns of the core assets and machines, investment needs, cost-per-unit performance, process quality indicators and others. In case of duplicated factories, it has to be assessed if the acquirer’s or the target’s factory has a higher score and should be used therefore in the long-run as the single hub. Additionally, for the target setting of manufacturing process integration workstreams, a comprehensive benchmark might deliver best-in-class performance reference points concerning cost, time and quality indicators (DePamphilis 2015, p. 224). These benchmarks might be deployed by analyzing a set of consistently defined manufacturing KPIs, like quality and scrap rates, quality gate pass throughs, unit cost targets, time to market, capacity utilization rates or Kanban and pull principle indicators. Joint Logistics Network A joint logistics and supply chain strategy might frame the whole value chain, starting from supplier management and material insourcing, up to warehousing and customer deliveries. It is, therefore, a “physical bridge” between the CE and CM module. Only a holistic view on the JBD, mirroring the linkages and feedback loops between its different parts, will detect the full value potential of logistics

4.2  Integration Masterplan: Planning the Transition

211

synergies. As logistics is a data intensive task, IT (CA) is also closely linked to it. IT serves somehow as enabler for leveraging any logistics optimization and synergy levers. The Integration Approach and intended JBD, especially the inhouse value chain and customer delivery process, will define the dedicated joint logistics network. Besides, external factors, like the customer and market footprint and the supplier network will influence the best-fit logistics footprint, defined as a seamless flow of products and information within the network of manufacturing, warehousing and distribution. The core target of the supply chain integration is to assure continuity in product supply and service delivery to customers, to maintain service levels and delivery times, and to realize targeted synergies. Typical efficiency gains of the logistics network are working capital potentials by optimizing the inventory and warehousing architecture, the account payable policies and the accounts receivable management by leveraging invoicing strategies. Additionally, the optimization of the physical warehousing footprint might offer also significant investment savings or divestment potentials. This optimization of the global logistics network might be driven by an analysis of the sales, order, distribution and delivery process, as well as by applying multiple KPIs, like delivery time, delivery quality, overall investments, geographic reach, unit costs impact and efficiency gains of logistics, customer’s satisfaction levels as well as inventory turn. External and internal best-of-both benchmarks might support the target setting process. Joint Footprint and Seamless Transition of Support Functions: Finance  Independently from the Integration Approach, the integration of the financial systems has to provide from Day One onwards transparency with respect to the financial performance of the target company and the joint activities. Another mission-critical activity is the identification of synergy capture. The integration of the two pre-deal independent finance functions is the core underlying part of the CF integration module but is as well a precondition for measuring financial targets and synergy capture in all other integration modules. The CF integration module is as well interwoven with other support functions, like IT—due to reporting and accounting reasons—and HR—for management, staffing and development reasons—. Last not least, the CF integration sets the ground for the Synergy Management, especially the tracking, controlling and measurement of synergies during the integration phase. The understanding where FCF is flowing and which value drivers are the most important is a precondition for successful Synergy Management. The CF integration model frames a bunch of mission-critical financial workstreams and processes, like the treasury and cash management integration—including cash pooling—, the transfer and merging of financial institution relationships of the target company on the acquirer, the design of a consistent equity and debt capital market communication which covers the integration story, the establishment of a joint risk management, group and management reporting system according to the to be applied accounting standards, and last not least the assurance of tax conformity on all levels.

212

4  Integration Management

Like in the case of group accounting and consolidation, the integration of financial systems is typically driven by many subprocesses. These might involve joint book keeping procedures, accounts and general ledger mapping or uniform signature approvals, which are in more or less any transaction mandatory. In the mid-term, the design of joint budgeting and planning processes, financial and management reporting lines and processes, as well as compliance standards have to be built up. In finance, as in a couple of other functionalities, a further integration task is the assessment in how far outsourcing and shared service centers should be used and offer cost-efficient alternatives to in-house solutions. Midterm the finance function structure has to be adjusted according to the finance vision, describing how the finance function should look like post-acquisition and how it should fulfill on future needs of the JBD, like digital payments. Job profiles have therefore to be redesigned together with HR and employees with the according skillset internally developed or externally recruited. A continuous integration task for the finance top-management is the optimization of the financial structure, meaning the mix of equity, debt and hybrid financing instruments including different maturities, currencies and floating versus fixed rate debt structures. This task starts on the buy side already with the arrangement of the acquisition financing, maybe by using a short-term, but expensive bridge finance instruments. In case a full transition of the target is not intended or simply financial capabilities are missing, financial transition service agreements (TSAs) might be additionally signed with the seller to safeguard an ongoing financial transparency with respect to the target’s performance from Day One onwards. Joint Footprint and Seamless Transition of Support Functions: HR  HR is a centerpiece within integration processes and is responsible for a multitude of sensitive integration tasks, like the harmonization of payroll, bonus and reward programs, the coordination of HR policies, the appraisal of management, the design of staffing and management development plans, as well as of job profile descriptions, the conduct of employee surveys about the progress of integration, and the design of not only functional but also cultural training programs. As HR supports all other integration modules concerning staffing and capability assessment matters, it is, as IT and Finance, a highly interactive integration module. This means as well, that HR integration has to be executed extremely sensitive, as any problems will backfire on all other integration workstreams. From the described multiple tasks, only a selected set of the most important HR integration workstreams will be discussed in the following. From a strategic point of view, especially for transformational integration processes, a best-of-both-approach might be recommended. The advantages of such an approach would be a much wider talent pool for management appraisals or set of HR processes. Besides, a higher likelihood of key talent and capabilities retention by increasing the buy-in of both company’s employees and by creating a one company culture would be achieved.

4.2  Integration Masterplan: Planning the Transition

213

A further core role of HR is the design of dedicated job profiles which has to be in line with the skill set needs of the defied JBD. By an appraisal of existing capabilities and talents among the acquirer’s and target’s employees as well as a blending with the needed skill sets to deliver on the JBD, detailed job profiles can be drafted and dedicated recruiting program initiated (Pritchett et al. 1997, pp. 69–85). A contingency plan might supplement the hiring plan, as the leave rate might be high during the integration phase. The integration of compensation & benefits plans must be run in compliance with labor laws and is a very sensitive task, as it influences the employee’s perception of the transaction’s impact on the individual job situation. Besides, the compensation & benefits plans, bonus programs and employee development plans might be important to retain critical talent (Lajoux 2006, pp. 262–268; Hanson 2001, pp. 79–80). HR capabilities might already be involved during the Due Diligence to evaluate the strength and weaknesses of the capabilities of the target company’s management teams and talent pool. But HR becomes a true mission-critical part for Day One readiness by implementing pay and benefit plans, providing employee transition plans or designing detailed functional job profiles. A fast progress within the HR integration is mandatory to reduce uncertainty and avoid culture clashes. Additionally, competitors might approach and lure away key talent (Pritchett et al. 1997, p. 67). Joint Footprint and Seamless Transition of Support Functions: IT and Platform  IT and digital capabilities are another source for significant synergies, especially in today’s fast evolving digital ecosystems. But the potential to realize decent IT synergies depends significantly on the Integration Approach and the intended JBD. In case the acquirer scales the target’s SBD by a collaboration approach, most likely the operating systems, including IT, will be kept independently, and IT cost-synergies therefore limited. Nevertheless, for most acquirers the integration of the IT systems is one of the core integration tasks, starting at Day One. A head-start for complex integrations of different IT landscapes and platforms demands an intense review of the target’s software, hardware and digital capabilities already during the Due Diligence. Core questions of the IM for the short-term IT integration might be: – How to avoid IT interphase problems and to protect Day-One readiness? – How to safeguard for all mission-critical business processes data and system accessibility, security and migration? – How to assure the availability of all communication, e-mail and intranet applications? Mid-term, questions like how to assure system integration and the transition to or alignment with the intended joint IT-architecture will dominate. Besides, as IT is not just about systems and as well about capabilities, IT competencies have, together with HR, to be evaluated, trained, developed and, in case of gaps, hired. Having decided on the IT integration priorities and addressed IT risks by putting in place contingency plans, the IT transition and target systems should be frozen within the IM, as this serves as

214

4  Integration Management

the reference point for the IT migration and the coordination of the multitude of IT workstreams. Due to the close link to employee capabilities and all parts of the JBD a shared IT vision might help to set the target for the future IT landscape and systems and to foster how it will be interlinked with other business matters. This might also help to make the right decision between simple IT system migrations or where a new IT system or platform set-up might be more efficient. It involves also the question of what has to be done on the IT system and capability side to support a potential upscaling of the Business Design in terms of size, new products or other growth initiatives. For the mid-term IM, a high priority issue is the intended IT architecture. The IT architecture covers broad areas, like the IT operating model (ERP system) and organizational design, the IT infrastructure and hardware integration, the software integration, and more modern topics, like the joint cyber security approach or the integration of Big Data and AI tools. Customer exposed IT systems, like CR tools or billing systems, as well as IT systems for mission-critical competencies, should be treated with special care during the integration and might be more topics for the midterm integration and optimization.

4.2.2.7 Core Capabilities & Management (CC) Integration Module The competitive advantage of the JBD will be shaped by the core capabilities of the target and acquirer and how those are integrated. Especially for the integration of those core capabilities and the retention of key talent the tone-of-the-top and involvement of the top-management within the integration process is decisive: Definition of Top-Level Organization and Leadership Team The nomination and announcement of the new organizational structure and top-management team at ­Day-One is a high priority task, as it has a lasting impact on how the transaction will be implemented and perceived by the target’s and the acquirer’s employees. The design of the leadership (C-level) management and integration team has to be defined even before the integration starts. Core elements are here the early and transparent communication of selection criteria for the joint management team positions, a short selection timeline and a transparent and objective management appraisal process. Also, clear joint decision-making processes, management reporting standards, budgeting processes and governance principles have to be established and communicated from Day One onwards. Later in the integration process, the management team will act as a role model for the transition process and perceived culture changes. Additionally, the integration team has to be selected as early as the leadership team. This involves also the definition of necessary core integration capabilities and principles. Closely aligned is the potential hiring of external consultants, if internal integration capabilities might be limited. Retention of Core Capabilities: Talent Integration and On-Boarding  In many acquisitions, especially in high-tech, service industries, pharma, luxury goods or media, the talent pool and management capabilities represent often one of the primary reasons why

4.2  Integration Masterplan: Planning the Transition

215

of an acquisition. The embodied knowledge and capabilities of the employees are the true driver of such transactions. A brain drain or loss of key talent capabilities might be therefore disastrous for a transaction. The loss of a substantial number of key-talent might involve significant dis-synergies, as new employees have to be recruited, trained and integrated within the new joint organization. Additionally, a high employee turnover most likely will degrade morale and productivity (DePamphilis 2015, pp. 213–214). Nevertheless, due to missing or uncoordinated talent transition plans, as well as undervalued culture and communication needs, talent integration remains still nowadays a challenge in many transactions (PWC 2017b, p. 18). The design and establishment of a staffing and key talent retention process is therefore essential. Key talent could be defined as those employees who will significantly contribute to the reason why meaning the targeted core capabilities of the transaction. This key talent has to be identified already during the Due Diligence. Based on this knowledge, staffing and talent retention plans could be formulated at an early stage of the integration process to retain critical talent and capabilities (PWC 2017b, p. 18; Galpin and Herndon 2014b, pp. 199–202). If key personnel from both companies are a fundamental part of the integration, the acceptance of the integration program might even increase. A tailor-made talent retention program has to address and clarify sensitive management and employee questions like pay, bonus programs, benefits, potential job profilings including responsibilities and reporting lines, and career planning initiatives immediately after closing. The design of a joint reward and compensation system is a centerpiece: The coordination of diverging standalone reward systems to one joint design of a compensation and benefit plan is one of the most sensitive tasks of any integration process and talent retention. Especially bonus programs of two merging companies might have very diverse designs (Hanson 2001, pp. 182–185) Moving from the individual talent to the joint company perspective core ingredients of such a corporate talent retention plan are talent and capability identification, assessment of the talent pool and the selection processes. Besides, training and development programs with respect to mission-critical skills, and initiatives which foster team and corporate identity building might supplement the corporate talent retention and development plan. The future organizational design must on the one side mirror the functional structure of the JBD, on the other side leverage the intended core capabilities and talent pool. Each specific function and organizational unit need to decompose the necessary capabilities and mirror them with the skill sets and profiles of the existing talent pool. In case of significant capability gaps hiring profiles and programs are to be defined and should supplement the talent retention program. Based on this capability and talent assessment, the detailed staffing plan can be tailored around the corporate needs and outside recruitments. Additionally, a successful retention management is built upon frequent communication and interaction between top-management and key talent. This should safeguard

216

4  Integration Management

talent involvement within the integration process and highlighting the positive impacts of the transaction for key talent development and corporate strategy. One core ingredient to foster communication with and openness to key talent are partnership programs, built on a one-by-one mentoring with senior executives (buddy programs).

4.2.2.8 Co-operative Ecosystem (CE) Integration Module The Co-operative Ecosystem (CE) integration depends significantly on the specific industry pattern and Business Design of the target and the acquirer. Nevertheless, purchasing strategies and key supplier partnering as well as co-operations with leading research institutes and universities might be relevant nowadays for most industries: Integrated Purchasing Strategies and Key Supplier Relationships Purchasing integration is an AAA-topic within most transactions of manufactured goods industries, offering substantial cost-driven synergies by reducing the cost of goods sold per product and increasing EBITDA-margins. These savings might be realized by a switch to the most cost-efficient suppliers, as identified within the Due Diligence, and by the bundling of purchasing volumes of the joint business activities, as the purchasing power of the joint company might substantially increase in upstream supplier markets. But not only ­transaction-based cost savings are important in supplier relationships, as multiple industries are characterized by complementary offerings. Economic theory distinguishes between two types of supplier–customer relationships, substitutes and complements. While the presence of substitutes reduces the value of a product, complements increase the value of the joint offer. Well known examples are the pairing of ink cartridges and printers, as the latter has little value without the first and vice versa. The same holds true for the value of razors which depend upon the supply of blades and shaving foams, the combination of play consoles and games or the typical software–hardware combination on laptops and other digital gadgets. Where products are close complements, they have little or no value in isolation as customers value the whole system and not the separate parts (Grant 2016; Scott 1999; Brandenburger and Nalebuff 1996). Therefore, the IM has also to address the needs of the supply base of critical supplements, as they might have a significant impact on the joint CV (Rothermael 2001) and the overall value creation in the CF module. The sensitive handling of the network of complementary offers might be even more demanding than supplier programs focusing on cost-cutting initiatives. Alliances with Co-operative Platforms, Research Institutes and Universities Newer innovation approaches, like open source innovations, network economies and business model innovations, stress the importance of strategic networks in creating lasting competitive advantage and for leveraging innovation initiatives (Adner 2006; Breschi and Malerba 2005; Chesborough et al. 2000; Dougherty and Takacs 2004; Shapiro and Varian 1999). Open innovation approaches are built on the sharing of ideas and technical know-how among companies, research institutes and universities. In industries where

4.2  Integration Masterplan: Planning the Transition

217

innovation plays an important role, the integration of the eco-system enables companies to buy in and licensing out technology. The JBD should strengthen such collaborative networks that might comprise IP co-operations, licensing deals, component outsourcing, joint research networks or collaborative product developments. These ecosystems are very sensitive to strategic changes within their co-operations. The IM has to address these sensitivities and analyze how the co-operative networks could be even more fostered by the JBD (Wassmer and Dussauge 2011).

4.2.2.9 Cashflow and Financial (CF) Integration Module The Cash Flow and Financial (CF) integration model is the financial mirror of all other integration modules and therefore closely aligned with all of them. Furthermore, a close relationship to the Synergy Management, which will be addressed in detail within the next chapter, exists: Integration of Management and Financial Reporting Guidelines Especially for Day One Readiness and the 180-days integration plan the financial system integration plays a major role. The financial and accounting organizational design, processes and responsibilities have to be decided at an early stage. This was already addressed within the CA integration module. Synergy Capture and Full Value Leverage Besides these more operational integration tasks, the financial integration has to support the value leverage and full synergy capture. A consistent financial integration will be realized by providing financial transparency and accuracy, as well as short reporting and consolidation cycles. The ultimate target is to get an in-time top-down view on the financial performance of the integration, especially with respect to synergy capture and core value drivers of the transaction. For the synergy capture assessment, the financial systems provide the backbone of financial data, reports and processes. Additionally, it serves as a data feed-in platform for the Synergy Scorecards, which are a centerpiece for the synergy implementation. The CF integration model together with the Synergy Management must assure synergy capture on the cost, on the balance sheet, as well as on the revenue side, to maximize the joint operation’s FCF. The CF integration module should also enable a professional cash management, including cash pooling initiatives, minimizing working capital needs and optimizing the finance mix between equity, debt and mezzanine funding. Besides, the tax optimization of the transaction and the joint company is supported.

4.2.2.10 Corporate Organization (CO) Integration Module The organizational integration complexity depends foremost on the gaps in the standalone organizational principles, meaning which functional, product, regional, or divisional organizational principles were pre-transaction in place (Lajoux 2006, p. 223). Besides, the number of organizational layers on the acquirer and sell side ­pre-transaction

218

4  Integration Management

and within the intended JBD play a major role. Pre-transaction organizational structures of both companies must be understood in detail, including their strategic reason why. The latter may be driven by the specific needs of the companies’ markets, channels and ecosystems. A sound understanding will support a sensitive design of the new joint organization and any necessary structural changes. Also, the decision on a more centralized or decentralized organization has to be taken, whereby more centralized pre-transaction structures might make the integration smoother, but might also be less entrepreneurial driven. In more centralized organizations, support functions might be more easily coordinated within the 180 days integration plan. Operating units might be integrated or not within the midterm plan depending on the expected synergies and needs of autonomy to protect the core business of the target. Organizational integration involves as well the definition of new or redrafting of existing formalized responsibilities, processes, policies, governance models and duties as well as role models for each management layer and function. Here, a more streamlined organization structure with a reduced number of management layers and reporting lines might simplify integration tasks. All those tasks have to be coordinated closely with HR.

4.2.2.11 The Role of Communication for the Integration Masterplan A rigorous, fast and fully transparent integration communication strategy has to support and supplement the IM. Communication is the “voice of the integration” and acts as a stabilizer and coordinator. A tailored and energizing communication may even act as a catalyst for transformational change. Any communication flow has to be in-time, transparent and consistent. A successful communication approach makes employees feeling well informed, will focus them on core integration tasks and energize integration efforts and teams. An aligned communication strategy and workstreams with integration priorities and mission-critical change initiatives are for the transition to the targeted JCD and JBD an important ingredient. A tailored communication strategy has to highlight integration targets and milestones of the transition program. It has thereby to address the different information needs of the internal constituencies, like employees or management, as well as external constituencies, like antitrust authorities, shareholders, analysts, customers, suppliers and the co-operation partners within the joint company’s wider eco-system (DePamphilis 2015, p. 217). On the one side, the general information and communication needs of the different stakeholders have to be integrated into a holistic and consistent communication strategy. On the other side, the design of such a communication strategy must deliver as well stakeholder specific individual communication content and apply constituent specific communication channels, like social media networks, press releases or capital market news. The communication flow already starts with the transaction announcement and has another peak at Day-One. Before publicly announcing a transaction, the acquirer and the target have to prepare a joint communication masterplan which addresses the joint vision of the transaction and milestones of the integration, as well as the specific information needs of the major constituencies of the joint company. At the announcement date, the

4.2  Integration Masterplan: Planning the Transition

219

target’s and acquirer’s top-management has to communicate clearly the transaction story. This might include the strategic rationale of the transaction, the integration vision and a rough canvas of the intended JBD. The consistent and repetitious communication of the transaction rational and messages by the top management should support a smooth transition by addressing cultural and information needs. This should also limit any ­“not-invited-here” syndrome, especially at the target’s employees. Also, the communication masterplan has to control the transaction news flow and must prepare responses in case of unintended leakages of transaction sensitive details. In the aftermath of Day One, the communication masterplan should support the overall integration process. Besides, a successful communication strategy reduces potential anxieties of the employees, especially on the target side, retains talent and supports to build identity (Engert et al. 2019). Communication around key integration milestones, like the announcement of the top-management team, restructurings or relocations, might be especially sensitive. For the design of such a communication strategy, feedback mechanisms, like pulse checks, are important. They provide an idea if communication massages have been understood and what is going right or what is going wrong. In the latter case counter initiatives have to be defined. The intended change must be understood and accepted by all employees. For the overall communication strategy, the following iterative steps and lead questions might provide a consistent framework for communication planning, execution and monitoring. The latter might rest on permanent feedback algorithms if communication messages are understood and supported by the employees. A consistent communication strategy defines WHO (management) has to communicate What (content) and When (time) to Whom (Addressee) and How (through which communication channel): – WHOM—identification of key constituencies: A communication strategy for an integration project must be tailor-made and deliver targeted messages. Internal constituencies, like employees, must be informed continuously about the integration priorities, milestones, and progress as well as the personal impact of the transaction. Especially critical talent may be informed early about their career path and role within the integration process. External stakeholders, like investors and analysts, have to be convinced about the transaction rationale and intended synergies. Besides, customers must feel comfortable about their own deal value add, like new services or products and the continuity of business relationships. – WHEN—timing and milestones of communication messages: A focused communication planning must also identify communication high-times, like Day One or triggering events of the integration, like the announcement of the leadership team and the target organization for the employees or shareholder meetings for the investors. The communication masterplan has to balance sending the right messages at communication high times and ensuring regular communication flow in-between. A well-timed communication strategy requires a dedicated communication process for the design,

220

4  Integration Management

review, approval, and dissemination of communication content with clearly defined deadlines and responsibilities to ensure a fast communication flow. – WHY and WHAT—communication content: Any integration communication flow has to address the reason why of the transaction and the integration vision. The transaction rational must be broken down on milestone specific core massages. The communication strategy has to support the step-by-step transition to the targeted JBD and JCD. Therefore, all communication content must be anchored in a set of key messages at each milestone and on the intended synergies. Such a milestone specific communication strategy must also address what the transition means for the individual employee and why it offers more upsides than risks to initiate an emotional buy-in. The core communication messages should be tested and refined before rolling them out across the whole new organization. – HOW—Communication channels: For reinforcing the communication message, a broad set of communication channels including town hall meetings, welcome e-mails, management discussions, social media and press releases, one-by-one onboarding and others have to be applied (Galpin and Herdon 2014a, p. 181). Each communication content has a specific context and demands a specific channel. For each of those channels, a dedicated communication story has to be drafted. Furthermore, for the monitoring and controlling of the communication success, the communication should be two-way. Only if communication has an impact, by supporting the transition to the JCD and JBD, it is a successful communication. Installing feedback mechanisms and refinements of the communication content ensures that communication messages are received, understood and initiate the intended change. Feedbacks could be gathered by pulse checks, town hall meetings, focus groups, tailored emails and selected ­one-by-one management feedbacks (Siegenthaler 2009, p. 156). – WHO—The top-management and the IPH are responsibe  that the right message and information flow cascades through the entire new joint organization. After this framing of the overall communication strategy a couple of constituency specific communication contents might support the change efforts in the sense of a “360 degree” communication: Employee Communication (Including Unions) For the employees, it must become clear what will change for the joint organization as a whole and themselves specifically as well as how the transition will work out in detail. Employees have an intimidating interest in any information on the transaction and especially on its impact in terms of job security, compensation & benefits and their career development plan. Therefore, an in-time and detailed communication strategy which levers all appropriate communication channels is important to retain talent, to minimize ambiguity or, even worse, resistance to change (Kansal and Chandani 2014). A fluent communication should foster a high degree of motivation to participate in the integration process. Employee communication has to deliver on transparency, honesty and integrity.

4.2  Integration Masterplan: Planning the Transition

221

A mix of employee letters, town hall meetings, on-site meetings, skype- or teleconferences and webcasts might be applicable and effective to initiate and facilitate a fluent communication between top-management and employees and to support integration efforts. But a personal communication channel, either by top-management or the direct superior is a mandatory element to address and discuss sensitive personal issues. Within this face-to-face dialog, clear answers on the direct individual impact and consequences of the transaction are expected by the employees. This personal communication level has to be embedded in an overall integration massage. Crafting a strong, convincing integration vision, as described within Sect. 4.1, and which is communicated by the ­top-management should provide the frame for the personal communication efforts (Hanson 2001, pp. 152–172). Customer Communication  The constituency specific part of the communication program should also take attention of customers, as most likely competitors will approach them as soon as the merger or acquisition is announced. Not surprisingly, customer churn is post-acquisition in most cases higher than in normal times (DePamphilis 2015, p. 214). A reiteration of the joint company’s customer commitment and highlighting the customer value add of the transaction are prerequisites of customer communication to avoid customer drain. Core messages for the customers must be therefore that product or service delivery and quality, as well as customer and aftermarket services, will be maintained on existing level or even improved post-closing. Also, likely benefits associated with the transaction, like an increased bundle of products and services or new customer solutions, should be part of customer communication. These messages should be delivered in face-to-face meetings or by personal contact of the top management or a high-level key account for each dedicated customer. Such communication initiatives should give the core customers the feeling to be well informed and that they are an important partner along the integration process. Eco-System Partner Communication  The same should hold through on the supplier side, especially for key suppliers with high-tech or critical deliveries. The suppliers or complimentary product partners need to understand the transaction rational and likely consequences. It might be a good starting point to define the best interface between the joint company and the key suppliers to transmit the integration communication. The ultimate target is to ensure these valuable relationships with the company’s core suppliers and partners. Additionally, the communication strategy also has to take care of the relationships with the joint company’s wider eco-system, like research institutions and universities, anti-trust authorities or communities. All external communication, like press releases, has to be aligned with the internal communication strategy.

222

4  Integration Management

Capital Market—Investor, Financial Institution, Equity & Debt Market— Communication  A straightforward argumentation concerning the strategic rationale and the financial impacts of the transaction, like targeted synergies or the means of payment and the financing of the purchase price, is key for the company’s investor relations in equity and debt markets (Lajoux 2006, pp. 388–403). A loyal shareholder, bondholder and financial institution base might be of special interest during the turbulent times of an integration process. Especially on the debt side contracts might include change of control closes. In this case, the target firm’s pre-transaction lenders, public or private, have to be asked for allowance, otherwise, outstanding debt has to be, on-top of the acquisition’s bridge finance, refinanced. A further financial threat might be loan covenants, which are in most instances based on interest coverage ratios, like interest to EBITDA or similar ratios. The lenders might have a special interest in the cash profile and forecasted performance of the joint company to fulfil in-time promised principal and interest payments on their debt.

4.2.3 Culture Transition Program: Planning the Transition to the JCD By ignoring the need for a culture transition program with detailed change initiatives, the joint organization risks transformation failure and ending in a culture divide and not integration. Culture change has to be made a central plank of the overall transitional change initiative (Carleton and Lineberry 2004, p. 81). Based on the pre-transaction SCD Diagnostics and the JCD Blue Print, which was stress-tested during the Due Diligence with respect to its robustness, a culture change program is the transition mechanism from the two SCDs to the intended JCD. The challenge is here not to expect a total culture transformation of the target to the acquirer’s culture. Much more, the intent is to design-focused and tailored interventions in both SCDs for the transition to the JCD. Besides, the culture transition should avoid the risk of culture clashes by neglecting the target’s and the buyer’s corporate culture origin and potential gaps. This culture transition is more an evolutionary than a revolutionary process, which is anchored in a clear and transparent architecture of joint values, norms and intended behavioral patterns. The culture transition program should be initiated and planed from a holistic point of view, especially as its elements are interdependent. The core task of the culture transition program is the design of an integrated, consistent bundle of change initiatives. The intent of those change initiatives is to “defreeze” the stand-alone cultures, to initiate and orchestrate the transition to the new intended value set of the joint company, and to deepen mid-term this joint culture mindset on all organizational layers. The transition to the JCD might be fostered by shared standards, processes and practices including operating procedures, harmonized compensation & benefits plans,

4.2  Integration Masterplan: Planning the Transition

223

Orchestrate culture transion by change champions

Energizing culture change by topmanagement

Iniate culture design workshops and test runs

Culture transion program

Track culture change by pulse checks

Orchestrate culture change scrums and full-scale roll out

Fig. 4.23   The culture transition program

governance and controlling processes, or joint ethical values and attitudes. A designated cultural change program might be built around 5 interrelated principles, as described by Fig. 4.23. Orchestrate Culture Transition by Change Champions The culture change team plays an important role in the intended culture transition. Change champions might be implemented as ambassadors of culture change initiatives. The job of these change champions is thereby to orchestrate the organizational change initiatives, to design and implement culture change workshops, initiatives and workstreams, to integrate the top management within the organizational change process, as well as to build an organizational change bandwagon throughout the entire organization. Change champions have also to be sensitive to and address potential change resistance and culture clashes. Initiate Culture Design Workshops and Test Runs The culture transition might be kicked-off by a first wave of culture change and integration workshops within which the Blue Print of the new joint values, beliefs, norms, as well as intended management

224

4  Integration Management

behaviors and practices, might be detailed end refined. Based on this value architecture dedicated change initiatives and workstreams will be defined. With test runs the applicability of the drafted change initiatives could be tested before any full-scale rollout. For each of the organizational layers and functions, the dedicated workshops have to be tailor-made. They fulfill multiple targets, starting from simply get to know the joining company’s culture, management styles and employees, to offering an exchange platform for the clarification of expectations, open questions and roles, to—last not least—detailing the JCD and its intended values and beliefs. Orchestrate Culture Change Scrums and Full-Scale Roll-Out  First, test-runs and scrums might back-test the intended joint value system. For the full-scale culture transition a cascading structure, starting at the top and tripling down through the organizational layers, might be appropriate. Dedicated intercultural trainings might support the rollout and foster the understanding of the partner’s pre-transaction SCD. Additionally, on corporate level long-term incentive plans may focus the organization to fulfil on the joint vision and set of common high-level cultural integration goals. They may also foster a sharing of best-practices, thereby creating acceptance and an one-company understanding. Such best-practices include, besides operating standards, ethical values, governance principles, employee performance standards, or compensation and benefits programs. Track Culture Change by Pulse Checks  Culture change has to be consistently tracked. This could be done by pulse checks, which initiate a feedback loop between the integration team and the employees, if: – the latter understand and share the targets of the culture transition program, – if employees support the intended change and – if they feel well informed about the change initiatives and milestones. Pulse checks nowadays are based on standardized e-mails with a detailed set of integration questions. This allows a broad coverage of the entire organization with respect to the perceived integration progress. These pulse checks could be supplemented by ­one-by-one management meetings or group discussions to get a deep-routed feedback. Energizing Culture Change by Top-Management Commitment and the “ ­tone-ofthe-top”  Change champions initiate and orchestrate change initiatives. But the ­top-management has to take the leadership role for the overall transformational change process. A coordinated, visionary and energetic leadership team might therefore perfectly complement the role and responsibilities of the change champions. Coordinated means thereby, that the top-management team has to assure leadership consensus

4.3  Transition Management

225

on strategic matters and integration priorities. The top-management acts as a crucial role-model for the intended change as well as for the targeted values and behaviors post-closing. Also, the top-management might signal change with symbolic acts and use walk the talk for consistently communicating a powerful and compelling integration vision throughout the joint organization. Besides, it has to balance soft culture issues with tough synergy capture. The ultimate target for the top management together with the culture change agents and the IPH is to assure the realization of the intended JCD and JBD. The Link Between the Culture Change Program and Communication Strategy  ­Content-wise the integration communication initiatives are built upon the integration vision, mission and JBD, as well as the core values of the new JCD. The target of the communication initiatives within the culture transition is to facilitate the intended values, norms and behaviors and to foster the acceptance by all employees throughout the joint company. If a fast, open and transparent corporate communication is embedded within the corporate culture, it can be applied as a support tool for a sensitive transition of the two SCD to the JCD. Besides the verbal and written communication, as well symbols—like, for example, the design of the new company logo in case of a merger—, might be used to communicate to the employees that a new joint culture will be developed, whereby the employees are a part of this transformational journey and both companies will be integrated on this transition.

4.3 Transition Management The Transition Management with all its integration projects and workstream has to ensure that the new JBD meets the ongoing business and customer commitments, but also that the financial and synergy targets are captured as well as integration milestones realized. Integration principles should guide this transformational change through the whole integration process, including Day One readiness, the short-term integration by the ­180-days IM, the midterm integration and finally the scaling phase (Fig. 4.24):

4.3.1 Integration Principles Integration principles guide the integration efforts from the very first integration pilot program up to the wide-scale roll-out of the IM: For the transition to the new JBD numerous interdisciplinary integration teams will be required and have to be coordinated by the Integration Project House (IPH). The IPH and its team are responsible for driving the integration process, coordinating the integration

226

4  Integration Management Integraon Strategy (JBD & JCD freeze)





Integraon needs and priories defined on  Strategic raonal  Valuaon & synergies  Due Diligence blending  Integraon risk analysis Integraon-Strategy Design Integraon vision & mission  Integraon Approach  Integraon targets  Integraon intensity  Alignment with Synergy Management  Speed and ming

IntegraonMasterplan (IM) 

Design of IM, modules , workstreams & -scorecards

#8 CP

CV #3 #9 CF

CR #4 CH #5

#2 CM

#10 CO







#1 CS CA #6 CC #7



Culture Transion Program



Design of IntegraonProject House (IPH) and built up of necessary integraon capabilies



Design of and training on integraon toolkit



Coordinaon with Synergy Management

JBD & JCD refinement and freeze

Integraon Monitoring, Controlling & Learning

Transion Management Integraon guidelines  Definion of responsibilies  High degree of transparency  Focused, aligned communicaon



Culture Transion Management



Implementaon of IM  Day One readiness  100 days IM  Mid term IM  Full potenal leverage plan



Integraon tracking



Integraon controlling  Gap assessment  Definion of counter acons



Integraonal learning





Lessons learned and Post Mortem Report



Integraonal Learning & Best-Pracce Plaorm (IL&BPP)

Redefine core areas of Integraon & Synergy Management for longterm full-potenal value leverage

Fig. 4.24   Integration Management: Transition Management

modules and workstreams, installing the integration management reporting process and providing the integration toolkit. The integration module managers and workstream teams bear the execution task and thereby the responsibility to achieve their specific integration targets. Integration teams should be staffed from the acquirer’s and the target’s side, as this would provide a best-of-both talent pool for the integration. As well this would send a consistent signal throughout the joint organization, that both company’s employees will be taken seriously on-board and should actively participate in establishing the JBD and JCD. Target Setting and Responsibilities A coordinated target setting process with clear responsibilities is mandatory for the IPH and the integration module managers. This will reduce the risk to get lost in complex integration processes and avoid the duplication of integration tasks. The individual integration targets should guide, motivate and give direction. Besides, they serve as a core ingredient for the design of the Integration Scorecards (ISCs). Transparency and Communication  Another important integration principle is to foster seamless, transparent and open communication from Day One onwards and throughout the integration process. Nowadays information flows are at Internet speed. Therefore, hiding any unpleasant trues, like restructuring needs, is not appropriate. To speed up integration and retain talent, an open and transparent communication is a must-have (Fig. 4.25).

4.3  Transition Management

227

Target se ng and responsibilies

Transparency and communicaon

Integraon Principles

Realize IM and JCD by consistent change program

Commitment of the top + highly skilled change agents

Balance JBD implementation urgency with JCD sensitivity

Fig. 4.25   Integration principles

Commitment of the Top and Highly Skilled Change Management Capabilities The top management has to show commitment and guide the integration process, as the ­tone-of-the-top will be taken seriously within any change initiative. An effective and efficient transition management program focuses on actionable targets and addresses the critical value drivers of the integration. The hiring, training and continuous in-house development of change management capabilities are, therefore, besides the top-management commitment, a precondition for transactions and improves significantly success rates and speed of integration efforts as well as employee commitment.

228

4  Integration Management

Balance JBD Implementation Urgency with JCD Sensitivity  The realization of the integration program flows along the different four time-horizons. Throughout all of them, the balance between the more operative and quantitative JBD and the more qualitative and sensitive JCD has to be addressed. Realize IM and JCD by Consistent Change Program  The realization of the JBD must be based on the seamless execution of the IM by detailed processes, workstreams and change initiatives. The same holds true for the transition to the JCD. The complexity of those integration processes could only be managed by a consistent change program.

4.3.2 Implementing the Integration Masterplan The implementation of the IM might be structured along four sequenced steps: – – – –

the assurance of Day One readiness the execution of the short-term IM (100-days plan) the realization of the mid-term IM the full potential plan which scales the JBD and JCD beyond the integration horizon

These four steps will be discussed in more detail in the following:

4.3.2.1 Assurance of Day One Readiness The implementation of the IM has to assure as a top-priority Day-One readiness, meaning from the very beginning of the integration journey a smoothly running day-to-day business. A structured IM has the advantage of Frontloading integration planning and being prepared for execution. Core target of Day One readiness is to assure business continuity. This includes especially “mission-critical” processes. At the same time customer, talent and core capability retention has to be addressed. Besides, regulatory and post-transaction obligations have to be fulfilled and integration risk, which could derail the deal, from Day One onwards monitored and addressed. On the management side, financial transparency and the implementation of the acquirer’s governance and compliance guidelines are early-stage must-haves. Last not least, a consistent communication strategy for external constituencies, like shareholders, customers or the joint company’s wider ecosystem, besides the internal constituencies, like employees, is an early-stage key success factor (Fig. 4.26).

4.3  Transition Management

229

CM

CS

Customer onboarding  Customer informaon about the transacon and its likely impacts on the customer-supplier relaonship  Sensive pre-transacon gaps in terms and condions harmonisaon  Cross-selling and joint customer offer 

CE

CA

CR

CV

CH

CC IT Idenficaon crical IT architecture  Migraon of most important data and funconalies  Ensure process and management data availability 

HR

Finance Closing B/S & Accounts  Full financial transparency  Management reporng system  Cash Mgt. (e.g. payments,…) 

Idenficaon of core talent and JBD capabilies need  Retenon of talent  Contract & pay conversion  Ensurance of legal framework 

Operaons

CM

Process flow assurance  Business connuaon 

CM

Fig. 4.26   Day one readiness heat map

A transaction-specific Day One heat map might identify high-speed integration needs. Especially the Customer & Market (CM) and the Core Asset (CA) integration module demand typically a couple of early-stage integration tasks: – CM integration module: Along the integration process former customers of the acquirer and target might be approached by competitors. Therefore, customers have to be early informed about the transaction targets, their implications on the ­customer-supplier relationship, and the potential advantages of the integration for the client, for example, a more holistic customer solution. Customer commitment and retention programs, as discussed above, should be initiated from Day One onwards to onboard them and to signal the joint company’s ongoing commitment. – CA integration module: Within the CA integration module especially the three secondary value chain activities HR, Finance and IT are challenged already on Day One: IT has to identify critical IT architecture to avoid any shutdowns and initiate smooth system and data transitions from the target to the acquirer. Besides, process and management data availability have to be assured. HR has to identify rapidly core talent and JBD capabilities needs. Based on this assessment tailored talent and management retention plans, as well as employment contracts and pay conversion could be initiated, which are in line with legal frameworks (Hanson 2001, pp. 79–80).

230

4  Integration Management

– CF: The finance department has to prepare the closing accounts and provide full financial transparency and data integrity. Also, joint management reporting systems, budgeting guidelines and planning and reporting processes have to be installed as well as cash management systems (e.g. payment solutions) implemented. Besides, the CF integration module has to take control of the target’s FCFs, identify the value drivers and assure synergy capture from Day One onwards The further integration modules, like the customer minded CV, CR, CH and the broader CS, CO, CF and internally focused CC module are more mid-term efforts. The integration of the product-service bundles of the CV module needs definitely time to be adjusted and integrated according to the targeted customer use-cases. The same holds true for the distribution channels and most of the CR activities. As synergy capture is a short- to midterm endeavor CF is like CS also a more mid-term topic, whereas the adjustment and merger of core capabilities (CC) and the organizational structure (CO) is a longer-term integration task.

4.3.2.2 Executing the Short-Term Integration Masterplan The top priority of Day One to protect business continuity must be retained also along the execution of the short-term IM. Short-term is thereby understood as the first phase of executing the integration and is somewhere between the first 100–180 days after closing.5 Besides, the transition to the JBD by starting to implement the IM along the 10C modules is the core target of this phase. The top-level structure to execute the IM modules is ideally identical to the 10C structure of the IM. Therefore, the short-term integration content is more or less covered by the 10C IM modules. Nearly any function and organizational layer will be involved, at least in ­One-Company Integration Approaches. An intense change program has to make the transition to the JBD happen and must be well-thought and orchestrated. Each of the 10C integration modules will be broken down on dedicated change initiatives and workstreams with precisely defined timelines, milestones and deadlines. The implementation of the JBD should focus on the build-up of the defined JBD as well as on core value drivers and synergies. The IPH will kick-start the integration execution by orchestrating the integration modules and initiatives, providing integration tools and training, and initiate a fluent and continuous integration management reporting process. Additionally, the culture transition program, as driven by change agents, and the approval of the second line top-management and organizational change needs are kicked-off at the start of the execution of the short-term IM. This should ensure a ­step-by-step transition to the JCD. The target is to mobilize the acquirer’s and target’s organization for the culture transformation journey.

5The

short-term integration plan is in some articles and text books also described as 100-day plan, e.g. by Davis (2012, p. 12).

4.3  Transition Management

231

Whereas the JBD integration handles the more quantitative tasks the culture transition addresses the “soft skill” side of the integration. In parallel to these core tasks, the execution of the short-term IM should also realize any “low hanging fruits”, meaning easily to be captured synergies, along the integration process. These quick wins are important, as they will motivate and build credibility throughout the entire organization. A further workstream is the establishment of a seamless integration communication, which should keep all important external and internal constituencies informed, and which has to start from Day One onwards along a regular communication timeline. Along with the implementation of the short-term IM, a lot of important decisions have to be taken. These will be addressed by a close coordination between the IPH and the steering committee of the specific transaction, to ensure top management involvement. Besides, the steering committee has to decide on integration specific tasks like integration project approvals, sign-offs, resource allocations or staffing, and should track the integration progress closely at dedicated intervals, most common  every 2–3 weeks. An additional high priority task for the short-term IM, especially from a top-management point of view, will be the implementation of the joint governance, compliance, financial reporting and budgeting principles. This will demand a detailed account mapping for consolidation purpose, and a thorough cash, payment and financial institution interface integration.

4.3.2.3 Realizing the Mid-Term Integration Masterplan By realizing the mid-term IM, the full JBD integration and JCD transition should be achieved. In most instances, this phase will last one year up to 18 months in addition to the execution of the short-term IM. A clear cut-off date has to be defined, otherwise integration will be a never-ending journey and might be perceived as a failure. In the following, just a couple of typical and important mid- to long-term IM execution issues will be highlighted, as most topics have been addressed within the IM discussions: The CS module should achieve the competitive positioning of the joint company within the peer-group by shaping the joint competitive advantage. This goes hand in hand with the CV integration completion by realizing the full bundle of joint product and service offerings, including platform strategies, if applicable. If the joint offering goes beyond the simple add-on of the stand-alone offerings this might be one of the most crucial long-term efforts of an integration project. Additionally, the joint product and service portfolio is closely linked to the mid-term CM module integration execution, as it will define, at least partially, the potential share-of-wallet extension on the customer side. To have a tailored customer approach and address the most crucial use-cases, a detailed customer segmentation might be used as a supplement. A best-of-both marketing mix, a coordinated channel and brand management strategy, as well as a joint sales and aftermarket footprint, might be top priorities of the CR and CM integration modules.

232

4  Integration Management

On the more inward focused CA module the establishment of the joint R&D pipeline and platform or an integrated manufacturing footprint might be the dominant issues. There might be a couple of specific R&D or plant projects which might go beyond the 18-month horizon of the mid-term integration plan. Last not least, for the CC module the development, scaling and exploitation of the joint core capabilities have to be realized. The talent and capability development is crucial to achieving this mid-term target.

4.3.2.4 The Full Potential Plan: Scaling JBD, JCD and Synergies for the Long-Term The typical M&A process ends with the realization of the midterm IM. This “end-point” also should be defined time wise, as integration processes bear the risk to become everlasting. But the further shaping of the joint competitive advantage based on the original transaction rational, the scaling of the JBD and the development of a winning culture based on the JCD should be extended beyond the integration phase. Based on a review of the integration progress, the achieved or missed targets—including the assessment of the route causes—in building the JBD, and the joint culture progress, the full potential leverage of core capabilities and strategic positioning beyond the IM could be defined. Leverage is partially based on what was learned along the integration. Additional synergies, possibilities to optimize the Business Design, potentials for efficiency gains or additional markets and new use-cases might have been identified along the integration journey.

4.4 Integration Monitoring, Controlling and Learning A disciplined and holistic process of integration requires finally a consistent and transparent tracking and reporting of the integration progress as precondition for the effective controlling and management of the integration. Core targets of the integration controlling are the realization of the originally intended transaction rational, especially the JBD and JCD implementation, and the synergy capture. The tracking and controlling of the integration progress should focus on key integration issues and workstreams, core value drivers as well as synergy deliverables. It should enable an in-time transparency concerning mission-critical questions, like: – If integration targets are met along the integration project (milestone tracking) – if gaps in the realization of the originally intended IM and workflows exist ­(plan-realization comparison) – how potential counter measures and initiatives could be initiated (in case of deviations between realized and intended IM module performance) Besides, the tracking of integration success and failure is also a pre-condition for integrational learning and the build-up of a best-practice learning platform (Fig. 4.27).

4.4  Integration Monitoring, Controlling and Learning Integraon Strategy (JBD & JCD freeze) 





Integraon needs and priories defined on  Strategic raonal  Valuaon & synergies  Due Diligence blending  Integraon risk analysis Integraon-Strategy Design  Integraon vision & mission  Integraon Approach  Integraon targets  Integraon intensity  Alignment with Synergy Management  Speed and ming

IntegraonMasterplan (IM) 



Integraon guidelines



Integraon tracking



Definion of responsibilies





High degree of transparency



Focused, aligned communicaon

Integraon controlling  Gap assessment  Definion of counter acons



Integraonal learning

#1 CS #8 CP

CV #3 #9 CF

CR #4 CH #5

#2 CM

#10 CO 

Culture Change Program



Design of IntegraonProject House (IPH) and built up of necessary integraon capabilies



Design of and training on integraon toolkit



Coordinaon with Synergy Management

JBD & JCD refinement and freeze

Integraon Monitoring, Controlling & Learning

Transion Management

Design of IM, modules , workstreams & -scorecards CA #6 CC #7

233





Culture Transion Management Implementaon of Integraon-Masterplan  Day-One readiness  100 days plan  Mid term plan  Full potenal leverage plan





Lessons learned and Post Mortem Report



Integraonal Learning & Best-Pracce Plaorm (IL&BPP)

Redefine core areas of Integraon & Synergy Management for longterm full-potenal value leverage

Fig. 4.27   Integration Management: Integration monitoring, controlling & learning

Integration Scorecards and KPIs might support to measure, if integration goals are met or, in case of significant deviation from the intended integration path, if countermeasures have to be initiated. The integration process is time critical and the integration modules are interdependent. Accordingly, integration progress has to be closely monitored at pre-defined milestones (Engert et al. 2019). To control and measure the integration modules, they have to be broken down in detailed integration workflows. The management of the integration controlling is a core task of the IPH, which will be discussed in more detail in Chap. 6 about M&A Process Management & Governance. At the endpoint of the integration intended synergies should have been realized and transitory solutions should have been overcome by the full implementation of the JBD and JCD.

4.4.1 Integration Tracking and Scorecards Integration Management should be based on a consistent process which ensures a regular measuring, tracking, controlling and reporting of integration progress (Galpin and Herndon 2014b, p. 42). A tool-based approach might support those efforts: Integration Scorecards (ISCs)  The evaluation if a transaction is on track, or, in ­retro-perspective, was successful, is traditionally based on the assessment if financial goals and the transaction rational have been achieved (Vazirani 2012). A more holistic approach might add the view of additional external and internal constituencies, like

234

4  Integration Management

customers, employees or suppliers (Galpin and Herdon 2014a) by using a Scorecard approach. Integration Scorecards (ISCs) may serve as a tracking and early warning system. Such ISCs mirror a selected set of financial, synergistic and Business Design specific integration performance indicators to ensure that integration activities, workstreams and projects are broadly covered and financial performance stays on track, as defined within the IM. An increasing number of companies measures integration performance nowadays not just with financial indicators like ROIC improvements, revenue growth, cost savings or project integration costs, but add operational drivers (PWC 2017b, p. 24): ISCs for the tracking of integration progress might be built around the following indicators, but must be tailored according to the specific Integration Approach and intended JBD: Financial KPIs of ISCs might compare pre- versus post-closing performance of: – Capital market indicators, foremost based on share price performance versus a defined peer group (short-, mid-, long-term)6 – RoIC performance of the merged company – FCF conversion rate, performance and CAGR – EBITDA and Invested Capital performance and development – Revenue performance, CAGR and growth momentum – Cash and debt development – Linkage to Synergy Management—I: Volume of realized synergies versus planned – Linkage to Synergy Management—II: % of in time realized synergies Besides those financial indicators, operational KPIs of ISCs should use a balanced mix of inward and outward indicators, covering employee, innovation, integration ­process-specific and customer matters: Culture, talent, employee and capability KPIs of ISCs might address: – – – – – –

Employee leave and absence rates Talent retention or—vice versa—churn New applications development (especially for JBD critical capabilities) Employee satisfaction assessments, e.g. by pulse checks Number of escalations within integration process Development of employability measures, like “best-companies-to-work-for” listings

6The

Cumulative Abnormal Return (CAR) as the share price outperformance post-transaction is the most applied financial indicator for measuring transaction success within scientific studies: Event studies measure for a dedicated company i the CAR in comparison to a tailored peer group for a defined event window around the announcement date of the transaction: T  CARiT =  rit − E(rit), with E(rit) = αi + βi rm. t=1

4.4  Integration Monitoring, Controlling and Learning

235

– 360-degree leadership survey or focus group-based indicators (Carleton and Lineberry 2004, pp. 118–119) – or even more advanced measures, like LinkedIn analytics Market and customer KPIs of ISCs are typically: – Customer retention or—vice versa—churn – New customers gained – Development of customer satisfaction scores (complemented by customer surveys or feedbacks) and, vice versa, customer claims – Market share development – Development of pricing indicators – Number or volume of the joint company’s customer offers (cross-sells) – In time customer fulfillments or deliveries Innovation and capability KPIs of ISCs based on: – – – –

Number of patent filings Time to market Number and revenue development of new product or service introductions Percentage of sales or revenue from new products and innovations in comparison to total sales or revenue – Market share gains in new segments – Number of new use-cases successful introduced – Successful knowledge transfer between the two merging companies (based on a detailed capability and functional level break-down) Integration project and process KPIs of ISCs might focus on: – – – – –

Financial and management reporting performance (quality, time, accuracy) #/time delay of missed, red flag integration modules Milestone performance (missed/achieved) Overshooting/undershooting of planned integration project cost Integration costs relative to synergies, turnover and purchase price

Besides these KPIs each ISC should capture essential cornerstones of the specific integration module, like the responsibilities for the specific integration module, the team members, the targets and most important milestones of the integration module, the tracking of the overall degree of implementation as well as of the specific KPIs of the integration module, and, last not least, synergy impacts and side effects on other integration modules.

236

4  Integration Management

The sum of the ISCs should capture all integration modules and therefore provide an in-time overview of the degree of implementation and potential hurdles of the overall integration project. They frame the management reporting process and should foster integration responsibilities, accountabilities and transparency.

4.4.2 Integration Controlling ISCs are also perfectly suited for the tracking and controlling of the integration project. Nevertheless, they have to be supplemented by a detailed integration management process, assuring a consistent reporting and controlling of integration progress by the top-management. The controlling of the integration progress should be based on a regular review, most likely every two to three weeks, by the steering committee of the integration, involving the top-management of both companies. The preparation and orchestration of those integration steering committee meetings are one of the key tasks of the IPH. For the preparation of those steering committee meetings, an update of all integration modules has to be prepared and the most important integration subjects and deviations distilled. The latter could be detected by Degree of Implementation (DoI) and gap assessments. This will support to focus the steering committee meetings on the most important integration decision points. Within the steering committee meetings, especially countermeasures for those modules which deviate most significantly from their milestones have to be decided upon. Besides, the IPH has to assure a feedback loop of these decisions into the integration modules.

4.4.3 Integrational Learning: Post Mortem Report and Learning Platform “We learn from experience that men never learn anything from experience…” once the novelist George Bernard Shaw wrote. To avoid this pitfall, the assessment of what went wrong or well in past integration projects is a good starting point. Feedback loops, learning algorithms and integration best-practice platforms should foster this learning from past transaction pitfalls and successful integration cases (Davis 2012, pp. 13, 27). In the end, this should professionalise in-house M&A and integration teams and ultimately increase the long-term M&A success rate. The key target of integrational learning is simply to become better in the next transaction. A capability assessment might identify how experienced the target’s and the acquirer’s management teams are concerning M&A skills. By identifying the gaps between M&A capability needs and existing capabilities also the buy-in of external consulting support could be tailored.

4.5  Integration Management for Digital Targets and Business Designs

237

Lessons Learned and Post Mortem Report  For the continuous development of inhouse M&A capabilities the lessons learned of a transaction, in the sense of a brief recapitulation of what went wrong and what went well from the beginning of the Embedded M&A Strategy up to the closing of the integration process, should be summarized within a Post-Mortem M&A Report. This report should be discussed with the involved M&A specialists and managers shortly after finalizing the integration project to crystallize the lessons learned and potential improvements for the next M&A project. Based on these lessons learned, internal M&A capabilities could be strengthened as well as M&A tools (re-)designed. Learning & Best-Practice Platform  Especially for multiple acquirers the implementation and scaling of a Learning & Best Practice (IlBP) Platform, by applying the potentials of digital M&A tools, might foster an even more intense and continuous M&A capability development. Such an M&A platform could be cloud-based and accessible throughout the organization.

4.5 Integration Management for Digital Targets and Business Designs The Integration Management of digital targets is a sensitive task for the acquirer: The new parent company has to balance integration needs to leverage the digital capabilities of the target within the acquirer’s BD framework with the necessity of the target to stay autonomous for keeping its entrepreneurial spirit and retaining critical digital talent on board. There are two major risks of digital target integrations, the overburdening of the target company with the acquirer’s integration complexities and processes and the risk to lose critical digital talent on the target’s side. The core management responsibility for the integration of digital target companies might be therefore the preservation of the critical success factors of its SBD post-transaction and a sensitive Culture Design integration. Key employees and talent have to be kept on board applying suitable incentives, retention packages, and development programs within the acquirer’s context (Fig. 4.28). On the other side three major topics have to be addressed to lever the transaction rational for digital target integrations: – General acquirer’s management principles, like e.g. governance, reporting and budgeting process standards, as well as capability and talent management, have to be transferred to and aligned with the target company. This assures compliance with the acquirer’s standards. – Also, non-mission-critical parts of the target’s SBD could be integrated at an early stage, as, for example, logistics networks, after sales back-office overlaps or procurement operations.

238

4  Integration Management

Embedded M&A Strategy

#1

• Ecosystem Scan with focus on: − Digital disrupve technologies (IP scan and VC investment flow) − Use-cases: White spots detecon • Embedded M&A Strategy: Idenficaon and assessment of future digital compeve advantage and capability needs • BMI-Matrix for tailored growth strategy • JBD and Integraon Approach Blue Print • Fit Diamond focus on digital targets and capabilies

#4 • • • •

#2

Transacon Management

• Valuaon and (F)DD addressing the unique CF paern of digital BDs: − High growth rates, but risky and volale FCFs − Foremost B/S light BDs, therefore focus on P&L − JBD & synergy model based on revenue scaling • Applying advanced DCF methods − DCF scenarios and simulaons (Monte Carlo) − Reverse DCF and VC valuaon for back-tesng • Verificaon of Integraon Approach − SBD Blending and JBD Proof-of-Concept − SCD Blending and JCD Proof-of-Concept

Integraon Management

• Tailored Integraon with balance of − Leveraging defined parenng advantage to scale targets SBD − Sustaining targets standalone momentum and BD success factors • Retain and develop crical talent • Implement necessary compliance • Scale targeted culture transion • Back-track integraon progress

Synergy Management

Idenficaon of digital synergy levers • Back-tesng Synergy Scaling model Parenng advantages to scale target SBD • Back-tesng parenng advantage Revitalize buyer’s SBD by target capabilies • Synergy-valuaon blending Tailored Synergy Scaling Model

#5

#3

• Rapid scaling of target’s SBD • Focused implementaon of Synergy (revenue) Scaling Model

M&A Project Management & Governance Digital M&A playbook

Fig. 4.28   E2E M&A Process Design for digital and business model innovation driven transactions

– A third and the key task for the integration of digital targets is the leverage of parenting advantages by implementing critical parent capabilities which are essential for the scaling of the target’s SBD and the capture of revenue synergies. This involves a sensitive transition of capabilities, management and employees between the parent and the digital target. A first step could be the identification of cross-selling and growth leverages by sharing best practices and implementing a know-how transfer or the exchange of advanced technologies and platforms.

4.6 Summary of Integration Management In the following a set of crucial questions will be discussed, which might guide the management through the integration jungle before the key success factors will close the discussion on Integration Management:

4.6.1 Critical Cross-Checks and Questions For the board as well as for the IPH leadership team a set of tailored question might serve as a suitable cross-check if all critical integration issues have been addressed by the Integration Management:

4.6  Summary of Integration Management

239

Questions

Critical questions for Integration Management success: – Are Integration Strategy, vision and mission aligned with the transaction rational and do they address the transaction specific value drivers as well as synergy capture? – Does the parenting advantage support the integration and scaling of the target’s BD within the acquirer’s framework? Is an exchange of mission-critical capabilities therefore necessary? How about timing? – Does the Integration Approach keep the balance by protecting standalone business momentum, but also allowing to achieve intended synergies? – Is the JBD precisely enough defined before freezing and kicking-off the integration? – What modules of the 10C JBD are intended to be integrated and why? Is the transfer of parenting advantages of the acquirer on the target understood and initiated? – Which modules of the SBD should be kept independently? Why? Are business momentum and talent retention thereby assured? – Who will be the lead orchestrator of the integration (head of the IPH)? Has the integration team (IPH) the necessary integration capabilities and experience? – Is the top-management an integral part of the integration process and does the board communicate one integration massage? – Is culture integration taken seriously by the top-management and integration team? Are change agents for the culture transition defined and do they have the necessary capabilities? – Does the Integration Masterplan set the right priorities? Are integration tasks broken down in measurable and operational Integration Scorecards? – Is integration execution structured along a defined time path with dedicated milestones? – Are integration capabilities permanently improved by appropriate digital tools, post-mortem reports and best-in-class benchmarks?

4.6.2 Key Success Factors Best-practice M&A integration case studies, as well as multiple Integration Management articles and literature, have been researched to identify mission-critical integration success factors: An Integration Strategy should be defined early, transaction rational and synergy capture should guide through the integration jungle, top-management

240

4  Integration Management

Integraon capability leveraging and learning plaorm

Top management commitment (tone-of-the-top) and … capable project house

Seamless Joint Culture Design Transion

Focus integraon on transacon raonal and synergy capture

Frontloading Integraon & coordinaon with Synergy Management

Implementaon of Joint Business Design by Integraon Masterplan

Fig. 4.29   Key success factors for the Integration Management

communication should show commitment and a comprehensive change management should drive a seamless transition to the JBD and JCD. More detailed, six key success factors of Integration Management might stand out, as described by Fig. 4.29: Integration Focus on Transaction Rational and Synergy Capture  The focus on the originally intended transaction rationale as well as value and synergy creation should be retained throughout the whole M&A process. This might be supported by a compelling and energetic integration vision and mission as well as a set of focused integration targets, serving as a Northern Star and guiding all integration efforts. Frontloading of Integration Approach and Coordination with Synergy Management  The assessment of the best-fitting Integration Approach should be initiated as early as possible: Especially the Blue Print of the JBD and JCD should be already defined during the Embedded M&A Strategy and be validated during the Transaction Management. Additionally, as synergy capture requires the integration of the two SBDs, a close coordination of the Synergy and Integration Management is a further ingredient for a successful integration. The Integration Masterplan should focus on maximum synergy leverage. Implementation of Joint Business Design by Integration Masterplan The stress-tested Joint Business Design is an ideal starting point for the structuring of the Integration Masterplan. Based on the intended 10C JBD framework, a bundle of high priority integration initiatives could be defined for the Integration Masterplan. An integration priority matrix might be applied for the identification and prioritization of mission-critical

4.6  Summary of Integration Management

241

integration projects. Besides, timeline requirements and potential integration risks must be addressed. Integration champions implement consistently the targeted JBD. The transformational change management should apply a best-of-both-approach, meaning that the acquirer’s, as well as the target’s capabilities should be exploited for the achievement of the JBD. The defined JBD has to be implemented by a consistent set of transition initiatives. The retention of critical talent, the development of core capabilities and competitive advantages, as well as a maintained business momentum, are key targets at this stage. The Integration Masterplan must address Day One readiness by ensuring, besides other topics, integration take-off, as well as financial and management readiness. Additionally, top talent, core-capabilities and key customers should be retained through targeted initiatives. The integration should accelerate in the short-term and mid-term horizon of the transition thereafter. Seamless Transition to Joint Culture Design  Addressing culture integration issues, but at the same time also accepting differences in cultural origins, meaning gaps in the SCD, is a further success ingredient. Using a JCD concept assures that the two cultures are aligned, where necessary. This starts with the application of a detailed Culture Design Diagnostics within the Embedded M&A Strategy, as described in Chap. 2. Based on the detailed understanding of cultural values and gaps between the acquirer and the target company a new, winning Joint Culture Design (JCD) is defined. This JCD is then ­back-tested within the Due Diligence. The later enables an early detection of culture clashes and to be addressed culture integration issues. The JCD will be finally frozen and implemented within the Integration Management. A sensible culture integration is closely aligned with the overall Integration Approach. Besides, successful integrations make culture integration a top-management priority and responsibility. An open, transparent, and in-time communication strategy must thereby mirror the information needs of all internal, but also external constituencies. The communication flow should be continuous and must capture also a portion of constituent tailored massages. Tone-of-the-Top: Top Management Integration Commitment and Capable Project Team  Top-management involvement, commitment, accountability and leadership throughout the integration process is a mission-critical success factor for an integration. Besides, an agile, high-quality integration project team (IPH), supported by a capable change management and transition agents—which foster leadership and accountability for integration initiatives and workstreams at all levels—must be installed and maintained though-out the integration process. Development, Application and Leverage of Best-Practice Integration Capabilities  The integration should be guided and orchestrated by an Integration Project House (IPH) with all responsibilities and capabilities for the integration. The IPH is also in charge of the development and application of the integration toolkit and for the inhouse application training. Further, the IPH has to implement a transparent tracking and controlling of the

242

4  Integration Management

integration projects and foster learning-loops to create and apply best-practices in integration. The permanent improvement of integration competencies should be initiated by state-of-the-art tools, like learning platforms and learning loops.

References Adner, R. (2006). Match your innovation strategy to your innovation ecosystem. Harvard Business Review, 4, 17–37. Bacarius, M., & Homburger, C. (2005). A marketing perspective on mergers and acquisitions: How marketing integration affects post-merger performance. Journal of Marketing, 69(1), 95–113. Brandenburger, A. M., & Nalebuff, B. J. (1996). Co-opetition. New York: Bentam Doubleday Dell Publishing. Breschi, S., & Malerba, F. (2005). Clusters networks and innovation. Oxford: Oxford University Press. Carleton, J. R., & Lineberry, C. S. (2004). Achieving post-merger success: A stakeholder’s guide to cultural due diligence, assessment, and integration. San Francisco: Wiley. Chakrabarti, R., Gupta-Mukherjee, S., & Jayaraman, N. (2008). Mars–Venus marriages: Culture and cross-border M&A. Journal of International Business Studies, 40, 216–236. Chesbrough, H. W., Hansen, M. T., Nohria, N., & Sull, D. N. (2000). Networked incubators: Hothouse of the new economy. Harvard Business Review, 9–10, 74–88. Collins, J. C., & Porras, J. I. (1996). Building your company’s vision. Harvard Business Review, 9–10. Davis, D. A. (2012). M&A integration: How to do it – Planning and delivering M&A integration for business success. West Sussex: Wiley. DePamphilis, D. M. (2015). Mergers, acquisitions, and other restructuring activities (8th ed., pp. 209–236). Elsevier: Oxford. Doherty, R., Engert, O., & West, A. (2016). How the best acquirers excel at integration. McKinsey. https://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/ how-the-best-acquirers-excel-at-integration. Dougherty, D., & Takacs, C. H. (2004). Team play: Heedful interrelating as the boundary for innovation. Long Range Planning, 37(12), 569–590. Edmondson, G., Welsh, D., Thornton, E., & Palmer, A. (2005). Dark days at Daimler. Bloomberg Business Week, August 14, 2005. http://www.businessweek.com/magTopazine/content/05_33/ b3947001Top_mz001.htm. Engert, O., Kaetzler, B., Kordestani, K., & Koshy, A. (2019). Communication in mergers: The glue that holds everything together. McKinsey (ed.), January 2019. h t t p s : / / w w w. m c k i n s e y. c o m / b u s i n e s s - f u n c t i o n s / o r g a n i z a t i o n / o u r - i n s i g h t s / communications-in-mergers-the-glue-that-holds-everything-together. Galpin, T. J., & Herndon, M. (2014a). The complete guide to mergers & acquisitions – Process tools to support M&A integration at every level. San Francisco: Jossey-Bass/Wiley. Galpin, T. J., & Herndon, M. (2014b). The state of M&A integration effectiveness survey. Grant, R. M. (2016). Contemporary strategy analysis (9th ed.). West Sussex: Wiley. Grimpe, C. (2007). Successful product development after firm acquisitions: The role of research and development. Journal of Product Innovation Management, 24(6), 614–628. Guerra, F. (2009). Flawed conception. Financial Times, January 17, 2009. https//www.ft.com/content/8e4875e4-e401-11dd-8274-0000779fd2ac. February 22, 2019.

References

243

Hanson, P. (2001). The M&A transition guide: A 10-step roadmap for workforce integration. New York: Wiley. Haspeslagh, P. C., & Jemison, D. B. (1991). Managing acquisitions: Creating value through corporate renewal. New York: Free-Press. Joyce, E. (2013). Time Warner nixes AOL from Nameplate. Internetnews.com, September 18, 2003. http://www.internetnews.com/xSP/article.php/3079621/ Time+Warner+Nixes+AOL+From+Nameplate.html. Kansal, S., & Chandani, A. (2014). Effective management of change during merger and acquisition. Procedia Economics and Finance, 11, 208–217. Lajoux, R. (2006). The art of M&A integration: A guide to merging resources, processes & responsibilities. New York: McGraw-Hill. Lindgren, U. (1982). Foreign Acquisitions: Management of Integration Processes. Stockholm: IIB/ EFI. Lucas, L., & Rappeport, A. (2011). Mergers and acquisitions: A bitter taste. Financial Times, May 23, 2011. https://www.ft.com/content/03559624-8571-11e0-ae32-00144feabdc0. Mercer Bing, C., & Wingrove, C. (2012). Mergers and acquisitions: Increasing the speed of change. Employment Relations Today, 39(3), 43–50. Napier, N. (1989). Mergers and Acquisitions, human resource issues and outcomes: A review and suggested typology. Journal of Management Studies, 26(3), 271–289. Nonaka, I. (1994). A dynamic theory of organizational knowledge creation. Organization Science, 1994, 14–37. Osterwalder, A., & Pigneur, Y. (2010). Business model generation: A handbook for visionaries, game changers, and challengers. New Jersey: Wiley. Pritchett, P., Robinson, D., & Clarsen, R. (1997). After the merger: The authoritative guide for integration success (2nd ed.). New York: McGraw-Hill. Puranam, P., Singh, H., & Zollo, M. (2006). Organizing for innovation: Managing the ­coordination-autonomy dilemma in technology acquisitions. Academy of Management Journal, 49(2), 263–280. Puranam, P., Singh, H., & Chaudhuri, S. (2009). Integrating acquired capabilities: When structural integration is (un)necessary. Organization Science, 20(2), 313–328. PWC. (2017a). M&A integration: Choreographing great performance – PwC’s 2017 M&A integration survey report. https://www.pwc.com/us/en/press-releases/2017/pwcs-2017-ma-integration-survey.html. PWC. (2017b). M&A Integration: Choreographing great performance – PwC’s 2017 M&A integration survey report. https://www.pwc.com/us/en/deals/ma-integration-survey/pwc-m-and-aintegration-survey.pdf. Rothaermel, F. T. (2001). Incumbent advantage through exploiting complementary assets via interfirm cooperation. Strategic Management Journal, 22, 687–699. Scott, F. M. (1999). Strategic complements and substitutes. Financial Times Mastering Strategy Supplement, November 8, 10–13. Shapiro, C., & Varian, H. R. (1999). Information rules: A strategic guide to the network economy. Boston: Harvard Business School Press. Shrivastava, P. (1986). Postmerger integration. Journal of Business Strategy, 7(1), 65–73. Siegenthaler, P. J. (2009). Perfect M&As: The art of business integration. Cornwall: Academy-Press. Thompson, J. D. (1967). Organizations in action. New York: McGraw-Hill. Vazirani, N. (2012). Mergers and acquisitions performance evaluation – A literature review. SIES Journal of Management, 8(2), 37–42.

244

4  Integration Management

Wassmer, U., & Dussauge, P. (2011). Value creation in alliance portfolios: The benefits and costs of network resource interdependencies. European Management Review, 8(1), 47–64. Zaheer, A., Castaner, X., & Souder, D. (2013). Synergy sources, target autonomy, and integration in acquisitions. Journal of Management, 39(2), 604–632.

5

Synergy Management

Contents 5.1 Transaction Value Added (TVA) and the Role of Synergies. . . . . . . . . . . . . . . . . . . . . . . . 250 5.2 Synergy Diagnostics and Patterns. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 252 5.2.1 Demystifying Synergies—I: Financial Diagnostics of Synergy Patterns . . . . . . . . 253 5.2.2 Demystifying Synergies—II: Joint Business Design Diagnostics of Synergy Patterns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 258 5.2.3 Valuation and Prioritization of Synergies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 262 5.3 End-to-End Synergy Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 264 5.3.1 Synergy Management & Embedded M&A Strategy: Synergy Diagnostics & Scaling Approach. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 265 5.3.2 Synergy & Transaction Management: Proof-of-Concept of Synergy Value and Scaling. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 267 5.3.3 Synergy & Integration Management: Synergy Capture—Implementation & Tracking. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 269 5.4 Synergy Management Toolbox and Synergy Capture Assessment. . . . . . . . . . . . . . . . . . . 272 5.4.1 Synergy Toolbox . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 272 5.4.2 Evaluating Synergy Capture . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 276 5.5 Synergy Management of Digital Targets and Business Designs. . . . . . . . . . . . . . . . . . . . . 277 5.6 Summary of Synergy Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279 5.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 279 5.6.2 Summary and Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 280

Abstract

Synergies are the holy grail of any transaction, as they define, together with the transaction premium paid, the value generated by an M&A initiative. Surprisingly, the concept of synergies is still a very vague concept. Synergies will be in the following understood as the net present value of additional Free Cash Flows created by a © Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_5

245

246

5  Synergy Management

transaction which goes beyond the standalone values of the acquirer and the target. In essence, synergies are a surplus concept. The key target of the Synergy Management along all the primary modules of the E2E M&A Process Design is to capture these synergies. Therefore, Synergy Management by itself is an End-to-End process, which supports any of the primary M&A processes: Within the Embedded M&A Strategy, the Synergy Management has to identify (Synergy Diagnostics) and map the portfolio of potential sources of synergies (Synergy Pattern) by the combination of the acquirer’s and the target’s SBDs. Besides, a Blue Print how those synergies could be scaled (Synergy Scaling Approach) within a JBD has to be drafted. Additionally, a first rough valuation, timing and evaluation of the likelihood of the synergies are paramount at this early stage, as the synergies and the standalone value of the target define the upper boundary of any indicative purchase offer. The identified synergies have to be verified by the Transaction Management, as the transaction value add is based on “real $” and not “power point $”. The Due Diligence serves as a ­proof-of-concept of the Synergy Pattern and the Blue Print of the Synergy Scaling Approach. Applying the 10C JBD, the early synergy estimates could be broken down into detailed synergy levers. These more detailed synergy values have then to be feedback into the update of the valuation. Finally, Synergy Management is a centerpiece of the Integration Management. This holds especially true as the premium is paid already at closing, but the synergies have to be captured within the integration process. For any transactional value-added and integration success the synergy realization, tracking and controlling is therefore of essence. Additionally, a feedback loop and learning ecosystem for the optimization of the Synergy Management is part of a long-term M&A capability approach. Synergies define, if a merger or acquisition project creates or destroys value, as they are in essence the origins of the improvements in earnings and FCF which are created by the combination of two companies. The problem is, that empirical studies show that most transactions do not or not on a timely base realize promised synergies or underdeliver on synergy capture. Nevertheless, the forecasts of intended synergies increased in the last couple of years (Kengelbach et al. 2018, pp. 5 and 17). Therefore, a rigorous Synergy Management which drives the identification, the verification, the timing, the implementation and the tracking of the targeted synergies along the E2E M&A Process Design became even more a decisive factor for synergy capture and transaction success (Fig. 5.1).  Definition Synergies could be described very broadly as the shareholder value added which is realized by the acquirer due to the acquisition of the target company or by the merger of two companies. Synergies might be levered on the target’s, the acquirer’s or both sides.

5  Synergy Management #1 • • • • •

Embedded M&A Strategy Embedded M&A Strategy Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond & Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

247 #2

Transacon Management

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − JBD blending and JBD Proof-of-Concept − Culture blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

#3

Integraon Management

• Integraon strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan • Transional Change: Implement JBD • Culture Transion • Integraon tracking and controlling • Integraonal Learning & Best Pracce

Synergy Management

#4 Top-Down Synergy Mapping and Synergy Scaling Approach

Synergy Proof-of-Concept and Synergy-Valuaon Blending

Synergy Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and M&A Toolkit

M&A Knowledge Management

M&A playbook

Fig. 5.1   The E2E M&A Process Design: Synergy Management

To get a deeper understanding of the characteristics of synergies the core principle of corporate finance will be applied: Companies do create value if they raise and invest capital to generate FCFs with a return on that invested capital which is higher than the cost of capital (Koller et al. 2020). Therefore, synergies are generated if the combination of the two companies creates higher FCFs than the two companies would generate on a standalone basis. In this case, the value of the combined company VA+T is higher than the sum of the standalone values of the target VT and the acquirer VA:

VA+T > VA + VT The value contribution of synergies SYN could, therefore, be defined as the difference between the value of the new, joint company post-transaction VA+T and the sum of the parts of the standalone values of the target VT and the acquirer VA pre-transaction.

SYN = VA+T − (VA + VT ) For the calculation of the Transaction’s Value Add (TVA) from this net present value of the synergies (SYN) the premium paid by the acquirer to the target’s shareholders (P) has to be deducted (Fig. 5.2): TVA = SYN − P This implicitly means, that a transaction does only increase shareholder value on the acquirer’s side, if, and only if, the net present value of the realized synergies is higher than the acquisition premium. This is the crucial buy-side transaction hurdle rate. The flip-sided outcome is, that if the forecasted synergies fall short of the acquisition premium requested by the sell side, the management team on the buy-side has to abandon the intended acquisition prior to closing, as it would be value destructive. The verification of the value of the synergies within the Due Diligence and the confirmation of how they could be captured and scaled by the new JBD is, therefore, mission-critical.

248

5  Synergy Management

NPV of synergies

Standalone value Acquirer: VA

Standalone value Target: VT

Premium

TVA Transacon Value Add

Combined value: VA+T

Fig. 5.2   Synergies, premium and Transactional Value Add (TVA)

From a more detailed valuation point of view, the total value contribution of the synergies is equal to the net present value of the additional future FCFs generated by those synergies. The net calculation involves the integration and one-time costs to realize the synergies as well as dis-synergies, like, for example, the potential drain of important customers. As the value contribution of the synergies is based upon the net present value of additional FCFs, not only the total value but as well the timing of the synergies is of essence. A realistic assessment of how long it will take to capture the intended synergies is another substantial task of the Synergy Management, besides their identification and value estimate. Concerning the financial pattern of synergies, operating synergies, like cost, revenue and balance sheet synergies, and financial synergies, like reduced cost of capital or tax losses carried forward of the target which could be deployed by the acquirer, could be differentiated (Damodaran 2016, p. 2). The pattern and value of the synergies are based on the specifics of a transaction and the JBD, especially the core assets and capabilities. Damodaran frames this: “The key to the existence of synergy is that the target firm controls a specialized resource that becomes more valuable if combined with the bidding firm’s resources (Damodaran 2016).” Nevertheless, the target could also increase the value of the resources and capabilities of the acquirer. Especially nowadays synergies are not limited to the target company. The latter might be the case, where the acquirer intends to revitalize his own portfolio by an acquisition. Investors often question if those synergies could be realized within the integration and a couple of studies show that their skepticism seems to be justified in many cases (Cogman 2014; Kengelbach et al. 2018, pp. 18–19). Typical root-causes of synergies failures are: – Synergy values are overestimated and not broken down in detailed levers or, even worse, just used as a plug variable to bridge the gap between high purchase prices and low standalone values of the target

5  Synergy Management

249

– Only synergies on the target-side are assessed, meaning synergies on the buy-side as a second fundamental source for synergies have been neglected – The identification of synergies is addressed too late, meaning within the Integration Management – No verification of synergies throughout the Due Diligence is initiated – Sloppy execution, unclear responsibilities and missing controlling negatively impact synergy implementation and capture – Underestimation of time needs and efforts along with the transition to the new JBD – Integration costs to realize the synergies are not figured in – Culture hindrances or organizational slack is underestimated As the synergies are the bedrock of any Transaction Value Added these hindrances to synergy capture are fundamental risks. Therefore, the E2E M&A Process Design explicitly integrates the Synergy Management as a separate E2E process which runs in parallel to, but is interwoven with the primary M&A processes, the Embedded M&A Strategy, the Transaction Management and the Integration Management: The first Sect. 5.2 explains the center role of synergies for any transactional value creation by providing a deep-dive with respect to the relationship between stand-alone value of the target company, transaction premium, purchase price, synergies and TVA. Based on this understanding the Pattern of Synergies will be classified from a financial and 10C Business Design perspective. In   Sect. 5.3, the Synergy Management as an integral part of the overall E2E M&A Process Design will be discussed. The core question is here how a Synergy Management could be designed along the whole M&A process, which ensures a seamless interaction with the primary M&A processes. Precise touchpoints between the Synergy Management and each of the primary M&A Process Design modules supplement this view: – The Synergy Diagnostics, the Blue Print of the Synergy Scaling Approach and a first evaluation of the synergies in the Embedded M&A Strategy phase – The proof-of-concept of the Synergy Pattern and Synergy Scaling Approach in the Due Diligence – The implementation, tracking and controlling of the synergies within the Integration Management – Furthermore, concepts to create a feedback loop and learning ecosystem for the optimization of the Synergy Management will be designed. Last, not least a holistic toolset of Synergy Management will be presented. Multiple tools could be applied for the identification, verification, tracking and implementation. These will be highlighted in Sect. 5.4. Additionally, it will be asked how synergy implementation could be evaluated.

250

5  Synergy Management

In the two final steps, as within prior chapters, the module outcomes will be applied to the specifics of the acquisition of digital targets (Sect. 5.5), before lessons learned as well as key success factors will close the discussion on Synergy Management (Sect. 5.6).

5.1 Transaction Value Added (TVA) and the Role of Synergies Both parties of an M&A deal will only agree to a potential transaction if they could realize a net-increase in their wealth, which could be described as Transaction Value Add (TVA). Value accreditive versus destroying transactions will be defined from a buy- and sell-side: – From a target’s shareholder perspective, the potential sell-off is only attractive, if, additionally to the stand-alone value, a premium could be realized. The stand-alone value of the target company is defined by the intrinsic Equity Value based on an Enterprise DCF valuation of the target company or, in case of a stock listed company, by the market capitalization. A rough indicator of premia paid within acquisitions, independently from a specific industry or regional characteristics, is round about 30% of the stand-alone value of the target company (Kengelbach et al. 2018, p. 13; Gaughan 2013, p. 298).1 The volume and pattern of synergies are thereby from industry to industry and even from transaction to transaction substantially different. – The acquirer’s view starts as well with the stand-alone value of the target company. Additionally, the acquirer might realize synergies. The stand-alone value of the target company plus the net present value of the synergies defines the maximum purchase price. Only if the final negotiated purchase price, including the premium and any transactional side payments, is below this threshold, value is created for the acquirer’s shareholders: Standalone Value, Premium, Purchase Price, Synergies and Transaction Value Added For the acquirer’s shareholders, the value neutral purchase price is the sum of the target’s stand-alone value and the net present value of all synergies, as described by Fig. 5.3. This implies a simple transaction decision rule on the buy-side: Only transactions where the net present value of synergies is higher than the premium are value accreditive, meaning having a positive TVA on the acquirerer's side (Koller et al. 2020, p. 566;

1Gaughan

(2013, p. 298) identified within the timeframe 1980–2011 based on Mergerstat Review and Econstats.com data slightly higher purchase price premia. This study shows as well, that premia paid in acquisitions have a positive correlation with high stock market valuations.

5.1  Transaction Value Added (TVA) and the Role of Synergies

251

Transacon Value Add TVAA for acquirer Premium P = TVAT (Transacon Value Add for seller)

Standalone value Target Co

SELL SIDE

NPV of synergies

Standalone value Target Co

Purchase price

BUY SIDE

Fig. 5.3   Transaction Value Added, synergies, purchase price, premium and target standalone value

Gaughan 2013, p. 54; Sirower 1997, pp. 20 and 46). This assessment rests upon a couple of specific assumptions: – The stand-alone value of the target company is based on the efficient capital market hypothesis: The intrinsic, DCF-based equity value of the target company should in such circumstances be identical to the market capitalization in case of the stock listed company.2 – It is also assumed, that the stand-alone value of the target company is identical for the seller and the acquirer. This assumption would be not correct, if, for example, the latter could execute value increasing strategies, like restructurings, des-investments or growth initiatives, which are beyond the target’s management possibilities. These improvements of the standalone value have to be separated from synergies, which the buyer might leverage for the target company by being a better parent. The latter synergies are the unique acquirer advantages. – The net present value of the synergies is here assumed as given. In reality, there is a timewise disconnect, as the purchase price has to be paid at closing, but synergies are realized later within the Integration Management. This is summarized in the ­well-known phrase “price is what you pay, value is what you get”. Implicitly, M&As are built upon an unbalanced chance-risk profile: In case the acquirer could not realize all the synergies within the integration the transaction would be in the aftermath value dilutive. Figure 5.4 shows such a case of a value dilutive acquisition:

2Harding

and Rovit analyze the potential difficulties in the calculation of the standalone value (Harding and Rovit 2004, pp. 81–83).

252

5  Synergy Management

Transacon Value Diluon - TVAA for acquirer

Premium P = TVAT (Transacon Value Add for seller)

Standalone value Target Co

NPV of synergies

Standalone value Target Co

Purchase price

SELL SIDE

BUY SIDE

Fig. 5.4   Transaction Value Dilution, synergies, purchase price, premium and target standalone value

Due to this significant effect of synergies on the Transaction Value Added, in the following subchapter the focus will be on the sources of synergies and how they could be identified.

5.2 Synergy Diagnostics and Patterns Despite that the term synergy is widely used and the volume of synergies decides on the value contribution of a transaction, no universally accepted definition of the term synergy exists. In the following, synergies are broadly understood as the additional value which is created by the integration of two companies’ Business Designs, independently from the type of transaction, beyond their standalone values and which would not be existent, if the companies would not join forces (Damodaran 2006, p. 541). From a corporate finance point of view, synergies are measured as the net present value of future Free Cash Flows which are driven by these synergies due to the combination of two companies: Typically, synergies are understood as value upsides which are realized by the acquiring company through an implementation of best practice approaches or a transition of own core capabilities on the target. Besides, efficiency gains and economies of scale are sources of synergies. But also vice versa, the transition of core capabilities and best practices from the target to the buyer could generate substantial synergies. This synergy ­feed-back loop is described in Fig. 5.5. The highest level of synergies might be those which are realized in the JBD by deeply integrating the two SBDs. An example might be economies of scale.

5.2  Synergy Diagnostics and Patterns

253

Joint Synergies Synergies levered on the Joint Business Design by integrang the two Standalone Business Designs

Acquirer Synergies Synergies driven by the transfer of competencies and best pracces of the target Co. to the acquirer

Parenng Synergies Synergies driven by the transfer of competencies and best pracces of the acquirer to the target Co.

Fig. 5.5   Synergy loop between acquirer and target

Obviously, this synergy loop becomes more powerful the stronger are the feedback loops of synergies between the acquirer and the target company. In the following synergies will be characterized from different perspectives: – the financial decomposition of synergies – the diagnostics of synergies by assessing the intended 10C Joint Business Design – the valuation and prioritization of synergies with the Synergy Matrix

5.2.1 Demystifying Synergies—I: Financial Diagnostics of Synergy Patterns A first question in the assessment of synergies is, if these could be realized by nearly any potential acquirer (standalone improvements) or if they are unique for a dedicated acquirer (true parenting advantages), as explained by Fig. 5.6: This might have a significant impact on the distribution of the synergies between the buy- and sell-side. If a major part of the synergies could be realized by multiple bidders, the bulk of synergy benefits might, most likely, accrue on the sell-side, whereas unique synergies might offer the buyer a better bargaining position. One very common classification of (true) synergies is by their financial origin. This classification has the advantage that it is close-knit to Enterprise Value. The standalone value of a company was described in Chap. 3 as the sum of the future DCFs generated by the company. Therefore, a transaction is only value accreditive, if the net

254

5  Synergy Management

Operang Synergies Revenue (Growth) Synergies Cost Synergies Invested Capital Synergies Financial Synergies

(True) synergies

Parenng Advantages Standalone Improvements

Standalone value addded

(Value added versus standalone case of seller) Standalone value

Fig. 5.6   Synergies versus standalone improvements

present value of the joint future FCFs of the target and the buyer are increased beyond their standalone values. Therefore, the rout-causes of synergies should be in line with the value drivers of the continuing growth formula. Following this approach, as described by Fig. 5.7, three different sources of operational synergies, which depend significantly on the JBD and Integration Approach, and financial synergies could be identified: – Revenue synergies – Cost synergies: Higher efficiencies or bundling effects – Balance sheet synergies: Optimization of the JBD which reduces the necessary amount of invested capital – Financial synergies: Decreasing the cost of capital or taxes, This classification could be embedded in a consistent Financial Synergy Pattern framework: In line with this corporate finance view, the synergies can be classified and detailed, as described by Fig. 5.8:3 Revenue (Growth) Synergies Growth synergies are here understood as revenue synergies and have therefore top-line impact. Growth is an important value driver in M&As (Gaughan 2013, pp. 58–62; Koller et al. 2020, pp. 583–584; Damodaran 2016). Nevertheless, revenue growth synergies are

3Most

text books and articles just separate between revenue or sales and cost synergies; e.g. Davis (2012, p. 72).

5.2  Synergy Diagnostics and Patterns

255

REVENUE SYNERGIES

COST SYNERGIES

g   NOPLAT1 −  ROIC   Value = WACC − g

INVESTED CAPITAL SYNERGIES

FINANCIAL SYNERGIES Fig. 5.7   Valuation and financial synergy patterns

Synergy paerns and modelling: Operang versus financial synergies Synergies: VA+T > VA + VT Operaonal Synergies Revenue Synergies

RONIC

(aracve innovaons)

RONIC & g

Financial Synergies*

Cost Synergies Economies of Scale

(Riding blue oceans, cross sell)

(procurement, new prod. tech)

Higher Growht Investment

(New BD, markets, capabilies) or

Opmized Joint IC

(Less Working Capital, CapEx needs)

Fig. 5.8   Financial Synergy Pattern

Cost savings in BD (SG&A)

Tax savings

(losses carried forward)

Unused debt capacity, excess cash of acquirer or non-opmized target capital structure

Beta Diversificaon versus conglomerate discount?

256

5  Synergy Management

in most instances harder to achieve than cost synergies. The latter are more dependent on the inner constituencies of the JBD, especially in case of efficiency gains, whereas revenue synergies are also dependent on external factors, like customers, and are therefore harder to predict. Typically, it also takes longer to capture revenue synergies in comparison with cost synergies (Chartier et al. 2018, p. 3). Additionally, higher revenues are only value increasing if they are converted into higher profitability and, in the end, increase FCFs. This can be seen in Fig. 5.6, as growth in invested capital is only value contributing, if the spread is positive, meaning the Return on Invested Capital is higher than the cost of capital. Multiple levers for revenue synergies exist. It is important to understand the sources of revenue synergies to be able to assess their value impact. Revue synergies could be classified along three dimensions, where to sell, what to sell and how to sell (Chartier et al. 2018, p. 4): – Where to sell: This lever of revenue growth synergies involves cross selling potentials between the acquirer and the target, better regional market or customer segment access, channel expansion options, for example by web-based distribution, or new customer wins. A typical use case might be the consumer goods industry, where the acquisition of a local competitor might enable the acquirer also to introduce the own brands via the target’s distribution and communication channels. Another case might be the acquisition of a cloud company by a digital platform company, where cloud services or software as a service could be sold by the online platform company through their own online channels. – What to sell: Product innovations, new service offerings, or the bundling of both in the sense of a new, full-coverage customer experience could offer a second growth lever. This might include an optimized brand portfolio or rebranding which could lever the exploitation of specific customer segments. Especially attractive new bundles of customer solutions and an optimization of the brand positioning offer not just revenue growth potentials, but most likely are as well strong value levers. Also, a higher innovation rate post-transaction, driven by joint R&D efforts or a reduced development time for innovations, might boost revenue growth and ROIC of the combined company. Besides, a reduction and refocusing on high volume products and services could serve as an attractive growth lever. – How to sell: This covers best-practice transfers concerning the brand, marketing and sales capabilities. The transfer of best-practices in brand-management between the acquirer and the target could leverage top-line revenue growth and are often used, for example, within luxury goods industry acquisitions: Here the likes as LVMH or L’Oréal acquire typically underutilized brands and scale them with their world-class marketing and branding expertise. Another growth lever, which is part of “how to sell” and which as well increases the ROIC post-transaction, might be a joint and consistent pricing strategy, especially in case of intra-industry acquisitions where industries get more horizontally consolidated. The price increase would boost revenues as well as ROIC.

5.2  Synergy Diagnostics and Patterns

257

The revenue synergies are also in most instances revolving synergies, meaning that they increase continuously future FCFs. But, the  realization of revenue synergies within the Integration Management is in most instances more challenging and less certain than cost synergies, because they always include the customer side. The latter have to be convinced to do (more) business with the joint company post-transaction. Nevertheless, in the last years, most likely driven by the need for new business models, shareholder response with respect to sales-driven synergies became more positive (Rehm and West 2016, p. 11). Cost Synergies Cost synergies increase RoIC. Economies of scale, as cost advantages due to scale effects of the joint operations post-closing, are one of the core reasons for transactions. Economies of scale reduce the costs per product (unit) and therefore the percentage cost of goods sold (CoGS), which increases RoIC and FCF of the joint activities (Gaughan 2013, pp. 62–72). The same holds through in case of learning curve effects, which are also size driven synergies and reduce cost per unit. Learning curves effects are found especially in manufactured goods industries, but are as well applicable in technology markets, like the chip industry. Cost synergies are especially relevant in horizontal mergers and acquisitions, as in transactions within a given industry volumes could be easily bundled. Besides economies of scale, economies of scope might exist. This is, for example, the case in automotive OEM transactions where joint platforms produce different brands or series in one factory and the bundling of purchasing volumes offers significant synergy potentials across all brands or series. Other possibilities of cost synergies are the transition of different capabilities and functional strengths between the acquirer and the target. Functional or core competency driven cost-savings might exist in technology intensive industries or the pharma and chemical sector by fostering joint R&D departments and programs. Additionally, nearly any industry offers potentials for savings in headquarters costs, like sales, general and administration (SG&A). Invested Capital (Balance Sheet) Synergies Invested Capital advantages are the third lever of potential operating synergies. The most crucial value potentials, at least in case of manufacturing industries, might offer an optimization of the capital expenditure (CAPEX) program or a benchmark driven reduction of the joint working capital. A reduced level of Invested Capital due to a CAPEX optimization could be achieved, for example, by a joint utilization of factories or R&D facilities. A newer, interesting case in the high-tech industry is the joint usage of server farms for cloud and other online businesses. The second lever of Invested Capital synergies offers the optimization of the working capital, for example by a reduction of the inventory level. The latter are typically realized with a short timeframe post-closing by a best practice transfer between the acquirer and the seller.

258

5  Synergy Management

Financial Synergies Financial synergies (Gaughan 2013, pp. 82–84), are different than revenue, cost and Invested Capital synergies, as they are non-operational. Invested capital and financing synergies are nevertheless partially intertwined, as financing advantages might be realized by the reduction of the necessary Invested Capital. Especially in cases, where the financing capacity on equity and debt markets might be limited, a reduced Invested Capital might offer headroom for deleveraging and new investments. Financial synergies might reduce also the Weighted Average Cost of Capital (WACC). The combination of two companies might increase the debt capacity and might lead to a higher debt ratio and lower WACC. But this might only hold if second order effects like higher costs of distress do not compensate for the primary advantage. Another financial synergy could be tax advantages. Losses carry forward might be exploited by the new joint company, but not by the target on a standalone-bases. Tax savings are a double-edged sword, as they reduce on the one side the tax shield, meaning the direct impact on the cost of capital of a reduced tax level, but, on the other side, increase the Net Operating Profit less Adjusted Tax (NOPLAT) as the key input for the FCFs. Nevertheless, the net value effect is positive. Additionally, in a wider sense, financial synergies might be realized if the excess cash of the buyer might be used to finance highly profitable projects of the target company, which the latter could not fund by itself. This is often an argument in case of the acquisition of a start-up by an incumbent. A further portfolio argument for financial synergies might be triggered in cases where the buyer and the target have counter-cyclical ­cash-flow patterns, which would result in a reduced joint risk and therefore cost of capital (Damodaran 2006, p. 541). Nevertheless, more or less all financial synergies are based on the assumption of imperfect capital markets and should, therefore, be handled with care. Dis-synergies Last not least, dis-synergies have to be addressed as well. They might rest on cost increases driven by a higher complexity of the JBD or integration costs. Their net present value has to be deducted from the sum of net present values of operating and financial synergies.

5.2.2 Demystifying Synergies—II: Joint Business Design Diagnostics of Synergy Patterns An alternative approach for the identification and decomposition of potential synergies is the assessment of the underlying Joint Business Design. As Business Designs of different industries and even of companies within a specific industry or peer-group might substantially deviate—this uniqueness is exactly on what competitive advantages rests—, the derived synergies within this approach are significantly target and acquirer specific.

5.2  Synergy Diagnostics and Patterns

259

To apply this approach, the JBD Blue Print has to be described prior to the synergy assessment, as proposed by the E2E M&A Process Design with it’s  Frontloading Approach. A showcase might be a European multi-brand consumer goods company, which acquires a competitor in the North American market. In such a case there might exist multiple synergies pools within the intended JBD post-closing, like the streamlining of the joint global manufacturing network (CA), the bundling of purchasing synergies (CE) or cross-selling potentials between markets (CM) and channels (CH) (Fig. 5.9). To explain the Approach of Synergy Diagnostics with the 10C JBD concept, in the following a couple of typical synergy pools of Joint Business Designs will be discussed: CC Synergies R&D synergies might be based on the transfer of technology standards or best-practices between the target and the acquirer. This transition might lead, on the one side, to new innovations, strengthening the revenue side, or to significant cost advantages, especially in case of high-tech companies, web-based business models or pharma businesses, due to overlapping R&D programs. By integrating and reorganizing the R&D portfolio and introducing more rigorous R&D portfolio review processes, the efficiency might be significantly increased. Another driver might be economies of scale (De Man and Duyster 2005; Cassiman et al. 2005). The acquisition of intellectual property rights or patents is nowadays in multiple industries, like media, pharma or technology, one of the key reasons why for M&A.

CA

Acquirer‘s SBD CS SBD Buyer‘s CA CP

CC

CV

CR CH

CP

CC

CH

CO

Target‘s SBD

Fig. 5.9   JBD Synergy Patterns

• String-of-pearl strategy • Service supplements or complementary products • System soluons • White spot detecon

CR

CS CA CE

CC

• R&D know-how transfer • Joint R&D capability plaorm • Access to IP rights, patents • Technology or process standards • Best-pracce methods

CM

CR CH

CH

CC Synergy pools

CV

Synergy pools

• Personalized approaches • Web presence

CM

CF CO

CM

CF

Synergy pools

CS

• Economies of scale & bundling in purchasing • Single and / or LCC-sourcing • Simplificaon

CR

CV

Joint Business Design

Synergy Pools

CO CS CV

• Streamlining global manufacturing • Best of both process automazaon • Joint R&D Network • Joint digital plaorm • Working Capital Opmizaon

CE

CM

CF

CA

Synergy Pools

CO Synergy pools

Synergy Pools

• Customer crossselling approach • Complementary regional markets

Synergy pools

• Distribuon channel cross-sells or streamlining • Markeng mix excellence spillovers

• Flat hierarchies, reduced management layers • Reducon in HQ costs • Talent development and retenon

260

5  Synergy Management

In those cases, the acquisition of start-up companies and new Business Designs might allow incumbents to renew and leverage their R&D platform. Further potentials of capability synergies are best-practice process standards in case where one company might have, a more mature or experienced operational practice and team. For example, joint purchasing practices and standards might uplift the merged purchasing team capabilities and quality post-transaction. Besides, best practice approaches, especially manufacturing methods, like Kanban, Total Quality Management or Six Sigma concepts, might offer additional synergy potentials. They intend not only to reduce costs but also to optimize pull-through times by simplifying manufacturing, sales or distribution processes. CE Synergies Purchasing synergies play a center role for most M&As, especially in consolidation plays, where two sizeable companies within the same industry merge. There exist multiple approaches to achieve purchasing synergies: One lever of purchasing synergies are supplier price gaps between the acquirer and the target for a specific product or service prior to the transaction and where both companies use the same or a similar supply base. These synergies could be easily diagnosed during the Due Diligence by comparing purchasing conditions at specific suppliers and by applying a volume prioritizing ABC-assessment. Also, these kinds of synergies might be easily realized post-closing, by approaching those suppliers where significant price gaps exist to agree on lowest cost terms. A further lever are economies of scale in purchasing. These go beyond the simple comparison of purchasing structures and might be realized by the bundling of purchasing volumes of the acquirer and the target company to achieve lower unit costs. The impact of these purchasing synergies is dependent on the transaction-driven increase in the purchasing volume and the price-elasticity of demand on the supplier’s side. An example might be the media industry, where M&As increase the scale and improve the bargaining power with content providers. The standardization of purchased products and services offer another CE synergy potential. Here the focus is more on the technical standards in the sense of what the company buys and not at which price. Additionally, limiting the number of offered products and to concentrate marketing and sales on fewer, winning products and services could not only lever revenues but as well simplify purchasing processes and offer further scale advantages. This might be especially relevant for industries where the acquirer and target buy technically advanced sub-systems or services. CA Synergies CA synergies are deeply ingrained in the JBD. For manufacturing companies, the streamlining of the global manufacturing footprint might offer substantial cost and investment savings. Besides the streamlining of the joint factory network, higher utilization rates of plants and machines might offer additional synergy potentials. For R&D

5.2  Synergy Diagnostics and Patterns

261

intensive industries, like pharma or technology, a joint R&D network may have the same effect. On another page are working capital synergies. Those might be achieved by: – Optimizing accounts receivables by invoicing strategies, best-practice or factoring approaches – Reducing inventories by just-in-time processes or a streamlined warehouse network – Accounts payable optimization by supplier programs Working capital optimizations are also from a financial point of view attractive as their reduction increase one-by-one FCF. CO Synergies Organizational design synergies might rest on a simplification of management processes as well as on a flattening of hierarchies and management layers within the new JBD, increasing the responsibility and leadership bandwidth of each manager. Another efficiency driver, intended by most M&As, is the reduction in headquarter costs, as only one department for any central function might be necessary. High-quality talent development and retention programs, as well as HR best practices, might safeguard core talent retention and offer efficient management development approaches. CV Synergies CV synergies target more attractive or innovative customer solutions and use cases by the combination of the unique set of capabilities on the acquirer’s and the target’s side. A dedicated strategy in this sense are string-of-pearl M&A strategies, where an acquirer complements his footprint along an industry value chain by up- and downstream M&As. In a broader sense also acquisitions which focus on supplementary services or complementary products might pay in on the same argument. The latter are paramount in today’s ecosystems with ever-shifting boundaries. Especially in B2B markets, the development of higher-level system solutions by the acquisition of the target company might be intended by such a strategy. Even beyond those approaches are acquisitions which try to detect and develop totally new markets or customer use cases, meaning untested and -discovered white spots. All in all, CV synergy-based M&As are exclusively driven by revenue synergies. CR Synergies CR synergies have to be assessed very sensitive, as they are exposed to customer proximity and intimacy. Easily these close ties could be damaged and customers lost by a naïve synergy assessment. At least a long-term horizon might here be mandatory to achieve any customer relationship synergies.

262

5  Synergy Management

CH Synergies Channel synergies might rest on distribution strategies, where cross-selling potentials due to the acquirer’s and target’s different channel access and footprint might exist. A more technology-driven case is the use of the web-access of a target company by an incumbent with less digital market access and knowledge. Another channel lever are logistic network optimizations, which is foremost an efficiency and cost-driven synergy case. A last channel synergy might be driven by marketing excellence spillovers, for example in brand portfolio management, strategic pricing or communication strategies. This practice is successfully applied within the luxury goods industry, as explained prior. CM Synergies Cross-selling might boost revenue growth. Examples are a joint and coordinated go-to-market mechanisms, a stringent customer share of wallet extension strategy or the cross-selling in regional markets in case of complementary market footprints pre-transaction. Within a holistic M&A approach, synergies should be analyzed from a business and financial view to create a detailed synergy understanding and integration priorities: To involve operational managers for the synergy estimation, besides the M&A team, is recommended, as they might improve the quality of the synergy verification within the Due Diligence. It might as well increase the acceptance of synergy targets and the support within the integration.

5.2.3 Valuation and Prioritization of Synergies Due to the significant impact of synergies on the TVA their value, but as well their timing must be planned in detail. Based on a transparent and robust assessment of all potential synergy pools of a transaction, the priorities for the Synergy Management within the Integration Management could be decided upon. For the prioritization of synergies their pattern, timing, and FCF impacts are determined: Pattern of Synergies The pattern of the synergies could be defined by the above classification of financial and JBD synergies. This analysis will also stress how bullet-prove or vague the intended synergies are. For example, cost-driven purchasing synergies might have a higher likelihood to be realized by bundling strategies and supplier programs as more soft revenue synergies based on cross-selling strategies. Nevertheless, any synergy must either reduce costs, increase the FCFs by higher revenues, reduce the need for Invested Capital or the cost of capital to have a value impact. Timing As the value of the synergies was defined by their net present value effect, the timing of the synergies is important for their value contribution (Harding and Rovit 2004, pp. 81–83). The timeframe for the realization of synergies depends on multiple factors:

5.2  Synergy Diagnostics and Patterns

263

The pattern of the synergies defines partially the time need for their realization. For example, cost or working capital synergies are typically more short-term captured than factory restructuring based or revenue synergies: The efficiency programs and ­cost-cutting initiatives on headquarter level or purchasing programs might be realized already in the first 100 days along the IM, whereas revenue synergies, the restructuring of the global manufacturing footprints or the integration of R&D platforms might need a significantly longer timeframe of up to two years. Additionally, the complexity of the transaction structure, the size of the transaction, as well as the complexity of the involved companies and their SBDs might have a decisive impact on the time length of synergy implementation. The valuation impact of timing is straight forward: As synergies are calculated on a net present value basis, synergies which might be realized later have a less significant value impact (Gaughan 2013, p. 81). Another question is if the synergies are recurring or onetime effects. Recurring synergies have a significantly stronger value impact. On the one side, one-time cost reductions have only an FCF impact within the given planning period in which they are realized and increase the value of the joint company by the present value effect of this one-time FCF improvement. A permanent lower cost level, on the other side, has a much higher net present value impact, as it consistently increases future FCFs. Value and Free Cash Flow Impact of Synergies After this classification of the synergies, their value contribution could be forecasted and stress-tested within the Due Diligence. As the value contribution of the synergies is calculated on a net present value basis, the total value surplus is simply the sum of the net present values of the individual synergy pools. Besides, the synergies could be classified according to their time needs in short, mid, and long-term synergies. Synergy Matrix Given the timing and value impact of the synergies the Synergy Matrix, as described in Fig. 5.10, defines three different synergy fields, high-priority synergies, long-term synergies, and low hanging fruit synergies: – High priority synergies: This kind of synergies could be realized short-term and have a significant value impact. Typically purchasing synergies account for high priority synergies. High priority synergies should be a focus point within the 100 days IM of the Integration Management. – Long-term synergies: they have as well significant value impact, but need a mid to long-term time horizon for their implementation and are a core part of the midterm IM. – Low hanging fruit synergies: These synergies might have just a minor value impact, but might be realized within a short time horizon and with minimum integration efforts, like cost-cutting initiatives on headquarter level. After this prioritization of the synergies the integration of the Synergy Management into the broader E2E M&A Process Design framework is discussed:

264

5  Synergy Management

Time need for Synergy Capture

Short Term

High Priority Synergies

Low Hanging Fruits Synergies CA: SG&A Synergies

Midterm focus

CC: R&D

Long Term Low

CA: Purchasing Synergies

CM: Cross-Sell Synergies

CA: Manufacturing Synergies

Long-Term Synergies High

Value Impact Fig. 5.10    Synergy matrix—Prioritization of synergies

5.3 End-to-End Synergy Management As an E2E support process by itself, the Synergy Management runs parallel to and is integrated with the primary M&A processes, the Embedded M&A strategy, the Transaction Management and the Integration Management. This is described by Fig. 5.11. Within each step of the primary processes of the M&A Management the Synergy Management has to fulfil specific tasks: – Core tasks of the Synergy Management within the Embedded M&A Strategy phase are the mapping of potential synergy pools (Synergy Diagnostics) and the drafting of a Blue Print of the Synergy Scaling Approach – The Transaction Management is aligned with the proof-of-concept of the ­top-down synergy estimates and the Synergy Scaling Blue Print – The Integration Management goes hand-in-hand with the Synergy Capture, meaning synergy implementation, tracking and controlling The overview of the tasks of the Synergy Management is described in Fig. 5.12 and will be detailed in the following subchapters:

5.3  End-to-End Synergy Management

Embedded M&A Strategy

#1

• • • • •

Embedded M&A Strategy Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond & Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

265

Transacon Management

#2

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − JBD blending and JBD Proof-of-Concept − Culture blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

Integraon Management

#3

• Integraon strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan • Transional Change: Implement JBD • Culture Transion • Integraon tracking and controlling • Integraonal Learning & Best Pracce

Synergy Management

#4 Top-Down Synergy Mapping and Synergy Scaling Approach

Synergy Proof-of-Concept and Synergy-Valuaon Blending

Synergy Implementaon, Tracking and Controlling

M&A Project Management & Governance

#5 M&A Capability Map

Integraon Project House (IPH) and M&A Toolkit

M&A Knowledge Management

M&A playbook

Fig. 5.11   Synergy Management as an E2E support process for the primary M&A modules

Synergy Diagnoscs & Synergy Scaling Approach 

Synergy Diagnoscs: Synergy Map in line with strategic fit - Porolio of qualitave synergy levers



First rough financial top-down esmate (quan ta ve) of synergy values (with benchmark)





Synergy Proof-of-Concept & Synergy-Valuaon Blending 

Proof-of–concept of top-down synergy es mates and Synergy Scaling Approach



Detailed and reframed priories by Synergy Matrix (porolio): Timing, value, likelihood Design of Synergy Master Program between signing & closing with detailed Synergy Scorecards:



Combining synergy concept with Standalone Value Blue Print of the Synergy Scaling Approach



First dra of synergy cases and framing of requirements



Es mate integraon costs (dissynergies)

o

Using informa on from DD & Synergy-Matrix

o

Synergy business case with valua on impact

o

Implementa on plan and milestones ( ming)

o

Defini on of teams, tasks and responsibili es

o

Necessary investments, resources & capabili es

o

Dra of milestone and DOI repor ng



Update combined value with latest synergy esmates

Synergy Capture: Implementaon & Tracking 

Final validaon and sign-off of Synergy Master Program and Synergy Scorecards o

Goals and value targets

o

Timing & milestones

o

Responsibili es (project owner)

o

Resources needed



Synergy implementaon



Synergy tracking o

By DoI

o

Project repor ng and loops



Synergy controlling and connuous synergy update



Synergy learning loop: Develop synergy database

Fig. 5.12   Synergy Management subprocesses

5.3.1 Synergy Management & Embedded M&A Strategy: Synergy Diagnostics & Scaling Approach As the synergies determine, together with the paid premium, the TVA, the potential target- and acquirer-specific pools of synergies should be defined as early as possible. Therefore, a holistic Synergy Management starts already within the Embedded M&A

266

5  Synergy Management

strategy phase with the Synergy Diagnostics and Mapping of the transaction specific mission-critical synergies. The discussion of potential synergies is well placed within the initial definition of the Transaction Rationale of the potential acquisition or merger. This also allows the close coordination between the definition of the competitive advantages of the transaction and its financial impact, in the sense of synergies. This interplay will be described for three cases of different transaction rational: Lever Market Access Within cross-border M&As, the intent of the M&A Strategy is typically a better access to the target’s core markets. In such cases, cross-selling opportunities and therefore revenue synergies might be the highest prioritized value levers. Product or Brand Portfolio Complementarities and Extensions The same might hold true for the majority of acquisitions in the luxury goods or pharma industry, where the buyer might intend to leverage the target’s brands or intellectual property throughout their own organization. Revenue synergies are again mission-critical. Industry Consolidation Plays In contrast, if the transaction rational is an industry consolidation play, which offers strategic levers by the bundling of purchasing volumes and the optimization of the global manufacturing footprint, cost synergies might be paramount to capitalize the value of the transaction. Within the definition of the Embedded M&A Strategy, therefore, a Synergy Map of the most likely and important transaction- and JBD-specific synergy levers should be achieved. This should be supplemented by a description of the underlying assumptions of Synergy Capture. Based on this qualitative assessment of the synergy pools a first rough top-down estimation could be initiated and benchmarked with other public transactions of the peer-group. The Top-down Calculation of Synergies and Transaction Value Add TVA 1. Calculation of Standalone Value of acquirer and target company: The valuation of the standalone value is based on the calculation of the Enterprise DCFs of the two companies by using pre-transaction FCFs and company specific WACCs. By deducting debt and debt-like items the two standalone Equity Values are determined and added. This leads to the combined value of the two companies without any synergies (pre-transaction). 2. Calculation of Combined Value post transaction: The combined value is based on the Enterprise DCF with synergies evaluating the joint FCFs and cost of capital post-closing and based on the Joint Business Design. A rough plausibility check of the combined value is the assessment if the ROIC development of the new joint company is roughly in line with industry peers. 3. Calculation of Synergy Value: Synergies from a top-down perspective are simply the Combined Value (with synergies) less the two Standalone Values (without synergies). 4. The Transaction Value Add (TVA) is then simply the Synergy Value minus the premium paid to the target’s shareholders.

5.3  End-to-End Synergy Management

267

The bottom-up calculation of synergies A bottom-up calculation of the separate synergies might be a suitable proof of the top-down calculation of the synergies. Therefore, the multitude of synergy pools must be broken down by a framework like the 10C JBD and be evaluated by calculating the net present value for each of them. The sum of those net present values of synergies should be in line with the top down estimate to provide a robust valuation proof.

Additionally, the Synergy Scaling Approach, meaning how the most crucial synergies might be levered post-transaction, should be defined within the M&A Strategy. This offers the possibility to run also a proof-of-concept of this Synergy Scaling Blue Print within the Due Diligence. A first framing of the most important synergies in Synergy Scorecards might supplement this step finally.

5.3.2 Synergy & Transaction Management: Proof-of-Concept of Synergy Value and Scaling The most important interactions between the Synergy Management and Transaction Management are within the Due Diligence and the valuation phase. One of the most important tasks of the Due Diligence is the verification of potential synergies between the two companies. Before the final deal approval at the end of the Transaction Management phase, the board has to run a plausibility check of the robustness of the synergy estimates, meaning if they are real and deliverable (Davis 2012, p. 13). Within the Due Diligence, the Blue Print of the Synergies Map, as defined very broadly in the M&A Strategy phase, could be assessed with respect if, how far and along which realistic time-horizon they could be realized most likely within the integration. The synergies will be at this stage broken down and evaluated not only top-down but also bottom-up, to achieve a deep understanding of how likely they could be achieved. Given this much higher granularity of synergy estimates, likely synergies could be assessed and benchmarked. The important relationship between synergies and valuation was already discussed in Sect. 5.1. Holistic valuation models integrate the financial impact of the synergies, their net present value estimates, from the beginning. This allows as well a separate valuation of the transaction with and without synergies and therefore the definition of the maximum premium. Especially during times of bullish M&A markets, the management team and the supervisory board have to assure, before the final deal signing, that the promised synergies are bullet-proof, meaning realistic and achievable. This is in so far challenging, as usually the acquirer’s management team lacks the opportunity to discuss synergy potentials and ways to realize them in detail with the target’s management team prior to closing (Kengelbach et al. 2018, p. 20). A top-line approach for a plausibility check might

268

5  Synergy Management

provide additional insights besides the Due Diligence efforts. This could be achieved by the comparison of the forecasted ROIC and EBITDA- or EBIT-margins under the assumption that forecasted synergies will be realized with the margins of best-in-class competitors within the peer-group. If the synergies lead to margins which overshoot those of the benchmarks significantly, they might be too stretched in the given industry and ecosystem environment. Synergy Program and Synergy Scorecards The verified synergies within the Due Diligence are an ideal starting point to draft the Synergy Program and the Synergy Scorecards, which describe how those potentials could be realized within the Integration Management by specific synergy workstreams and projects. Besides they should assure that robust processes and mechanisms are in place so that the intended synergy projects are also realized. Clear synergy objectives and milestones are crucial parts of the workstreams and processes to ensure integration success on time. The draft of the Synergy Program and Scorecards already in the Transaction Management is mandatory to finally verify the value potential of the synergies prior to signing and to detail the Synergy Scaling Approach. The Synergy Program has also to be coordinated and interwoven with the IM to assure a seamless transition from the Transaction Management to the integration. A brief synergy proof-of-concept example is shown in Fig. 5.12. Purchasing synergies by low-cost country sources and bundling effects might offer substantial value improvements. A sensitive analysis might use two scenarios, a realistic and an aggressive one, for the assessment of those synergies. Purchasing synergies might be also interesting from a valuation point of view, as they will have most likely a long-term, recurring effect, by reducing the costs of goods sold of the joint company within all follow-on periods. The net present value of purchasing synergies mirrors the sum of the cost and therefore FCF advantages of all materials across the planning horizon. By this breakdown, a detailed understanding of the value improvement potentials of the purchasing synergy levers and in total across all the synergy fields will be achieved (Fig. 5.13). To ensure a fast and focused realization and scaling of the synergies within the integration the acquirer could use within the Due Diligence and between signing and closing of the deal a so-called clean team which might collect further data from the target to draft the Synergy Program. The clean team is a third party, independent team, which serves as a platform between the two company’s potential integration teams, as the latter might be limited to co-operate before closing due to legal restrictions. The clean team’s task is to detail the IM and Synergy Program, to ensure an accelerated takeoff after Day One. Therefore, the clean team will collect, assess and compare before closing confidential data to quantify and time in all detail the synergy levers. Additionally, the synergy team will work on how the synergies could be achieved and might develop a first draft of the Synergy Scorecards.

5.3  End-to-End Synergy Management

269

Decomposion total synergies Synergylever

Realisc Cost advantage p.a.

Decomposion purchasing synergies

Aggressive NPV effect

Costadvantage p.a.

NPV effect

Raw material

Cost advantage p.a. - realisc

Cost advantage p.a. - aggressive

A

R&D

B

Purchasing

C

Manufacturing

D

Sales

...

Cross-Selling

Total

Total

Fig. 5.13   Detailed purchasing synergy assessment by ABC and scenario analysis

5.3.3 Synergy & Integration Management: Synergy Capture— Implementation & Tracking For their value impact, the realization of the synergies within the Integration Management might be one of the most important processes within a whole M&A project. Vice versa, multiple studies underline, that a significant number of v­ alue-destroying acquisitions underdelivered especially concerning a focused implementation of the intended synergies. Therefore, a step-by-step implementation of the synergies within the Integration Management is of essence for the Synergy Management. This implementation of the synergies must be matched with the overall IM. A skeleton of important subprocesses of the Synergy Management within the Integration Management is shown in Fig. 5.14: This synergy implementation builds upon the synergy verification of the Due Diligence and comprises the Synergy Masterplan and Synergy Scaling Approach implementation, the definition of the synergy team and to be applied tools, as well as a dedicated synergy tracking, controlling and management including a dynamic learning approach: Freeze of Synergy Masterplan, Scorecards and Synergy Scaling Approach Ahead of the closing, the dedicated IM and Synergy Masterplan have to be finalized and at Day One officially released and rolled out. Such a Synergy Masterplan involves tasks like – The Synergy Scorecards: A description of the high-priority synergies for the first ­100-days of the integration and the long-term mission-critical synergies – the definition of synergy reporting processes, standards and timelines – the selection of the IPH and Synergy Program leadership team – the definition of the reporting standards and communication lines between the top management and the IPH with respect to synergy capture success

IINTEGRATION MANAGEMENT

270

5  Synergy Management

Blue Print Integraon Approach incl. JBD & JCD

Design of Integraon Masterplan

Stress-Tesng Integraon … Approach and Proof-of-Concept JBD & JCD

Day-One Readiness

Integraon Communicaon Execuon of Integraon Masterplan Implementaon JBD Culture Transion

SYNERGIE MANAGEMENT

Tracking, Controlling and Management of Integraon Success

Synergy & Scaling proof-of-concept

Synergy Masterplan and Scaling Model

Synergy Pool & Scaling Model Blue Print Pre -Closing

Synergie Team & Tools

Synergie Capture Synergie Tracking, Controlling and Management

Closing

100 days integraon.

1 year

Fig. 5.14   Subprocesses of the Synergy and Integration Management

Synergy Team and Tools The IPH has to manage and coordinate the synergy implementation. Additionally, it has to enable the project team by the design of appropriate synergy and project management tools as well as team reporting standards, like the discussed Synergy Scorecards. Besides, clear responsibilities, tasks and timelines with dedicated milestones for synergy capture have to be defined. Based on the list of prioritized synergies, the appropriate team members and functions have to be selected and involved. Synergy Implementation The overall target of the implementation process is a rigorous and in-time execution of the Synergy Masterplan, which bundles the different Synergy Scorecards, workstreams and initiatives. The implementation of each of those dedicated synergy projects, as described in detail in the Synergy Scorecards, is the task of the synergy teams. The IPH plays the role of the orchestrator of the overall synergy implementation and capture process. This split of responsibilities is essential for a successful synergy implementation. The reference point for the implementation process are the targets as frozen in the prior defined Synergy Scorecards. This enables transparency along the synergy implementation process and an early detection of deviations.

271

5.3  End-to-End Synergy Management

NPV of Synergies

According Due Diligence Proof-of-Concept

Upside Synergy Forecast

Downside Synergies, Addional Integraon Costs

Update on Synergy Capture

Update during Synergy Implementaon

Fig. 5.15   Synergy controlling

Synergy Tracking, Controlling and Management A permanent tracking of the synergies is mandatory for the transparency during the implementation process.4 This tracking should be triggered down on the level of the different synergy modules and even individual Synergy Scorecards and implementation projects. Such a high granularity of the assessment concerning the implementation progress of the individual synergy projects is suited for the application of the Degree of Implementation (DoI) methodology. The latter will be described in detail as one of the synergy tools within the next subchapter. The DoI method monitors the statues of the synergy implementation by applying milestones like the initial project idea, the project description with Synergy Scorecards, the synergy project implementation and the profit and FCF impact realization by the specific synergy project. Based on this detailed understanding of the status of implementation of the individual synergy projects, a permanent real-time monitoring and plan-versus-status reporting could be initiated. By consolidating bottom-up the individual synergy implementation projects, a full transparency, backed by the real-time information on individual project level, is achieved on the full synergy capture of the transaction. This is described in Fig. 5.15:

4Davis

(2012, p. 104) stresses the monitoring need within the overall integration process.

272

5  Synergy Management

Last not least, the synergy implementation should initiate counter-initiatives in case of negative deviations from the initial synergy estimates. Dynamic Learning and Feedback Loops The codification of best-practices and lessons learned within transactions might substantially improve the Synergy Management. After the closing of the synergy implementation projects, a post-mortem report describes if and how the synergies have been captured, what have been the lessons learned during the synergy implementation phase, and how the synergy tools and processes could be improved for the next transaction. Additionally, a debriefing session with the involved M&A team and operational managers allows to summarize lessons learned. The post-mortem reports and debriefings could be embedded in an information and learning platform for future M&A deal teams. The learning platform could also serve as a reliable and sound database for grounding realistic synergy estimates. With this holistic approach, a permanent learning loop is initiated, which in the long term leads to a step-by-step improvement of M&A capabilities and is of utmost importance, especially for serial acquirers.

5.4 Synergy Management Toolbox and Synergy Capture Assessment 5.4.1 Synergy Toolbox Due to the importance of the synergies for the value creation of the transaction, the design of synergy tools and their permanent improvement is essential for a professional M&A management. In the following, a couple of important synergy tools will be discussed, like value driver assessments, JBD analysis, benchmarks, the synergy prioritization matrix, as well as individual Synergy Scorecards and the Degree of Implementation method. Value Driver Diagnostics  Starting point of the Embedded M&A Strategy is the identification of potential synergy pools, as discussed. Therefore, tools which will focus on the diagnostics of the transaction- and JBD-specific synergy levers are in need. A corporate finance-driven approach is the value driver assessment (Koller et al. 2020, pp. 552– 555), as described in Fig. 5.16: The original idea rests on the well-known DuPont formula, which breaks down the key operating performance measure of Return on Invested Capital into the drivers of operating performance, measured by the profit margin (profit-to-revenue, whereby profit is in most instances interpreted as EBIT or NOPAT) and capital efficiency, measured by the revenue-to-capital ratio. This general idea could be used to identify the most crucial financial value drivers of the target company and the acquirer with a high granularity.

5.4  Synergy Management Toolbox and Synergy Capture Assessment

273

Value Driver A Price

Value Driver B

Revenues

NOPLAT

Units Material

COGS & SG&A

Labour

RoIC

SG&A CapEx

Value Driver C

Value Driver‘s ROIC Impact*

Invested Capital Cost of capital

WACC

Accounts Receivables & Inventories

Accounts Payables

*Impact of 1% change in value driver on ROIC

= Value Driver

Fig. 5.16   Value driver tree

The outcome might be a value driver tree which mirrors, based on past and actual performance figures, the key financial value drivers of the income statement and balance sheet, specifically for the transaction model and underlying JBD. Given this prioritization of the synergies, the top down estimate of the synergy volume could be broken down with a focus on the most important value drivers. Joint Business Design Diagnostics The JBD synergy driver diagnostics, as the value driver-based modelling of potential synergies, ensures a strong focus on the specific industry and even target company. The 10C JBD assessment breaks down the synergies on the individual modules, as described in Sect. 5.2.2. Based on this decomposition of the JBD and its specific synergy potentials, the strongest value contributing synergies are then selected as high-priority levers. Additionally, these synergies estimates might be benchmarked: Benchmarking  An additional possibility for the diagnostics, and even more for the verification, of potential synergies, is given by the benchmarking approach. Benchmarks could be implemented by three specific approaches to compare the JBD’s value levers: – A best practice comparison and assessment between the acquirer and the target company may serve as a starting point – A comparison of the intended acquisition with former transactions of the acquirer – A benchmarking of the intended acquisition with published transactions within the industry-specific peer-group. Especially for listed companies, a lot of details might be available for benchmarking purposes (Fig. 5.17).

274

5  Synergy Management

Benchmarking with peer group

Knowledge pool of former transacons

Best pracce transfer: target versus acquirer

 Purchasing (volume & bundling, lowest price, LCC,…)  R&D (streamlining / avoid duplicaon, R&D porolio,…)  Manufacturing (opmize footprint, LCC shi, integraon target / acquirer, Working Capital opmizaon)  Selling (Cross selling, market overlap, efficient sales organizaon, strategic pricing,…) Quanficaon and ming of synergies

Forecast of FCF and NPV of synergies

Fig. 5.17   Identification of synergy potentials by benchmarking

Synergy Matrix  The Synergy Matrix, which compares and classifies the synergies concerning their value impact and time-need was already applied in Sect. 5.1 (Herndon 2014, p. 58). This approach offers a simple and transparent tool, on the one side for setting priorities for synergy implementation, on the other side for addressing the different time and implementation needs of the individual synergy pools. A further advantage in case of an application already within the Embedded M&A-Strategy is, that it supports keeping the focus within the Due Diligence and integration on the most crucial synergy levers. Last not least, the Synergy Matrix allows the setting of time-specific implementation priorities. Synergie Scorecards  The Synergy Scorecard is a detailed description of a specific synergy project and fulfils multiple tasks. For the synergy integration team, the Synergy Scorecards are the key tool and reference point for the implementation of the synergies, as they are based on individual project level. Besides, they enable a real-time transparency of the Degree of Implementation of the different synergy implementation initiatives and early detect potential deviations from the synergy forecasts. Insofar, they are an important tool for the M&A project management and reporting. Content-wise, the Synergy Scorecard could be understood as a draft of how the synergies should be achieved. It summarizes the specific synergy field, the project approach of how the synergies should be delivered, the project team and responsibilities, the timing needs and milestones, the necessary resources and investments to deliver on the intended synergies, their value and profit impact and the actual status of their Degree of Implementation. Degree of Implementation (DoI)  The Degree of Implementation (DoI), which is sometimes also called degree of hardness, is a further tool for the synergy realization. In comparison with the Synergy Scorecard, the DoI methodology focuses more on the integration process than on the detailed description of the synergy project. The methodology

5.4  Synergy Management Toolbox and Synergy Capture Assessment

275

intends to know at any time the detailed statues and volume of synergy capture. The DoI levels could be set up as follows: – – – –

DoI 1: Synergy project has been identified and roughly valued top-down DoI 2: Synergy project has been set up and described in a Synergy Scorecard DoI 3: Synergy project has been started and is within the realization phase DoI 4: Synergy project is implemented and delivers on the intended FCFs

DoI 4 might even be split up into separate steps of closing the synergy project and the later profit and FCF improvements. Figure 5.18 describes a synergy tracking process with DoI: The synergy project teams have the responsibility for the implementation of the individual synergy projects and therefore as well for the management and reporting of the DoIs at each milestone. In case of a deviation from the intended timing or implementation success, countermeasures have to be initiated and the Synergy Scorecard updated. The IPH integrates the individual synergy projects and provides a summarized view on the synergy implementation statues for the top management. It will as well provide a plan-versus-realized comparison, based on milestone results, and a summary of potential countermeasures and initiatives. The application of these synergy tools enables an efficient and E2E consistent Synergy Management along the whole M&A process. Degree of implementaon 4 Degree of implementaon 3 Degree of implementaon 2 Degree of implementaon 1

Day One

Milestone1

Milestone 2

Fig. 5.18   Synergy tracking with DoI methodology

Milestone 3

Milestone 4

Milestone 5

276

5  Synergy Management

5.4.2 Evaluating Synergy Capture If the net present value of realized synergies SYN in comparison to the paid premium to the seller shareholders P decide on the Transaction Value Added TVA, the evaluation of synergy capture is key for any transaction. This is explained by Fig. 5.19 along the Integration Management time path: For the evaluation, if a transaction was successful, the Transactional Value Add TVA, as defined in Chap. 3, is applied:

TVA = SYN − P =

∞  t=1

FCFtSYN −P (1 + WACC)t

The TVA formula shows the fundamental challenge of value creation on the acquirer’s side: Whereas the seller’s shareholders are always advantaged by the paid premium, the acquirer’s shareholders only profit if the net present value of synergies overshoot the premium paid. But, additional risks lurk for acquirer’s shareholders. One is timing. Whereas seller shareholders are paid at closing, synergies are realized after closing in the years to come and are on risk of being not fully captured. Assuming an integration program might last 2 years, the net present value of synergies could be decomposed in the part realized along with the integration in the first two years post-closing SYNI and the long-term synergy value SYNLT thereafter:

SYN =

∞  t=1

2 ∞   FCFtSYN FCFtSYN FCFtSYN = + = SYNI +SYNLT (1 + WACC)t (1 + WACC)t t=3 (1 + WACC)t t=1

This decomposition shows that in most instances the bulk of synergy value is realized even beyond the integration process SYNLT, making it even more challenging to judge if

Sustainability of synergisc advantage? Can competors replicate benefits?

Timing? - Premium paid today vs synergies realized along integraon Purchase Price (P)

TVAR = P RTVAR =

P E qVT

∞

Standalone Value Target t0 (Closing) TVAR = Transaconal Value at Risk, RTVAR = Relave Transaconal Value at Risk

F CF SYN

t ∑ (1+ WACC )t

P (Premium Paid)

t=3

∞

TVA = SYN − P = ∑

F CFt SYN ∑ (1+ WACC )t t=1 2

t3

t=1

F CFt SYN

(1+ WACC )t

−p

t3+1

DNSV = Discounted Net Synergy Value

Fig. 5.19   Measuring synergy implementation and Transaction Value Added TVA

5.5  Synergy Management of Digital Targets and Business Designs

277

an acquisition premium at closing is justified by the value contribution of future synergies. The premium could, therefore, be also interpreted as Transactional Value at Risk TVAR.5 Alternative measures are therefore assessed as supplements. Empirical event studies use the Cumulative Abnormal Return within an event window around the transaction announcement to measure the stock price under- or over performance of acquirers. An alternative path is to use additional financial indicators to measure transaction success, such as: – – – –

ROIC performance versus peer-group NOPLAT, EBITDA or FCF performance versus peer-group Revenue growth trajectory (CAGR) versus market Debt coverage (EBITDA/Net-Debt) development

Additionally, operational measures might be applied as supplements to the financial indicators of M&A success: – – – – – – –

% of customer lost/gained Market share gain/losses Customer satisfaction changes Lost talents or key personal # of new job applicants # of patent filing development # or time delay of red flag integration modules

5.5 Synergy Management of Digital Targets and Business Designs Digital M&A has concerning the intended synergies a multitude of differences to traditional M&As. Within the latter cost, synergies play typically a center role. This traditional view of cost-driven TVAs is shifted within digital M&As to revenue (Chartier et al. 2018) and capability focused transactions. A sensitive Synergy Management for digital target has to address already within the Embedded M&A Strategy phase three interrelated topics: – First, the stand-alone attractiveness and value of digital targets, as well as the levers of synergies within the JBD rest foremost on revenue synergies. Therefore, the diagnostics of the pool of revenue synergy levers are mission-critical, whereas cost synergies and Invested Capital synergies could, more or less, be neglected.

5Sirower

and Sahni (2006, p. 87) described a similar idea under the term Shareholder Value at Risk.

278

5  Synergy Management

– Second, the parenting advantage of the acquirer to scale the target’s Business Design beyond the simple stand-alone development must be precisely defined: The parenting advantage of the acquirer might be based on supplementary core capabilities, providing management expertise for scaling the growth, brand management excellence, a global research ecosystem or a global sales and marketing network. The transaction and JBD specific parenting advantage have to be built in the Joint Business Design and serve as a precondition for the Synergy Capture of digital target acquisitions. A Blue Print of a tailored Revenue Synergy Scaling Approach should be therefore embedded already in the M&A Strategy phase. – Third, the impact of the target’s digital capabilities to re-innovate the acquirer’s Business Design. This is just the mirrored perspective of point 2. Within this context, the crucial questions are how the targets digital capabilities could be exploited to enter new digitalized use-cases as an extension of the acquirer’s SBD or how to enter new adjacent blue oceans of the acquirer’s business by leveraging the target’s core capabilities within the acquirer’s framework. For the latter, a perfect example might be the pharma industry where global champions like Novartis or Roche, by acquiring digital targets, combine their newer core capabilities in DNA sequencing with big data or analytics know-how of the targets to develop segment-of-one treatments, especially in oncology. These three points together will address the full value additivity potential of a specific digital transaction (Fig. 5.20). As digital M&A financial value drivers are more or less exclusively centered around revenue synergies, the proof-of-concept of revenue Synergy Capture and the back-testing of the Revenue Synergy Scaling Approach within the Due Diligence are

Embedded M&A Strategy

#1

• Ecosystem Scan with focus on: − Digital disrupve technologies (IP scan and VC investment flow) − Use-cases: White spots detecon • Embedded M&A Strategy: Idenficaon and assessment of future digital comperave advantage and capability needs • BMI-Matrix for tailored growth strategy • JBD and Integraon Approach Blue Print • Fit Diamond focus on digital targets and capabilies

#4 • • • •

#2

Transacon Management

• Valuaon and (F)DD addressing the unique CF paern of digital BDs: − High growth rates, but risky and volale FCFs − Foremost B/S light BDs, therefore focus on P&L − JBD & synergy model based on revenue scaling • Applying advanced DCF methods − DCF scenarios and simulaons (Monte Carlo) − Reverse DCF and VC valuaon for back-tesng • Verificaon of Integraon Approach − SBD Blending and JBD Proof-of-Concept − SCD Blending and JCD Proof-of-Concept

Integraon Management

• Tailored Integraon with balance of − Leveraging defined parenng advantage to scale targets SBD − Sustaining targets standalone momentum and BD success factors • Retain and develop crical talent • Implement necessary compliance • Scale targeted culture transion • Back-track integraon progress

Synergy Management

Idenficaon of digital synergy levers • Back-tesng Synergy Scaling model Parenng advantages to scale target SBD • Back-tesng parenng advantage Revitalize buyer’s SBD by target capabilies • Synergy-valuaon blending Tailored Synergy Scaling Model

#5

#3

• Rapid scaling of target’s SBD • Focused implementaon of Synergy (revenue) Scaling Model

M&A Project Management & Governance Digital M&A playbook

Fig. 5.20   E2E M&A Process Design for digital and business model innovations—Synergy Management

5.6  Summary of Synergy Management

279

core elements of the Transaction Management. Traditional Due Diligence topics, like the past-performance analysis within the Financial Due Diligence, are, on the other side, irrelevant, if the digital target is a start-up with no corporate history. The revenue synergies have also to be interwoven with the valuation model. Within the Integration Management, the Synergy Management will be focused on the rapid scaling of the target’s capabilities within the JBD. This will be mirrored in the Integration Masterplan. Typically, less intense Integration Approaches, like Alignment or Collaboration might fit best for digital target integrations.

5.6 Summary of Synergy Management 5.6.1 Critical Cross-Checks and Questions The bedrock of the Transaction Value Added is synergy capture. A set of critical cross-checks have therefore ultimate C-level relevance. Best-practice approaches of ­ Synergy Management will have detailed transaction and JBD tailored answers to the following set questions: Questions

– Transaction Value Added: Is the net present value of synergies sufficient to justify the intended deal premium? – Are synergy pools diagnosed and bullet-proofed? Do they offer enough granularity? – Are synergy volumes verified by industry best-practices? – Is synergy timing realistic? Are synergies one-time effects or recurring? – Is the Synergy Scaling Approach back-tested and is the model applicable to capture the mission-critical synergies which will decide on value add or destruction? – Are the critical synergies described in Synergy Scorecards and embedded in the broader Integration Masterplan prior to closing? – Do the IPH and integration teams have the right set of capabilities for a ­full-flagged scaling of the synergies? – Is a systematic Synergy Management with milestones and Degree of Implementation measurements in place? – For multiple-acquirers: Are feedback loops and post-mortem reports institutionalized to improve consistently Synergy Management capabilities? Nevertheless, at the beginning of this chapter “the warning signal was raised”, that most transactions undershoot in Synergy Capture. Besides, a “dark side” of synergies exists: Synergies might be used as pure justification of boards for paying stoning premia in today’s M&A markets, without having stress-tested if those synergies are likely to be captured. But even if synergies are diagnosed, their valuation and implementation might

280

5  Synergy Management

be, due to multiple rout-courses, incomplete and cursory: Often just the target company’s synergies are addressed, whereas the acquirer’s side is neglected. The integration costs to lever the synergies within the new JBD are often underestimated, as well as the time need to realize them. Or simply the granularity of synergy pools is to less to be addressed in detailed implementation initiatives and by clear-cut responsibilities.

5.6.2 Summary and Key Success Factors Synergy Management is an E2E support process of the primary M&A Process Design modules: Synergy Management starts already with Synergy Diagnostics of potential and likely synergy pools and the Blue Print of a tailored Synergy Scaling Approach in the Embedded M&A Strategy. During the M&A Transaction phase, specifically the Due Diligence, the synergy potentials are stress-tested concerning their likelihood, their forecasted volume and timing. A proof-of-concept of the Synergy Scaling Approach supplements this step. Synergy Capture understood as implementation, tracking and controlling of ­mission-critical synergies, is a substantial part of the Integration Management. Synergies should be framed and coordinated by the Integration Masterplan and detailed in Synergy Scorecards for ease of implementation and trackability. The targets of the Synergy Management are, therefore: – Consistent Synergy Diagnostics and Mapping: Identification of the crucial, ­transaction- and JBD-specific synergies that drive the valuation – Synergy Scaling Approach Blue Print at an early stage – Synergy and Scaling Approach proof-of-concept concerning value, timing and likelihood of synergy capture – Consistent Synergy Masterplan with Synergy Scorecards framing implementation initiatives – Rigorous Synergy Capture (tracking, controlling, management) – Learning cycles and feedback-loops to achieve best-practice within Synergy Management, especially for multiple acquirers

References Cassiman, B., Colombo, M., Gerronne, P., & Veugelers, R. (2005). The impact of M&A on the R&D process: An empirical analysis of the role of technological and market relatedness. Research Policy, 34(2), 195–220. Chartier, J., Liu, A., Raberger, N., & Silva, R. (2018). Seven rules to crack the code on revenue synergies in M&A. McKinsey & Company: October 2018.

References

281

Cogman, D. (2014). Global M&A: Fewer deals, better quality. Mc Kinsey – Corporate Finance 2014. Damodaran, A. (2006). Damodaran on valuation – Security analysis for investment and corporate finance (2nd ed.). New Jersey: Wiley. Damodaran, A. (2016). The value of synergy. New York: Stern University New York. http://www. stern.nyu.edu/~adamodar/pptfiles/eq/synergy.ppt. Davis, A. A. (2012). M&A integration: How to do it – Planning and delivering M&A integration for business success. West Sussex: Wiley. De Man, A., & Duyster, G. (2005). Collaboration and innovation: A review of the effects of mergers, acquisitions and alliances on innovation. Technovation, 25(12), 1377–1387. Gaughan, P. A. (2013). Maximizing corporate value through mergers & acquisition. Hoboken: Wiley. Harding, D., & Rovit, S. (2004). Mastering the merger – Four critical decisions that make or break the deal. Boston: Harvard Business School. Herndon, G. (2014). The complete guide to mergers & acquisitions – Process tools to support M&A integration at every level. San Francisco: Jossey-Bass. Kengelbach, J., Keienburg, G., Schmid, T, Degen, D., & Sievers, S. (2018). The 2018 M&A report – Synergies take center stage. The Boston Consulting Group, Inc. Koller, T., Goedhardt, M., & Wessels, D. (2020). Valuation – Measuring and managing the value of companies (7th ed.). New Jersey: Wiley. Rehm, W., & West, A. (2016). M&A 2015 – New highs, and a new tone; McKinsey on Finance #57, Winter 2016. Sirower, M. L. (1997). The synergy trap. New York: The Free. Sirower, M. L., & Sahni, S. (2006). Avoiding the “Synergy Trap”: Practical guidance on M&A decisions for CEOs and boards. Journal of Applied Corporate Finance, 18(3), 83–95.

6

M&A Project Management & Governance: The M&A Playbook

Contents 6.1 Purpose of the M&A Playbook: End-to-End M&A Project Management . . . . . . . . . . . . . 286 6.1.1 End-to-End M&A Process Map. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 286 6.1.2 End-to-End M&A Governance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 288 6.2 M&A Playbook and End-to-End M&A Process Design. . . . . . . . . . . . . . . . . . . . . . . . . . . 289 6.2.1 Development of an Embedded M&A Strategy . . . . . . . . . . . . . . . . . . . . . . . . . . . . 289 6.2.2 Execution of the Transaction Management. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 290 6.2.3 Managing the Integration. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 291 6.3 M&A in the 20s: Management of M&A Capabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 6.3.1 M&A Capabilities in the 20s. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 294 6.3.2 M&A Departments 2020+. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 296 6.4 M&A in the 20s: Digital Tools of the M&A Playbook. . . . . . . . . . . . . . . . . . . . . . . . . . . . 297 6.5 M&A Project Management of Digital Targets and Business Design . . . . . . . . . . . . . . . . . 299 6.6 Summary M&A Project Management & Governance. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 6.6.1 Critical Cross-Checks and Questions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 6.6.2 Summary and Key Success Factors. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 301 References. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 302

Abstract

M&A initiatives are typically highly complex: Internal capabilities might be supplemented by external expertise, for example, by insourcing consulting or investment banking services. Cross-border deals involve multi-country settings with the risk of culture clashes. Besides, the combination of two companies with different origins is per se an endeavour. Nevertheless, transactions are in the end also simply projects: The starting point of a dedicated M&A project within the Enbedded M&A Strategy phase is as soon as a specific target is chosen to be in detail investigated,

© Springer Fachmedien Wiesbaden GmbH, part of Springer Nature 2020 T. Feix, End-to-End M&A Process Design, https://doi.org/10.1007/978-3-658-30289-4_6

283

284

6  M&A Project Management & Governance: The M&A Playbook

typically triggering an indicative offer. The end point is the post-mortem report of the Integration Management. Each transaction has to be orchestrated by a fast, robust and high quality M&A Process Management. On a higher, tacit knowledge level, the M&A Process Management builds a bridge between the early stage diagnostics of M&A capabilities up to the institutionalized fostering of the in-house M&A knowledge after every transaction. As discussed in Chap. 3, transactions have foremost a significant impact on the acquirer’s financials, valuation and strategy. This triggers a significant C-level exposure. Project Governance, Compliance and an orchestrated Process Management with clear-cut milestones and board approvals are therefore mandatory. New vibrant ecosystems and business strategies revitalizing corporate portfolios will challenge the M&A department environment of the 20s. A canvas of likely necessary M&A capabilities and potential designs of the future M&A organization is therefore part of this chapter. Additionally, digital solutions and new technologies, like big data, machine-learning algorithms or AI will revolutionize the M&A market, capabilities and tools. The final subchapter tries to give an outlook on how these technologies might be applied to improve speed, quality, robustness and efficiency of M&A transactions in the 20s. M&A Project Management & Governance, as second support process of the E2E M&A Process Design, ties together the decisive knots throughout a M&A project (Fig. 6.1):

#1 • • • • •

Embedded M&A Strategy Embedded M&A Strategy Ecosystem & Target Scan Pipelining: Long- & Short-List Fit Diamond & Assessment Integraon Approach Blue Print − Standalone Business Design (SBD) Diagnoscs & Joint Business Design (JBD) Blue Print − Cultural Diagnoscs and Joint Culture Design (JCD) Blue Print

#2

• Dynamic Valuaon of Standalone Target (w/o Synergies) and Integrated Valuaon (w Synergies) • Due Diligence • Verificaon of Integraon Approach − JBD blending and JBD Proof-of-Concept − Culture blending and JCD Proof-of-Concept • Negoaon and Purchase Price Allocaon (PPA) • Acquisions Financing Concept

#3

Integraon Management

• Integraon strategy • Integraon Approach Freeze − JBD Freeze − JCD Freeze • Integraon Masterplan • Transional Change: Implement JBD • Culture Transion • Integraon tracking and controlling • Integraonal Learning & Best Pracce

Synergy Management

#4 Synergy Diagnoscs and Blue Print of Synergy Scaling Approach

#5

Transacon Management

Synergy Paern and Scaling Approach Proof-of-Concept

M&A Project Management & Governance

• M&A Capability Map • Navigang through the M&A Strategy

M&A Transacon Team & Toolkit M&A Playbook

Synergy Capture: Implementaon, Tracking and Controlling

• IPH , Team & Toolkit • M&A Knowledge Management

Fig. 6.1   The E2E M&A Process Design: M&A Project Management & Governance—The M&A Playbook

6  M&A Project Management & Governance: The M&A Playbook

285

 Definition For a seamless and successful transaction, the M&A Project Management & Governance applies a M&A Playbook with the following priorities: – A detailed assessment of the maturity of the in-house M&A capabilities serves as a mission-critical starting point, as M&A projects are highly complex and demand a multitude of specialized skills. – From the Embedded M&A Strategy phase onwards, the M&A Project Management has to assure, by transparent process steps, milestones and approvals, that the focus of the board and the M&A team is on a clearly defined transaction rational and value add. Additionally, for multiple acquirers, the portfolio of parallel M&A initiatives has to be coordinated by a M&A platform with stage gates. – Within the Transaction Management, the acquirer has to run a proof-of-concept of the investment thesis, assess the SBDs and the intended Joint Business Design, as well as verify the synergy estimates within a very short timeframe. Therefore, the M&A Process Management has to onboard highly capable teams, which are orchestrated by the M&A team. A second, corporate finance related matter is a robust valuation. The M&A Project Management has to assure that any synergy updates and risk assessments of the Due Diligence are feed into the valuation process. – Finally, the Integration Management with its clearly structured three horizons of Day One readiness, 100 days and midterm IM has obvious project characteristics and therefore applies a set of typical project management tools, such as DoI approaches and milestone reports. Hereby, the Integration Project House (IPH) plays a center role. – Throughout the M&A process, a close information loop between the board or Steering Committee as decision makers and the M&A or integration team as orchestrater has to be designed with E2E approval steps and stage gates. Within Sect. 6.1 the two crucial tasks of the M&A Project Management & Governance module, the assurance of a seamless transaction process and transparently structured board approvals will be discussed. Within Sect. 6.2, the process specifics of the three primary M&A Process Design modules are embedded in separate subchapters. The challenges of digital ecosystems, especially the levers of digital tools for M&A capabilities, organization and projects in the 20s, will be highlighted in the last two Sects. 6.3 and 6.4.

286

6  M&A Project Management & Governance: The M&A Playbook

6.1 Purpose of the M&A Playbook: End-to-End M&A Project Management For the design of and smooth navigation throughout a whole M&A project, a M&A Playbook is recommended. The M&A Playbook is the digital footprint of the E2E M&A Process Design. Such a Playbook provides a framework for all transactions by a shortcut description of the M&A Strategy and assures a well-structured, fast handover between the different M&A process steps for any transaction. Beyond a dedicated transaction, it serves as a transparent platform for the portfolio of M&A initiatives with standardized stage gates. The M&A playbook should enable, to keep the big picture, meaning the strategic rational of a transaction and its TVA, in mind and protect the M&A team from getting lost in the details of a M&A process. In the end, the M&A Playbook should pay in for higher quality, robustness, speed, efficiency and transparency of M&A projects. Besides, it should foster a strengthening of M&A capabilities and provide a powerful learning environment. Such a digital M&A playbook frames the following parts: – A brief summary of the Embedded M&A Strategy approach, including the intended strategic rational of M&As on the corporate portfolio and SBU level, the corporate finance framework, the expected TVA and synergy targets as well as the preferred external growth design – A short list of the attractive targets including their Scorecards – A rough Blue Print of the likely Integration Approach(es) as well as the intended JBD(s) and JCD(s) with defined parenting advantages – A digital M&A multi-project platform with clear stage gates and board approval steps An extended M&A Playbook may add a map of M&A capabilities and gaps, whereby the latter have to be overcome short-term by an insourcing of consultants or transaction specialists. The M&A Playbook is in so far much more than a collection of tools, templates and work samples. It is a transaction knowledge base, which enables seamless M&A processes along all stages of a typical M&A life cycle. The sketch of a E2E M&A Process Map with defined stage gates, as the crucial underlying part of such a M&A Playbook, will be discussed in Sect. 6.1.1. The governance and C-level approval view will be added in Sect. 6.1.2.

6.1.1 End-to-End M&A Process Map The underlying skeleton of a M&A Playbook is a M&A process model framework. On the highest level, the E2E M&A Process Design with the three modules Embedded M&A Strategy, Transaction, and Integration Management, serves as reference point.

6.1  Purpose of the M&A Playbook: End-to-End M&A Project Management

287

However, for a clear task structure, reporting lines, milestones and stage gates, a higher granularity is necessary. The following model, as described in Fig. 6.2, is a broadly applicable version of the second level structure, detailing the overall M&A Process Design. The Embedded M&A Strategy part kicks-off with a framing of the general strategic intent of external growth strategies and their targeted value contribution on the corporate level as well as for the strategic business units. Based on these guidelines, the identification of potential targets within the relevant ecosystem might lead to a long list of target companies, which could be boiled down by the application of the Fit Diamond to a short list of highly attractive targets. The latter step, from the overall M&A strategy to a specific potential target, serves as a first process and management approval step (stage gate 1). A dedicated M&A project from this short list typically kicks off with a first outside-in investigation and indicative valuation of the target company. This might lead to a Letter of Intent (LoI), which is a written document and states the interest of the acquirer in the target company. Besides, it includes a valuation range as a non-binding indicative offer and suggestions about the next steps. The LoI has to be approved by the board, as it is an important, if not legally binding, statement of the company. This step might be described as preparatory step of the Transaction Management (stage gate 2.1). If also the seller’s shareholders are interested in further discussions, the second and most intense phase of the Transaction Management, the Due Diligence will be agreed as a next step. On the buy side, this might involve multiple iterative steps in close coordination with the valuation update and board information loops. At the end of this phase the M&A team has to finalize the Due Diligence reports and summarize the most important findings, potential risks as well as an update of the valuation for a board discussion #1

Embedded M&A Strategy

#2

#3

Transacon Management

Integraon Management

Monitoring of dedicated M&A project by steering commiee at least every 2 weeks

Embedded M&A Strategy, Target Pipeline & Selecon (Fit Diamond)

Approval of M&AStrategy & Kick Off of Dedicated M&A Project

Indicave Valuaon & Leer of Intent

LoI Approval

Due Diligence, Synergy Proof & Valuaon Update

DD & Valuaon Report

Final Valuaon & (Asset/Share) Purchase Agreement Negoaon

Final Deal Approval

IPH & IntegraIM on Master- Approval plan Design

Integraon Management Loops

SG 1

SG 2.1

SG X.X

SG .2.2

SG 2.3

Stage Gate with mandatory board approval for next step

Fig. 6.2   M&A Playbook: E2E M&A Process & Stage Gate Map

SG 3.1

SG 3.2 SG 3.3SG 3…

Integraon Post Mortem Report & Transacon Closure

SG 3.F

288

6  M&A Project Management & Governance: The M&A Playbook

and preliminary approval. The latter is the second stage gate 2.2 within the Transaction Management. Preliminary approval means at this stage subject to final contract negotiations. Only if the acquirer’s team and the seller could agree on acceptable terms and conditions within the asset or share purchasing agreement, as well as the maximum threshold for the purchase price is not exceeded, the board on the buy side might finally agree to the deal, which is stage gate 2.3. After the final approval of the transaction, but even better, as proposed by the E2E M&A Process Design, within the Transaction Management, the Integration Strategy and Approach as well as the IM have to be prepared by the IPH and be approved by the board before Day One as stage gate 3.1. After this approval, the progress on the integration as well as synergy capture will be reported by 2–3 weekly updates. The whole M&A project will be closed by a post-mortem report and a final board decision (3.F).

6.1.2 End-to-End M&A Governance The governance of highly complex projects like mergers and acquisitions has to answer two organizational questions: – who is in command for the process and content deliveries within each process step – who is responsible to make final decisions at each stage gate The responsibilities with respect to the management of transaction processes seems to be clear-cut. The strategy team delivers on the Embedded M&A strategy, the corporate M&A team orchestrates the transaction management, especially the Due Diligence and the valuation, whereas the Integration Management is the responsibility of the IPH and the operational management of the business unit closest to the target business. This organizational design of M&A processes seems to be outdated nowadays. The early-stage valuation of attractive targets and synergies, the draft of the Blue Print of the JBD as well as the JCD within the M&A Strategy and the proof of concept of the same within the Transaction Management, request coordinated processes between Strategy and Transaction Management. Not surprisingly, especially companies exposed to dynamic shifts in their ecosystem and multiple acquirers more and more integrated their Transaction and Strategy Team. A smoother handover between the Transaction and Integration Management might be achieved with a manager from the transaction team joining or leading the integration. As an alternative, an operational manager, who will be in charge of the later integration might participate already in the early stage of a M&A process, especially during the Due Diligence. On the management side, the board will be responsible at least for the definition of the M&A strategy and the final approval of the transaction. For game changing portfolio transactions, the board would be even involved throughout the whole transaction process.

6.2  M&A Playbook and End-to-End M&A Process Design

289

For midsized or smaller deals, one board member might serve as a Steering Committee lead for the approval steps within the Transaction Management and for the sequential Steering Committee meetings within the integration.

6.2 M&A Playbook and End-to-End M&A Process Design The first level M&A Playbook structure along the E2E M&A Process Design modules and according project, capability and governance challenges will be briefly discussed.

6.2.1 Development of an Embedded M&A Strategy Within today’s rapidly shifting ecosystems with blurring boundaries, evolving new technologies and digital use cases, as well as vibrant competitive environments, strategic advantages have to be permanently renewed. A multitude of strategic initiatives, as pinpointed in Chap. 2 with the Business Model Innovation-Matrix, have to be initiated and executed at the same time to stay ahead of competition and innovate one’s own Business Design. This demands a strongly Embedded M&A Strategy, which is able to develop a clear view of which capabilities and competitive advantages are in need in the years to come and which ones have to be acquired by external growth strategies due to limited in-house potentials. Therefore, new targets might have to be detected in uncovered technology spaces or from adjacent industries. This requests a broad and complete set of capabilities of the M&A and strategy department. M&A Strategy Capability Map  If a company is in need to supplement its internal growth strategy with tailored acquisitions or mergers, a good starting point is to ask if the necessary capabilities for the execution of transaction strategies are available in-house. Due to nowadays complex environments, the traditional streamlined M&A focus on valuation capabilities plus a rough industry knowledge is no longer sufficient. Instead, a thorough understanding of market trends and upcoming technologies as well as business modeling capabilities are mission-critical for the design of a convincing M&A Strategy with a short list of highly attractive targets with strong acquirer fit. Target Search: Hunt for Competitive Advantage in Ecosystems Without Boundaries A rough picture of the complexity of new ecosystems and their challenges for the M&A Strategy and target search is described in Fig. 6.3. The diagnostics of the company’s ecosystem must mirror dynamics in the company’s competitive environment, shifts in the macro environment, technology disruptions and market trends. These are nonlinear processes and assessments. Therefore, the strategy phase might involve multiple feedback loops, proofs-of-concept and step-by-step stage gate discussions and approvals.

290

6  M&A Project Management & Governance: The M&A Playbook

ECOSYSTEM SCAN New Entrants Incumbent Competors

STRATEGIZING

Substutes

Industry Dynamics & Network

Suppliers Complements Capital Markets

Tangible & Intangible Resources Educaon (Capabilies)

MacroEcosystem

Infrastructure

• Which trends within the ecosystem are decisive for compeve advantage and the Business Design • Which capabilies are needed therefore

Technology Trends

Ecosystem Scan

Technology Access (e.g. IP)

Technology

Technology Capabilies Technology Tools

Trends, Use Cases & Markets Dynamics Switching Costs & Lock In Revenue Model

Use Cases & White Spots Needs & Pricing

M&A STRATEGY • Which targets might fit to deliver on the strategic raonal, compeve advantage and BD

Market Size, Growth & Segmentaon

Fig. 6.3   Dynamic ecosystems and Embedded M&A Strategy process

However, even more decisive are the impacts of these ecosystem levers on the corporate strategy, the M&A strategy and finally the target search and selection: – Which trends within the ecosystem are decisive for competitive advantage and the BD – Which capabilities are needed to implement the chosen strategy – Which targets might fit to deliver on the intended strategic rational, the competitive advantage and the BD development.

6.2.2 Execution of the Transaction Management The core processes of the Transaction Management are the valuation and the Due Diligence, whereby the latter is the more complex one as it involves multiple parties. Transaction Team: Orchestrating the Due Diligence  The management of this complexity is the responsibility of the Due Diligence team. It has to align the Due Diligence process with all internal and external stakeholders and design tailored and robust work streams and tools.

6.2  M&A Playbook and End-to-End M&A Process Design

291

The Due Diligence team also serves as single point of contact for target information and access. The ultimate intent of the Due Diligence was described as a p­ roof-of-concept of the strategic rational, the assessment of the mission-critical value drivers and the identification of potential transaction risks. Therefore, robust and fast processes are requested. This is achieved by feedback loops between the Due Diligence lead and the Steering Committee of the transaction on material Due Diligence outcomes. The stage gate model might use at a minimum three gates: The Letter of Intent approval kicks-off the Transaction Management at stage gate 2.1, mission-critical Due Diligence and synergy findings have to be reported at stage gate 2.2, whereas the final stage gate 2.3 with the go/no-go decision is subject to the final valuation and purchase agreement. More sizable, complex and international transactions might demand even more feedback loops with the Steering Committee and interim stage gates during the Due Diligence. Most antitrust regulations, like the Hart-Scott-Rodino (HSR) Act in the US, prohibit an acquirer to execute substantial integration steps of the target company prior to expiration of the statutory waiting period. To exploit the time gap between signing and closing, advanced M&A Process Designs use third-party advisers (“clean teams”) to review synergy levers and prepare the potential integration steps already prior to closing.

6.2.3 Managing the Integration Integration processes demand a transaction- and JBD-specific organization for setting the right integration priorities, the structuring of a tailored IM, the design of robust integration processes and workflows, as well as for the insourcing of the necessary capabilities. The integration is typically driven and orchestrated by the Integration Project House (IPH). Dedicated integration teams implement the modules of the IM. The integration teams are also in charge to realize the synergies, which have been finally verified during the Due Diligence. Both companies, the acquirer and the target, source the integration team. This ensures that best talent from both organizations is captured and sends comforting signals to the employees that capabilities and not hierarchies define new and important management roles. Besides, a Steering Committee of selected senior management from the acquirer as well as from the target organization support the integration teams. The core task of the Steering Committee is to decide on mission-critical decisions at each stage gate. To handle organizational integration complexities, a detailed integration project management structure and clear-cut responsibilities are necessary. A three-level project management structure, as described in Fig. 6.4, is for more complex or cross-border deals a suitable approach.

292

6  M&A Project Management & Governance: The M&A Playbook Steering Commiee Synergy Tracking

Integraon Manager (IPH)

Integraon Management

JBD Modules Ecosystem Integraon • Bundling & Supplier Streamlining • Low Cost Sourcing • …

Core Asset Integraon • Factory Footprint Opmizaon • R&D Network • Integrated Cloud Server Farm •…

Capability Integraon

Value Proposion Integraon

• Brand Management • Joint Product Porolio • Plaorm Mgt. • Best-Pracce Process • Service and System Business Implementaon •… •…

Channel Integraon

Go-to-Market Integraon

• Joint Distribuon • Cross Selling Channel Strategy • Pricing Strategies • Streamlining Logiscs • Streamlining Logiscs • ….

Organizaonal and Management Integraon Financial Integraon Strategic Integraon Legal Integraon

Culture Transion

Fig. 6.4   Integration Management: Steering Committee, IPH & integration teams

Steering Committee Members of the Steering Committee are sourced from the board members of the target’s and the acquirer’s company, which have a direct touch-point to the transaction. The Steering Committee is responsible for the overall leadership throughout the integration process and the setting of the priorities of the Integration Management. This involves also more soft tasks for the top management, like communication of the integration vision by talk-the-walk. This tone-of-the-top will be a decisive ingredient for the target’s and acquirer’s employees on how the transaction will be perceived. Important decisions have to be escalated from the IPH to the Steering Committee at the stage gates or even in-between for transaction-critical matters. Effective governance, in the sense of an early and focused escalation and a rapid resolution of critical issues, speeds up integration processes. Besides, the controlling of the integration process and deciding on suitable counter-measures in case of deviations is as well a part of the Steering Committee responsibilities. The Steering Committee is also in charge for the overall capability sourcing and the resource allocation within the Integration Management. Besides, not only dedicated resources have to be allocated to the IPH and teams, but also roles, responsibilities and authorities of the integration modules have to be decided upon by the Steering Committee. Integration Lead Manager and Integration Project House (IPH) The integration lead manager is the orchestrator of the integration process and head of the IPH. The key task

6.2  M&A Playbook and End-to-End M&A Process Design

293

of the IPH is the overall project steering and management, especially the coordination and integration of the different integration modules and work streams of the IM. The IPH has also to (re-)focus the different integration modules on the key targets of the integration: – of realizing the strategic rational – implementing the JBD and JCD – capture the synergies Another important responsibility is the in time and seamless reporting and controlling of the integration progress. For an efficient and robust integration organization, the IPH has to support the integration modules by providing tailored integration tools, by coordinating the different integration modules and their work streams, as well as to built a ­fast-track communication between the modules. The IPH has also to orchestrate external resources like investment banks, strategy consultants, lawyers, or communication specialists. Besides, the IPH is also in charge of the regular Steering Committee information on the integration progress and has to escalate important decisions. Therefore, a senior personality within the acquirer’s company might be best suited for the integration management lead. A recent study from PWC analyzed that deal success is correlated with cross-functional team engagement (PMC 2017, p. 17). The IPH might support the ­ cross-functional exchange by designing suitable work streams and taking care about feedbacks between the teams. Integration Modules and Teams  The responsibility for the implementation of the IM and its separate modules, as described by the Integration Scorecards, is the responsibility of the dedicated integration teams. The overall integration team is represented by all functional areas of the JBD with an exposure to the integration and the crucial synergy deliverablerables. Aims for the individual integration teams are the capture of targeted synergies and of the operational deliveries for implementing the JBD along each milestone. Within more complex transactions, the separate integration modules will have their own module lead, who coordinates the work streams and prioritizes decisions within the specific integration module. With respect to the communication, the integration modules are responsible for the integration progress and synergy report based on Integration and Synergy Scorecards. Operational wise the core tasks of the integration modules are the implementation of the defined workflows and synergy levers as well as the resource allocation within the module. To deliver on integration and synergy targets, the integration work teams must have access to accurate and timely information, must receive in-time feedback as well as have to be permanently updated on the broader perspective of the overall integration efforts and interdependency with other integration modules.

294

6  M&A Project Management & Governance: The M&A Playbook

• Understanding culture resistance & craing JCD • Understanding transi on challenges • Developing transac on ra onal & vision • Building the new JBD • Project management skills

Empathy & Culture Mind

• Sound M&A & valua on skills • Robust Due Diligence process management skills • Tacit know how by best-of-best learning

In-depth Ecosystem Knowledge

Entrepreneurial Spirit

• Design thinking for JBD development • Modelling capabili es

M&A & Valuaon Capabilies

Creavity

Technological Openness

• Understanding of ecosystem pa€erns and dynamics • Awareness of shiing boundaries (tech, use cases)

• Digital tool affinity: AI, algorithms, Big Data, Machine Learning, Block Chain knowledge • Pla‰orm design and pa€ern awareness

Fig. 6.5   M&A capabilities for the 20s

6.3 M&A in the 20s: Management of M&A Capabilities Based on the prior chapters’ discussions of the content of the different modules of the E2E M&A Process Design and the needs of a robust M&A playbook, a canvas of the capabilities for competing on today’s M&A markets is developed in the following.

6.3.1 M&A Capabilities in the 20s The development of inhouse M&A capabilities is a true competitive advantage,1 especially for multiple acquirers. By learning from past mistakes and actual best-practices, the company might strengthen its M&A capabilities step-by-step, might become more efficient and effective in the execution of transaction processes and might be enabled to execute multiple transactions—including divestments—at the same time for a true portfolio renewal. The development of those M&A capabilities might be achieved by the application of best practices and standardized tools, processes, and techniques. The following describes a short roadmap to develop the capabilities for transactions in the twenty-first century environment. This roadmap is a substantial part of the M&A playbook and also defines potential training needs of M&A capabilities throughout the organization (Fig. 6.5). An E2E view enables to rewrite traditional M&A role models and capability needs. Additionally, a gap assessment, which matches established acquirer’s capabilities with

1Galpin

& Herndon analyzed 12 major components with 75 different elements of enterprise M&A competencies (Galpin and Herndon 2014, chapter 14).

6.3  M&A in the 20s: Management of M&A Capabilities

295

M&A module specific needs, will highlight which M&A resources and capabilities have to be developed. Six capability clusters might stand out for the M&A capabilities in the 20s: M&A & Valuation Capabilities The bedrock of the M&A capabilities is the understanding of the standard set of valuation models. Besides, robust Due Diligence process management skills are mandatory. Whereas the first might be challenged by nowadays scientific questions of how to value startups, the latter might request industry-specific skills to assess the BD of the target company. The same holds true for the screening and diagnostics of potential target companies. In-depth Ecosystem Knowledge However, due to the underlying dynamics of today’s ecosystems the understanding of industry patterns for target detection, assessment and evaluation is too limit. Already at the early stage of target search, the most attractive targets for the future competitive advantage of the acquirer might be found in adjacent markets. This will demand a profound understanding of evolving technologies and use cases, which might be applicable for the JBD, also by M&A and strategy teams. Technological Openness  Additionally, advanced technologies like AI, machine learning algorithms, big data applications, and others will revolutionize transaction execution by building more robust, faster and efficient M&A processes and tools. As these new digital tools for M&A will play out as game changer in the 20s for in-house M&A teams as well as external consultants, this discussion on “how to run M&A” will be intensified in the next subchapter. Bolstered Creativity  M&A, and especially valuation, is perceived as a highly scientific capability. However, as the Business Model Innovation-Matrix described, M&A in the 20s must be thought in alternative settings and compared with growth strategies like incubators, accelerators, Corporate Venture Capital, Joint Ventures, alliances or in-house business innovations. This demands creativity to find new solutions and pathways. Besides, the modeling of the Joint Business and Culture Design might request the combination of state-of-the-art scientific knowledge with out-of-the-box creativity and tools like design thinking. Entrepreneurial Spirit  Typically, M&A departments are still organized as support functions for the board and the strategic business units. This is in contrast to the need of entrepreneurial capabilities for developing a sound and convincing transaction rational, to orchestrate the building of a new JBD or to orchestrate the integration of a complex target company. Empathy & Culture Mind Last but not least, empathy and culture sensitivity might become as well a crucial capability in the 20s. It starts with the diagnostics of the SCDs of the target company and the acquirer to assess culture gaps, continues with the

296

6  M&A Project Management & Governance: The M&A Playbook

development of a powerful JCD in which employees and talents of both organizations believe, and further with the need to understand culture change resistance within integrations as well as other transition challenges. The permanent “uploading” and training of this M&A capability set will become an own competitive advantage in the ever-changing market environments of the 20s.

6.3.2 M&A Departments 2020+ The discussion of the future capability needs for running highly efficient, fast and robust M&A processes leads to a second, closely aligned question: How should the organizational design of the M&A Department in the 20s look like? The answer to this question depends significantly on the overall Business Design, especially the corporate organization of the company, but as well on the company’s ecosystem. This is described by Fig. 6.6. Since the 2000s, as capital markets favored focused strategies, global powerhouses like GE in the US or Siemens in Europe listed their Strategic Business Units or sold non-core assets. In such circumstances, the typical organizational design of the 2000s as an interplay of Corporate M&A teams with the dedicated, in the transaction involved regional or SBU M&A teams might become less applicable. Blue chip corporations changed or are in a process of changing the role, responsibilities and capability profiles of the Corporate and the SBU M&A teams. Corporate M&A teams are more in the role of an orchestrator as well as stage gate owner. Additionally, the are in charge of corporate portfolio strategies which should lever parenting advantages. The SBU M&A teams, on the other side, focus on the classical M&A execution tools and capabilities, like Due Diligence and valuation. If the 20s are characterized by the discussed vibrant ecosystems with blurring boundaries and multiple, parallel running growth initiatives, new organizational designs of

2000

2019

Corporate Center

2020s

C-M&A Holding Center Corporate

2025+ Porolio &

Holding Center Corporate M&A Mgt.

Porolio &

Acve Holding Center Corporate M&A Mgt.

C-M&A M&A

SBU 1

SBU 2

SBU 3

SBU 1

SBU 2

SBU 3

SBU 1

SBU 2

SBU 3

S-M&A

S-M&A

S-M&A

S-M&A

S-M&A

S-M&A

S-M&A

S-M&A

S-M&A

= Corporate M&A = SBU M&A = Strategic Business Unit

Fig. 6.6   Organizational designs of M&A teams for the 20s

M&A

M&A

M&A

• C-M&A • S-M&A • SBU

M&A

M&A

6.4  M&A in the 20s: Digital Tools of the M&A Playbook

297

corporate and SBU M&A departments might have a more hybrid character. Besides, they will demand new capabilities, like digital technology affinity. Background Information European-US Study: “The organizational design of the M&A and strategy department 2025+2” The future organizational design of M&A and strategy departments of companies exposed to dynamic ecosystems have to address questions like: – What will be the preferred external growth strategies and initiatives (BMI-Matrix) in the 20s to gain competitive advantage in dynamic ecosystems? What are selection criteria for the best fitting approach? – What will be the structure of the future M&A and strategy department? Will they be deeply integrated, to foster a seamless M&A Strategy to Transaction transition, or separated, to achieve focused best-in-class capabilities? – How will the future interplay between corporate M&A teams and SBU M&A teams look like? The same for strategy? – What kind of workstreams are therefore necessary? How to orchestrate in vibrant ecosystems M&A processes? – What are the future M&A capability needs? Are M&A capabilities scanned, retained and developed? … and many further questions will be investigated.

6.4 M&A in the 20s: Digital Tools of the M&A Playbook Digital M&A tools, which apply new technologies like AI, machine learning algorithms or Big Data approaches will significantly change and support to build more robust, efficient and faster M&A processes. As the complexity of transactions as well as the involved Business Designs permanently increase, these digital tools offer substantial levers. Figure 6.7 provides a snapshot of selected digital M&A tools along the E2E M&A Process Design, which will be briefly discussed in the following: Digital Tools for the M&A Strategy  Many industries are exposed to technology disruptions and changing customer use cases. The application of digital patent and IP assessments, based on AI technology, enables the analysis of which market segments and technologies might be accessible, which technology fields are actually investment hotspots and which ones might be highly attractive with respect to building the company’s Business Design for the future.

2A

current study by the author on “the organizational design of the M&A and strategy department 2025+” explores exactly these question with leading European and US multiple acquirers and universities. The questions pinpointed above are a selection out of this study.

298 #1

6  M&A Project Management & Governance: The M&A Playbook M&A Strategy

Ecosystem Trend Scoung & Digital IP-Scan Fit Assessment & Target Pipelining

Transacon Management

#2

Financial , Legal, Commercial Due Diligence Automaon

#3

Integraon Mgt. Digitalized Milestone Tracking

Virtual Dataroom & Predicve M&A Digital Valuaon Tools Tech & Cyber DD (AI)

Digital Proj. Mgt. Digital Monitor

Synergy Management

#4

Digital Synergy Library, incl. Benchmark Data

Integrated Valuaon & Synergy Tools

Digitalized Synergy Verificaon, Tracking and Controlling

M&A-Project Management & Governance

#5

Double Sided Consulng plaorm

Online M&A Best Pracce Library

Online M&A Educaon

Cloud Based Digital M&A Playbook and Digitalized Toolkit

Fig. 6.7   Digital M&A tools for the 20s

Additionally, digital trend scouting by using the combination of machine learning algorithms and big-data assessments could be used to detect targets with new product or service solutions. A further example from the fit assessment and target pipelining are the application of search engines to gain insights on critical capabilities and talent in an early stage of a transaction. Digital Tools for Transaction Management  Within the Transaction Management especially the Due Diligence is exposed to digital technology revolutions. Big data and NLP assessments, search engines (e-discovery) and machine learning approaches offer efficiency and time gains, especially within the Financial and Legal Due Diligence. E.g. within the latter contract clauses like reps & warranties, exclusivity agreements, ­change-of-control clauses or IP-rights could be scanned fully autonomous within a wide range of contracts. In the meantime established tools are virtual data rooms, which substituted physical data-rooms, as they offer multiple advantages on the buy- and sell-side. A new development by leading data-room providers are predictive M&A market models based on big data assessments of M&A transactions within a Due Diligence stage. The Technology & Cyber Due Diligence developed as a new field within the overall Due Diligence process. It involves a detailed assessment of the technology platforms and ERP system architecture in use within the target company based on standardized digital assessments and checklists. As an addition, the compatibility assessment with the acquirer’s IT architecture could be used to kick-off an early-stage migration planning. The cyber assessment, as a supplement, focuses on the identification of potential cyber and web risks.

6.5  M&A Project Management of Digital Targets and Business Design

299

Digital Tools for Integration Management An efficient and effective Integration Management is essential for solving the complexity of integration projects. On the one side, digital tools used in the Due Diligence could be leveraged as well within the integration. Applications are e-discovery approaches for the assessment and tracking of legal responsibilities with the support of a digital closing condition monitor. On the other side, digital M&A project management tools are of value especially for the IPH. For the implementation, monitoring and controlling of the integration, digitalized Degree of Implementation (DoI) assessments and Integration Scorecards could track early deviations from the intended integration progress and trigger counter initiatives. Digital Tools for Synergy Management  Digitalized synergy tools intend an end-to-end tracking, controlling and management of synergy capture. Digital DoI measurements, milestone concepts, Synergy Scorecards and Maps are suitable tools for an advanced Synergy Management. The lessons learned of the synergy implementation could be used to establish a cloud-based digital synergy library. This database could be used to improve the synergy performance of follow up M&A projects and provides benchmarked synergy estimates in an early stage. Digital Tools for M&A Project Management & Governance A truly digital E2E M&A Project Management and Governance as a digital M&A Playbook exploits the potential of digitalization along all three primary M&A modules: Cloud based M&A project maps visualize the transaction portfolio already from the starting point of the M&A strategy, including mandatory governance and stage gates. Besides, real-time project reports and linkages to project tasks are embedded. Digitalized best practice templates and checklists, a digitalized project steering and a centralized data management are useful for the Due Diligence. Within the Integration Management a digitalized and consistent mapping of the project structure, of the work streams and task assignments, as well as a transparent status tracking and reporting of the integration modules and deliverables offer efficiency and quality gains. Last not least, cloud-based M&A best practice platforms and learning programs could be applied to professionalize the in-house M&A teams. The insourcing of past projects and best practices might offer a sound data source for machine learning algorithms and might foster mid-term the development of benchmark M&A capabilities.

6.5 M&A Project Management of Digital Targets and Business Design At the end of each of the prior chapters, the specifics of transactions focused on digital targets and business designs with respect to the primary M&A processes and the Synergy Management have been discussed. Within this closing subchapter M&A processes, work streams and tools, which cover the pattern of digital Business Designs, will complement this view. These are described and highlighted in Fig. 6.8.

300

6  M&A Project Management & Governance: The M&A Playbook M&A Strategy

AI driven Ecosystem- & IP Scan

Transacon Management

Business Model Innovaon (BMI) Matrix

Fit Diamond Assessment SBD and SCD Diagnoscs, JBD (10C Model) & JCD Blue Print

Valuaon of Digital Assets (Reverse DCF)

Integraon Mgt.

Startup DD: JBD 10C and JCD Proof-of-Concept

Valuaon Scenarios, Monte Carlo (“Blue Oceans”) FDD, LDD and Commercial DD Automaon by AI & Big Data

Tech / Cyber DD

Parenng Advantage for Target Leverage JBD & JCD Implementaon Analycs for Talent/Capability Mgt.

Earn-outs for Digital Assets

Analycs for Integraon and Mile Stone Tracking

Synergy Management AI and Pla‘orms for Synergy FC & Library (esp. for adjacent BDs) Blue Print Synergy (Revenue) Scaling Approach

Dra‹ of Organisaonal Alignment Needs for Synergy Scaling at Parent and Target Back-Tesng of Synergy (especially Revenue) Scaling Approach R

Analycs and Big Data for Synergy Scaling and Acceleraon Analycs for Fostering Parenng Leverage Tracking Dominant Design Implementaon

M&A-Project Management & Governance M&A Capability Modelling

Online M&A Best Pracce Library

Double Sided Consulng Pla‘orm (for Insourcing of Missing Capabilies

Mentorship Retenon Program Orga. Design and Culture Tools

Cloud Based Digital M&A Pla‘orm, Digitalized Toolkit and M&A Educaon

Fig. 6.8   E2E M&A Process Design for business model innovations—Project Management

Digital businesses are foremost on the edge of technology and positioned in adjacent markets. This environment is perfectly suited for the application of the Business Model Innovation-Matrix as alternative growth paths besides acquisitions, like incubation, acceleration, in-house venture capital or alliance approaches typically are available. As most of digital natives have no or very limited corporate history, digital Business and Culture Design play a central role along the whole M&A process. The Standalone Designs have to be diagnosed in detail already during the strategy phase. This allows to model a Blue Print of the Joint Business and Culture Designs as well as a tailored Integration Approach. These Joint Designs could be bullet-proofed within the Due Diligence, if they really pay in with respects to the targeted digital capabilities and intended transactional rational. JBD and JCD assessments might be for digital targets substantially more important than FDD or LDD matters. As the business model also the synergy patterns are specific in case of digital M&As. Chapter 5 analyzed that more or less all of digital target acquisitions rest on revenue synergies. Therefore, the Blue Print of the Synergy Scaling Approach should be Frontloaded into the M&A Strategy and back-tested with respect to its robustness within the Transaction Management. For the scaling of the synergies the parenting advantages have to be levered as a precondition. The tracking of the synergy capture is a top priority of the integration. However, also the review of parenting advantages, which allow the scaling of the target and to create a dominant Joint Business Design, plays a critical role.

6.6  Summary M&A Project Management & Governance

301

A last, but maybe the most important point, goes back to the origin of digital capabilities. They rest in the end on digital talent. Therefore, digital talent diagnostics, retention and development is mission-critical, especially for digital transactions.

6.6 Summary M&A Project Management & Governance Within this final subchapter, a selected set of questions serve as a cross-check if a company has a robust, consistent and digital M&A Project and Governance process for M&As in place. Thereafter a short summary of the M&A Project Management and Governance is provided.

6.6.1 Critical Cross-Checks and Questions The following questions might initiate and be used as a review of the inhouse M&A Project, Compliance and Governance performance. Questions

– Does a defined M&A End-to-End Project and Governance Process with precise stage gates and approval processes exist? Is a seamless flow between the different parts of a M&A project assured? – Are rules and responsibilities of the top-management, the M&A and the Integration Project House, as well as of all project members clear cut? – Are digital tools and capabilities used along this M&A Project and Governance model to improve speed, quality, efficiency and robustness of M&A projects? – Are all M&A projects covered by this model? – Are M&A capabilities fostered and lessons learned exploited to improve mid to long term M&A performance?

6.6.2 Summary and Key Success Factors The M&A Project and Governance is the second support process of the M&A Process Design. The ultimate target is here to implement a seamless and governance wise standardized M&A process with clear-cut responsibilities and milestones to avoid the common M&A failures, especially between the different stages of a M&A project. Such a M&A Project Management has to assure in the Embedded M&A Strategy that potential targets all over the relevant ecosystems are identified and evaluated along the same criteria (Fit Diamond). Along the Transaction Management the M&A Project

302

6  M&A Project Management & Governance: The M&A Playbook

Management must install a tight-knit feedback mechanism between the project management and the top management with respect to valuation updates and due diligence outcomes. The same holds true for the implementation but with a shift of focus on synergy capture and the implementation of the Joint Business and Culture Design.

References Galpin, T. J., & Herndorn, M. (2014). The complete guide to mergers & acquisitions—Process tools to support M&A integration at every level. San Francisco: Jossey-Bass/Wiley. PWC. (2017). M&A Integration: Choreographing great performance—PwC’s 2017  M&A Integration Survey Report. https://www.pwc.com/us/en/press-releases/2017/pwcs-2017-ma-integration-survey.html.