Want to be a Great Acquirer?
Do More Deals
John R. Cryan and Jeffrey L. Routh | August 26, 2010
The market demands growth in revenue, cash flow
and value, and the more that is delivered the higher
the demands, creating a management conundrum. At
a certain point most companies find that organic
growth alone is insufficient to meet expectations and
yet the prevailing wisdom is that most acquisitions
‘fail to create value’. What’s management to do?
The Problem with the ‘Prevailing Wisdom’
Many research studies show declining share prices
on most M&A announcements. It would seem that
the expected synergies typically don’t compensate
the buyer’s shareholders for the premiums paid. So
while most acquisitions do create value in aggregate,
that is the companies are worth more together than
apart, often more than 100 percent of the value enhancement
goes to the seller’s shareholders.
Despite the claim that acquisitions destroy value,
some companies excel as acquirers and deliver outstanding
value for shareholders. To evaluate this,
we studied the relationship between long term total
shareholder returns (TSR) and different acquisition
strategies and a variety of deal characteristics.
The only trait that consistently has a strong positive
relationship with long term TSR across each industry
is acquisition frequency1. The companies that
create value through acquisitions typically demonstrate
a greater propensity to acquire. We call them
Serial Acquirers and many generate outstanding results by better planning, executing and integrating
acquisitions than their less acquisitive peers.
Transactions are core to the corporate strategy of
these companies and are an explicit element of how
they expect to grow and operate in the future. Their
acquisition strategy is fully integrated with their
capital allocation decisions, capital structure policies
and investor communications. They have dedicated
resources responsible for ensuring the success of
each deal and they tout their ability to identify &
exploit opportunities. The Serial Acquirer’s track
record speaks for itself. They often trade at a premium
to peers as investor’s price-in exceptional but
disciplined growth.
To provide a practical demonstration of our findings
we focused on two of the world’s very best acquirers,
Danaher Corporation (DHR) and Cisco Systems
(CSCO), and their formerly public targets. Together
they have completed more than 175 acquisitions
since the mid ‘90s. Their industries, products, cultures
and strategies are vastly different yet both
achieve exceptional results by being better than the
competition at planning, executing and integrating
acquisitions(2).
Despite their differences Cisco and Danaher have
created substantial long term shareholder value
beating their industry indices by 3-4x. We examined
how they did it.
Value Creation: Growth AND Return
Their TSRs are driven by a powerful combination of
growth and return. Through our analytical lens,
since the mid 90s, Cisco and Danaher have delivered
over $33B of cumulative cash flow in excess of the
required return on all capital including intangibles.
We call this Acquisition Residual Cash Earnings
(ARCE).
Danaher’s M&A strategy emphasizes improving
rates of return while Cisco focuses on growth but
clearly it’s the combination of growth and return that
allows them to be successful year after year.
The Danaher Business System
Danaher’s deal strategy relies on the ability to operate
each target in a more efficient and therefore
more valuable way. They apply the Danaher Business
System (DBS), which is a culture where every
employee from the CEO to the shop floor is responsible
for improving the way work gets done.
Danaher has consistently earned a positive Acquisition
Residual Cash Margin (ARCM), or cash flow in
excess of the required return on all capital including
intangibles, as a percent of revenue. ARCM averaged
10% of revenue from 1996-2009, and has been
remarkably stable, despite buying lower return targets,
demonstrating the company’s ability to rapidly
integrate acquisitions and improve performance.
In 2007, the Company made its largest acquisition to
date, buying Tektronix. When asked about the deal;
Danaher’s CEO Larry Culp responded “Tektronix
was an acquisition we would’ve loved to have done 10
-years ago. We couldn’t it was too much of a ‘bet the
farm’, much more manageable now given our current
size.” Danaher’s ARCE peaked in 2007 at $1.4B.
When a business is run this efficiently, growth is tremendously
valuable. Danaher keeps acquisitively investing in growth and delivering desirable returns
on those investments. Even during the downturn in 2008 and 2009, Danaher delivered cash flow in excess
of the required return on all capital.
Danaher’s integration approach fits with its acquisition
strategy. DBS is not only a series of processes;
it’s a culture focused on efficiency. The implementation
within an acquired company is uncompromising.
Like many acquirers, Danaher attacks the SG&A of
its targets to improve efficiency. However, less obvious
but more remarkable and important is the company’s
ability to improve asset utilization. Danaher’s
consolidated asset intensity is less than half that of
their target companies, so for each dollar of revenue,
Danaher only requires half the assets.
Freeing up capital via asset efficiency improvements
creates value for Danaher’s shareholders and generates
additional cash flow to fund the next acquisition
without further diluting existing owners.
Like an astute value investor, Danaher has demonstrated
the ability to buy companies that are trading
well below the level implied by their stand alone forward
returns. Buying companies with bearish investor’s
expectations allows Danaher to pay a premium
that in most cases values the target below long term market norms. In the past Danaher’s acquisition targets
traded at a median discount to the market of
40% and even after paying a premium, the prices
offered still valued the enterprise at a substantial
21% discount, providing further upside potential to Danaher’s shareholders(2).
Cisco: New Platforms for Growth
Cisco’s overall corporate strategy and corporate
development approach is quite different from Danaher.
The Company identifyies future growth and
market opportunities rather than turnaround situations.
Despite the differences, the benefit of a proactive
M&A strategy is no less important. Their corporate
development process requires the company to
identify and capitalize on market disruptions
through new technologies and business models. Over
the past 14 years the company has averaged 26%
revenue growth which compounds to 2500% cumulative
growth!
Positioning the Company for future growth has required
Cisco to sacrifice near term returns experiencing
an 800 bps decline in Acquisition Residual Cash
Margin. However, despite the declining ARCM, the
larger Cisco generated peak ARCE dollars in 2008.
It’s a classic growth versus return tradeoff.
With an emphasis on growth, there is a bit more willingness
and ability to pay closer to full stand alone
value, but still 63% of its targets trading at a discount.
The effective Cisco acquisition prices are
likely lower than those in the table below if we recognize
that some of these were stock deals at the peak
of the tech bubble. Cisco astutely used its own richly
valued shares as consideration in these transactions,
and since the collapse of the internet bubble Cisco
has made mostly cash based acquisitions.
Cisco’s integration process is similarly well aligned
with its acquisition strategy. During the integration
phase Cisco continuously measures its ability to retain
employees, sustain revenue and launch new
products based on the acquired technology and capabilities.
Cisco’s ability to embed existing products within the
acquired company’s technology, and vice versa, delivers
more value to the customer and supports additional
growth by leveraging its massive global footprint,
product line breadth and organizational capabilities.
Successful M&A Processes
So what do these vastly different companies with
very dissimilar strategies have in common? They
excel in three key areas related to M&A that set
them apart from their peers:
- M&A Planning
- Execution Excellence
- Meticulous Integration
M&A Planning
Creating a robust acquisition planning process and
pipeline requires a long term strategy and vision for
the corporation and for the corporate development
function. Management teams must dedicate time and resources to evaluating opportunities that exist
today and could exist in the future, both in terms of
strategic fit and valuation.
Serial Acquirers excel in this area as they plan and
analyze continuously. This allows them to act
quicker because they’ve already done the groundwork
and laid the strategic foundation.
Superior Execution
With a continuous corporate development process,
Serial Acquirers are more likely to avoid the emotional connection to a transaction that draws so
many less frequent acquirers into a value destructive
M&A frenzy. Serial Acquirers continuously have a
finger on the pulse of the market and incorporate both
internal and external information into their deci-sion making processes. Serial Acquirers are content
to let a deal pass rather than become undisciplined
in the execution.
Meticulous Integration
Our research clearly demonstrates that post-merger
integration is where the shareholder value of the
deal is won or lost. Planning and execution are indeed
critical steps, but the integration of the target
must be achieved or the overall process fails.
What is the plan for doing things differently and creating
new value after you own the business? What
are the investments needed? Where can efficiencies
be realized? What milestones and performance targets
can be expected (same as those used to justify
the deal)? How can incentives be aligned with the
integration plan so those making it happen have a
stake in the success?
In many companies the integration process is assumed
to be a “given”. In others, they leave it to a
business unit to manage the newly acquired business
and there is no formal integration tracking. Do not
make these mistakes. Serial Acquirers have fully
dedicated acquisition teams managing the integration
process in meticulous detail.
Conclusion
Both Danaher and Cisco are industry leaders that
have demonstrated the ability to consistently earn
high returns and redeploy capital to drive growth.
Each has created significant value for shareholders
relative to the broader market and peers. They’re
routinely on Fortune Magazine’s ‘Most Admired
Companies’ List and they should also be regarded as two of the best acquirers in the world.
They are bold and transparent in their desire to acquire.
Their corporate culture, strategy, and management
processes form the infrastructure needed to
support their M&A competency, a competitive advantage
allowing them to succeed where so many fail.
Each commits significant resources to support its
acquisitions and M&A process, and the results speak
for themselves.
For those companies that have not experienced the
acquisition success of Danaher or Cisco, now is the
time to identify the formal and informal roadblocks
that limit the ability to profitably grow through acquisitions.
Begin by asking, what are the traits of
successful acquirers in your industry? What types of
deals tend to perform better? What can be done internally
to become an elite acquirer?
John R. Cryan (john.cryan@fortuna-advisors.com)
is Partner and Co-Founder of Fortuna Advisors LLC
Jeffrey L. Routh (jeff.routh@fortuna-advisors.com)
is an Associate in the firm’s New York Office.
Notes:
1. For more on our acquisition research see “Who Says
M&A Doesn’t Create Value?” at http://www.fortuna-advisors.com/buona-fortuna.html
2. More detailed analysis of Danaher and Cisco through
the Fortuna lens can be found at http//:www.fortunaadvisors.com/casestudies.html
3. See www.fortuna-advisors.com for more on Internal
Capitalism, Gross Business Returns (GBR), Residual
Cash Margin (RCM) and other aspects of Fortunalytics. |
