Making acquisitions work
Article Date: Feb 11 2008It could be over-optimism that explains why countless acquisitions fail to meet expectations. ‘People get a rush of blood sometimes and these things are not thought out,' says Andrew Hartley, joint MD of private equity firm August Equity.
'Often the strategies are fine, it’s actually the execution that goes wrong.'
The seafood chain FishWorks was a textbook example of how buy-and-build strategies can go awry. Now steadied by the ever-dependable Gary Ashworth, the company lost its way after opening seven restaurants within ten months. ‘FishWorks is a good idea that was poorly managed,’ comments Ashworth. ‘The business model will stay the same but you need to get the staff right. Some of them had taken their eye off the ball.’
Roger Parry, currently the executive chairman of marketing services group Media Square, has ‘done hundreds’ of acquisitions in his various roles at other companies over the years. He believes the acquiring concern must have a person in the senior management team who is the “champion” of a takeover.
‘Acquisitions that are done on an opportunistic basis, such as a company looking cheap, normally fail as there is no rationale for pushing them through. Often, they don’t have a real champion,’ he says.
Barrie Brien, chief operating and financial officer at another marketing services outfit, Creston, argues that there has to be a view on what the acquired entity will be giving to the overall company for the next ten to 15 years: ‘It must be a company that fits in strategically with your growth, otherwise it’ll unravel within five years.’
Acquiring problems
Various figures are thrown up but it’s generally agreed that somewhere around 75 per cent of acquisitions don’t deliver on expectations. Creston has acquired ten companies over the past 13 years and, according to Brien, they’ve been integrated relatively smoothly because brands as opposed to personalities were purchased. ‘Brands can’t walk out the door as easily as personalities,’ he says.
Buy-outs frequently end badly due to a lack of planning and integration or because too much was paid. Says Parry: ‘Typically a company will be looking for a 15 per cent return on investment (ROI). So if you invest £10 million, you would expect £1.5 million of cash flow per year.The majority of acquisitions fail that test.’
At Media Square, Parry is relishing the challenge of putting the company back on track after the previous leadership embarked on over 30 acquisitions in two years. ‘It was a diverse range of businesses, and that created three problems: there was no strategic rationale so the purchases were opportunistic; no individual champions tried to make them work; and the management was too stretched. If you have that many balls in the air at once, it’s difficult to control them all.’
Assuming there is a legitimate reason for buying, the next question is how to finance the deal. That’s going to present some interesting dilemmas for acquirers, as debt won’t be as readily available so larger portions of equity will be used as leverage.
‘There’s an enormous temptation for an entrepreneur to avoid equity dilution,’ observes Rob Donaldson, Baker Tilly’s head of private equity and M&A.
‘That is perfectly understandable, but the danger, especially as we enter an uncertain economic climate, is that you over-gear your own business and end up losing everything.’
For Parry, the financial package used depends on the sector. In the media-ownership business, he likes to buy a vendor without an earn-out or contingent payments. ‘It’s simpler and cleaner if you buy them outright because you’re buying an asset and
a business system,’ he says.
By contrast, he sees the earn-out as a useful tool when buying a professional services company: ‘Usually you are buying the services of the team who are currently running it, so you want to make sure they don’t get all of their cash upfront and that some of it is contingent on good performance.’
Creston’s Brien also favours this approach. ‘We have an earn-out phase of three to five years post-acquisition,’ he says. ‘We pay 60 per cent to 70 per cent of the original value and the rest as a consideration in shares.’ There may be other stipulations as well, such as a non-compete clause, so that if a person leaves they are not to be permitted to work in the industry for two years.
Financial mix
Often, the mixture of debt and equity that is used for a purchase will be determined by the structure of the holding company. ‘If you have an under-leveraged balance sheet, you will tend to do an acquisition purely with debt as it helps to create the balance sheet leverage,’ comments Parry. ‘At the other extreme, if you feel that your existing debt level is too high, you can use the opportunity of an acquisition to issue new shares. The advantage here is that you’re bringing in new cash flow and de-leveraging your top company balance sheet at the same time.’
August Equity’s Hartley says there has to be flexibility with working capital when undertaking a deal: ‘If you put too much pressure on cash flow and assume the best case scenario, you are going to cause problems. You need to be cautious and have a contingency plan; if you believe that something will be better, plan for something that is worse.’
Caution is a word that is suddenly in vogue again among CEOs. Brien, for one, admits that Creston is ‘slowing down absolutely on acquisitions’. The general view that the banks are running on a “business-as-normal” basis for mid-market companies seeking deals is dismissed by Baker Tilly’s Donaldson. ‘The mid-market is open but banks are definitely more cautious; they’re lending at lower multiples and the debt and arrangement fees are more expensive, and the covenant protection is far more onerous,’ he says.
Stable growth
Whether you’re seeking to acquire through the public markets, or opting for a straight debt or equity play, additional care will be required when deciding how to expand. For Parry at Media Square, the company is very much in recovery mode: ‘I’m telling people that acquisitions are not on the table. I want them to fix the operating economics of the existing businesses. We’ve already closed or sold 11 companies and there will be a number of others closed, sold or merged over the next few months… You don’t want to do acquisitions until you have a very stable operating base.’
Provided your affairs are in order, bargains will be there for the taking. ‘If you’re a trade buyer looking for deals then I think it’s a good time,’ says Donaldson. ‘Putting aside the economic uncertainty about a recession, which is increasingly likely, the thing that has changed is the competitive landscape for the buyer. They’re in a much stronger position if they’re cash rich then they were before.’
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