Mergers & Acquisitions and the Crisis: What's the Connection?

This text on mergers and acquisitions is based on the article M&A and the Crisis: What's the Relationship, written by our founder José Pedro Farinha. Let's dive into his reflections on this topic:

Introduction: M&A

In times of crisis in Portugal and around the world, it's worth thinking about how we're going to turn the market around and make the most of our competitive advantages. In companies, if we don't have the capacity to innovate, to focus on customers and think about opportunities beyond, we will hardly be able to survive a crisis.

Reasons why companies opt for a merger or acquisition

Companies don't have the option of not growing: growth is a constant necessity in the life of companies, so that they can keep up:

• All technological innovation;
• The useful life of products, unexpected crises;
• Increasingly aggressive competition, boosted by globalization and the ease with which companies can now be found quickly and cheaply all over the world.

For investors, managers and founders, there are two options for growing and strengthening companies:

1. Internal growth, that is, they grow organically, winning more customers, making more sales, developing new products, etc;
   
   
2. Or they can grow, or accelerate internal development, through so-called external growththrough operations such as mergers, acquisitions, share exchanges, joint ventures, etc.

We often hear the expression "10% of something is better than 100% of nothing", but are entrepreneurs really willing to give up ownership of their businesses? Of the majority of their company?

History has taught us that entrepreneurs tend to focus on "their backyard".

Let's take the example of agriculture in Portugal: we find many producers of the same products, neighbors, but each with their own land, with their own machinery and often competing with each other on price... What if they got together?

The main benefits of mergers and acquisitions for companies

If these farmers shared more powerful machinery, concerted marketing campaigns, the ability to add value to the product and the sale, transforming the primary product into an industrial product - for example fruit into dehydrated fruit, or legumes into canned food - they would have:

• More competitive advantages;
  
• More capacity to develop new products and gain scale;
  
• More capacity to meet consumer needs;
  
• They would be focused on their customers and better prepared to face any crisis.

And we can adapt this example to any sector of activity or any company. The capabilities acquired by external growth are immense - and there are several success stories of mega mergers and acquisitions that have given rise to giant companies with major competitive advantages over their competitors.

Some examples of mergers and acquisitions between large companies:

• Merger of Exxon and Mobil (1998);
• AT&T's purchase of Time Warner (2016);
• Purchase of ABN Amro by RFS Holding (2007);
• Merger of Heinz and Kraft (2015);
• Sale of Pfizer by Warner-Lambert (1999);
• Purchase of Mannesman by Vodafone (1999) etc.

Difference between merger and acquisition

When we talk about the process of external growth, we almost always talk about mergers and acquisitions, so it's important to understand the differences between the nature of one and the other:

• A merger implies that two or more companies join into one - which will be owned by all and which will be a common vehicle for the development of a certain economic activity, with a management model developed by all, resulting in a model that is the fruit of the union of all the entrepreneurs.
  
  
• A acquisition or buy/sell implies that someone more powerful (e.g. investors) acquires another existing entity and takes over the decision-making capacity of that other entity - in order to increase its critical mass.

In many cases of acquisition, there is a transition from the management of the acquired entity to the acquiring entity making the investment. However, this does not mean that we are facing a merger process - although it is sometimes difficult to decipher where one process ends and the other begins. 

Whenever an entrepreneur is called upon to make a decision related to mergers and acquisitions between companies, it is important to understand whether they are willing to buy another business, sell their own, or simply join another - and what the consequences of that decision might be. 

After the merger or acquisition: horizontal and vertical growth

It is also important to understand whether the operation involves bringing together similar and/or competing businesses (horizontal) or bringing together businesses that complement each other in the product's value chain (vertical).

What often happens is a mixed model: in which two similar businesses come together to gain the capacity to acquire another in the product's value chain. In other words: a horizontal process, followed by a vertical one.

Let's take the example of a picanha restaurant and an entrecote restaurant coming together to gain synergies and the ability to jointly acquire a butcher's shop. This is a horizontal process followed by a vertical one.

Main disadvantages and challenges of mergers and acquisitions

Usually, mergers and acquisitions are associated with transversal objectives, such as:

• Profitability of activities and investments;
• Development;
• Or downsizing the business.

Once the pre-established objectives have been achieved, it will be inevitable for the companies involved to reap benefits: such as increased market shares, strengthened financial or negotiating capacity.

But in order to achieve these objectives and, consequently, these benefits, some of the constraints and difficulties associated with mergers and acquisitions have to be overcome. And when we're talking about merging two businesses, perhaps the most difficult constraint to overcome is ego management.

Let's imagine that two neighboring restaurants decide to merge into one, so that they can gain greater negotiating power with suppliers and so that they can invest in a better-equipped kitchen. It all makes sense. But...

• What recipes and menus are you going to use?
• Who will be the head chef?
• What will the sales and checkout software be?
• Who will manage suppliers and purchases?

We could go on listing unanswered questions, which in reality are no more than simple problems for companies - if everyone involved and/or investors are willing to give in, depending on what is best for the business. Warning: not everyone is emotionally prepared for mergers and acquisitions, however simple the operation may seem.

How to evaluate businesses before mergers and acquisitions?

No less important than overcoming all the constraints related to culture and activity is finding the right value for an acquisition/sale or merger/exchange. Without this point perfectly resolved and agreed between the parties, there is no deal and no operation. Which brings us to the million dollar question:

How much is my business worth?

A.: by definition: it is the price at which one entity is available to sell something and another entity is available to buy it.

• What is the capacity to generate income in the future?
  
  
• What is the perpetual capacity to generate the same income?
  
  
• What are the expected development rates?
  
  
• How much investment is needed to generate these returns?
  
  
• What financing is needed to cover these investments and the financial flow of operations? Is there cash flow? Are there conditions?
  
  
• What extra-activity assets does the company hold?
  
  
• What contingencies are associated with the company's activity and assets?
  
  
• What is the specific risk of the activity or the markets where we are going to operate?

We can't think about correctly valuing our business or companies in general if we can't answer these questions. And only once we have these answers can we move on to the phase of assessing what changes there might be to these assumptions, based on a merger or acquisition/sale.

Only then will we be able to assess whether, from a financial point of view, the transaction is interesting and fair, so that we can define a reasonable range for the negotiation.

The process of selling a company: price and fair value

Once the previous phase has been completed, the price of the transaction (acquisition or sale) or the exchange ratio (merger) is determined. And the difference between the price and the fair value of the assets and liabilities that make up the operation results in the so-called goodwill: which can be positive or negative.

If negative, it means that the transaction was made for less than the Fair Value of these Assets and Liabilities - which could mean the existence of some hidden contingency.

If it's positive, it means that we've valued the deal more - perhaps because the merger/acquisition results in gains that aren't reflected in an individual analysis of the case. 

The secret to successful mergers and acquisitions

Once the top figures in the companies are aligned and committed to the same goals, we have to move on to the next and no less painful stage:

• Aligning teams and human resources;
• (Re)defining processes;
• Choosing the best tools;
• Define priority investments;
• Define forms of financing;
• Create a new culture.

Only in this way will it be possible for the new entity to succeed, taking advantage of the best of all those that incorporate it. For this phase, I share with you my three secrets for successful mergers or acquisitions:

• Define the objectives of the merger or acquisition correctly and clearly;
• Involve the teams that lead in this, so that a new culture is born in accordance with the defined objectives, where everyone involved is committed;
• Use specialized professionals from the various business areas: from financial consultants, legal advisors, auditors, among others...

...so that there are no "loose ends" to be sorted out later. Remember: in companies, what we save today will cost us much more when these "loose ends" become a problem that causes friction in the company between the various parties involved. These "loose ends" could even jeopardize the merger itself and all its benefits!

When to go ahead with mergers and acquisitions

But when is the best time to go ahead with a merger or transaction between companies? When companies are doing well? When they are doing badly? When the economy is growing, are these kinds of opportunities exploited? When we're in crisis, do we carry out these kinds of operations?

There is no right answer, each case is different. But there are no wrong times either: entrepreneurs and companies must be ready to evaluate the various options and, often, opportunities to partner with others - or to sell or buy a company - appear when you least expect them.

There will always be something to do:

• Assess the context and the various possible scenarios;
• Draw a projection with and without the possible operation;
• Evaluate the advantages and disadvantages of these scenarios;
• And make decisions based on this analysis.

Make sure that the scenarios you draw up are realistic and based on sensible assumptions, i.e. free of prejudices and preconceived ideas that have no real basis. A merger or purchase/sale between companies is a serious decision that must be assessed in a cold and rigorous manner.

Interested in finding out more? Remember that you can schedule a face-to-face meeting with one of our experts here. We look forward to hearing from you!