This week’s blog comes from Lisa Ashe, Turnaround Partner in EY Transaction Advisory Services
The strongest and brightest companies will always find opportunities in adversity. The big question for companies is how. How can they be the company that thrives in a world of rising uncertainty – and scrutiny?
I had the pleasure of attending and contributing to the Financial Times Future of Dealmaking event in London on 7 November, where we discussed the challenges of transacting in this volatile environment and what behaviours companies can adopt to optimise their strategies and dealmaking.
What I’d like to do in this week’s blog is share my thoughts on these discussions and where I think companies should focus to build value.
“Strategic deals always make sense”
The consensus from last week’s FT event is that we are probably two-to-three years away from the next global recession. I agree. Central bank support and additional fiscal spending (from some quarters) are likely to sustain growth for some time – perhaps until 2021/2. But, there are numerous caveats to this narrative, one of which is fundamental to our discussion.
Uncertainty was the dominant topic of the day because of its force in the economy, dragging on activity and growth with a continual possibility of these uncertainties crystallising and triggering greater damage. As several panellists noted, companies are well used to managing quantifiable risks. But it’s much harder to mitigate uncertainties when they are dealing with unknowns. Brexit has been so problematic for companies because they’ve never been sure how or when it would happen.
And yet, despite rising uncertainty, deal activity continues. Volumes and values have fallen since last year, but they’ve been by no means quashed. We came back to the reasons behind this again and again throughout the day. Strategic deals made for the long-term benefit of shareholders always make sense – and some deals make more sense today than last year.
A slowing economy, when combined with forces like technological disruption and sector convergence, make it imperative for companies to release capital to invest in faster growing areas; combine to cut costs; or embrace new horizons. Capital also remains ample for most – from record PE dry powder to low-cost debt financing – whilst equity investors remain supportive of deals with strong strategic rationales.
“The burden of proof rests with the company”
So, why are we focusing on uncertainty? Because this is no means business as usual. We can’t be sure that M&A will remain decoupled from the economic cycle, whilst economic, political and technological uncertainty create a much more complex transaction landscape.
It’s telling that the two most popular breakout sessions were on the impact of technology on deal origination and execution. Companies are buying businesses to help them fast-track innovation, but how do they know that they’re buying the “right” technologies and that they are paying the right price? Will a new entrant supersede their acquisition? Are they prepared for the additional integration and security challenges involved with buying start-up companies, which are likely to have very different cultures and undeveloped governance and IT structures?
More deals are also coming under the regulatory microscopes. Regulators face existential questions as they attempt to balance companies’ need to innovate and consolidate to combat new entrants, with the rights of customers and the unknown long-term impacts of new technologies. Meanwhile the boundaries and terms of regulator involvement look set to move again as the political map changes.
Scrutiny isn’t just coming from regulators. As our discussions revealed, in this volatile environment investors, politicians, consumer groups are all more engaged with the burden of proof on corporate strategy now resting increasingly with the company.
“You’re buying people, not spreadsheets”
This is a complex environment, but our discussions highlighted five areas where companies can act to optimise dealmaking opportunities and execution.
Deals are fundamentally about people. In some transactions, almost all the value resides in the knowledge of a few individuals; but in all transactions, integration will make or break the deal.
As several examples shared around the room showed, it’s important to align expectations early on and to spend time understanding the target’s culture to establish if they are willing to embrace change and collaborate. In some cases – most notably start-ups – larger companies might take a light-touch approach to integration. But, if the purpose of their deal is to share the acquired company’s technology and insights, they will need to find common ground through shared goals and values.
A sharpening focus on corporate conduct has increased the focus on corporate purpose. But we also heard how companies are increasingly integrating ‘purpose’ into their strategy as the evidence grows that non-financial metrics and long-term value can help business become more profitable and win the war for talent.
The concept of corporate purpose only works when companies are authentic and its goals believable. It also needs every member of the company pulling in the same direction – which leads us back into the discussion around deal integration and culture. This can’t be a top-down only exercise.
Investor scrutiny of strategy and deals will only grow as we approach the next downturn. In our discussions around activism, the consensus was that prevention is always better than cure and one way to do that was for companies to effectively be their own activists.
Activists attempt to build a more compelling narrative than that presented by the company. Therefore, companies should look to build and share their own, persuasive narrative by carrying out regular portfolio reviews, presenting a compelling and convincing strategic growth story, setting out clear purposes for each deal and embracing discussions with shareholders.
There isn’t a right or wrong answer to innovation and valuation. But our discussions highlighted approaches that help companies make better decisions, starting with thinking about if and how they buy. Could they take a more innovative approach to the deal and perhaps partner, licence or set up a Corporate Venture Capital fund (CVC) and take shares in companies until the technology is proven?
Rethinking approaches was another strong theme of the day. Companies aren’t buying the same kind of company, so they can’t use the same kind of methods. There was less risk 20 years ago that a newly acquired business would face an existential threat from a new technology within a year – or less.
One of the most interesting aspects of the discussion is the way that companies are increasingly stepping outside their own sector for deals, using the core business to drive organic growth and using acquisitions of new technologies to explore new growth areas.
It’s said that the more people you hear saying “this time it’s different” the closer we are to the next downturn! It’s encouraging that, although the market is no doubt “frothy” with high valuations and rising covenant-lite deals, our discussions highlighted the greater discipline in this cycle’s deals, versus 2005-7. PE contributors made this point most emphatically, talking about a greater focus on quality, equity buffers and management –experience being one of the biggest differentiating factors.
But, however well-intentioned a deal or strategy, integration is often a bumpy ride and events can turn against a company. Companies need to prepare and plan their deals stage by stage. Within and beyond the deal, companies need to build in strong governance and controls to ensure that they spot the warning signs. We know from tracking UK profit warnings how quickly and dramatically companies can stumble. Some things are different, but we do see the same mistakes made again and again.