Q&A: M&A strategy – creating shareholder value and managing risks
May 2016 | SPECIAL REPORT: OPERATING AN EFFECTIVE BOARD
Financier Worldwide Magazine
FW moderates a discussion on using M&A as a strategy to create shareholder value and manage risks between David McCourt at Granahan McCourt Capital, Diego S. Krischcautzky at Marval O’Farrell & Mairal, and Derek Devgun at Medtronic.
FW: As a means of achieving corporate growth and value, how would you characterise the success of mergers & acquisitions (M&A) as a boardroom strategy? Does recent deal activity highlight the benefits of M&A in achieving long-term value for shareholders?
Devgun: A well thought-out and properly-executed M&A strategy can readily contribute to a strategic acquirer’s corporate growth and value, but the proper measure of success depends on the underlying objectives of the M&A activity. For example, an early stage technology or intellectual property play will not result in much benefit to short-term revenue growth, but it would be a mistake to view it as a failure if it enables the acquirer to mitigate a later commercialisation-stage patent risk. On the other hand, an acquirer looking for short-term revenue growth will measure the success of its transactions very differently. Would-be acquirers are also well-advised not to overlook a periodic need to evaluate their existing portfolios to identify opportunities for the divestiture of non-strategic assets, and a well-executed divestiture can be seen as a success if it reduces burden on the remaining business or if it brings in cash for other transactional activity or to fund research and development.
Krischcautzky: From an Argentine perspective, it should be noted that our capital market is relatively small. The historically weak minority shareholder protection, the absence of institutional investors and the lack of appetite for stocks as a valid saving option for households led to a concentrated stock market where every major public company is controlled by a majority shareholder with low atomisation of stockholders. Therefore, M&A strategy is not really discussed at boardroom level but at majority shareholder level instead. Furthermore, in late 2013 new capital markets regulation was enacted, designed to create a friendlier minority shareholder environment. However, general macroeconomic conditions made the local capital markets largely unattractive for IPOs and M&A in general, so no real change took place. In December 2015, a new government took office with the aim of generating a more friendly business climate. Its first major step was settling the holdouts claim in order to put an end to a 13 year default of our sovereign debt. The default has been a big obstacle to facilitating the country’s and companies’ access to financing through capital markets. Equally, there has not been sufficient activity in this area to form a clear trend, but we expect this to change significantly in a few months’ time.
FW: What are the main challenges commonly facing acquirers when they pursue M&A as means of creating shareholder value? What steps can they take to identify risks likely to cause problems down the line?
Krischcautzky: A significant portion of the Argentine economy is still informal. Economists calculate that between 30 and 35 percent of the country’s activity is carried out irregularly. This has had an affect across the board, since any business undertaking is directly or indirectly exposed to dealing with informal situations. This leads to potential tax, labour, social security and reputational liabilities that a board would have to seriously consider at the time of evaluating an M&A transaction. Also, the web of regulatory barriers created in Argentina in the last several years, plus the antitrust system – where clearance cannot be expected within two years, and therefore only happens post closing, shifting all the risk of regulatory approval to the buyer – works as a strong disincentive for M&A as a shareholder value creation mechanism.
Devgun: Timing pressure is frequently a challenge, particularly when an acquirer is faced with a competitive bidding situation. Restrictions on access to key diligence imposed by the target or its advisers are also a common problem, particularly in the cross-border context. For example, it is not unusual for US companies engaged in what they regard as customary anti-corruption diligence to be met with bewilderment on the part of a foreign target, both as to the scope and to the extent of information requests. The most effective step that an acquirer can take to identify risks caused by these factors is to define a process for managing its acquisition activity and adhere to it as closely as it can, knowing that there will always be the occasional exceptional situation. One other risk-identification mechanism is to build a diligence team, both internal and external, that is resourced and equipped to make up for any bandwidth or logistical deficiencies on the part of the target.
FW: In your opinion, what key issues contribute to acquisition failure and value destruction during the M&A process? Do dealmakers often overlook important components of the transaction?
McCourt: The most difficult part of any M&A deal is finding a way to successfully integrate two different cultures, two different systems, two different geographies and two different sets of people with different values, goals and objectives. People often don’t spend enough time focusing on this and thinking out these aspects of a deal. Frequently when deals don’t work out, this is what causes the majority of the headaches. Even when a deal seems like a complete no-brainer, if you are not able to pull these aspects off successfully, you will often end up with a disaster. However, if you are able to achieve this integration, it just becomes a matter of executing and your likelihood of success will be far greater.
Devgun: One of the leading causes of transaction failure and value destruction has been a failure to plan properly for integration of the target, though in recent years most serial acquirers have developed more sophisticated infrastructures for managing integrations. In an integration context, proper talent management and employee retention plans are often key to transaction success. It is also important to avoid ‘deal fever’ during a transaction – in a competitive bidding situation, this can push up the price disproportionately, but even outside that context can result in negotiation of less-than-optimal deal terms. Finally, it is critically important for the negotiating deal team to present a united face – a well-advised sell-side will sense any disunity and will know readily how to exploit it. It is relatively rare for a sophisticated dealmaker to overlook important components of a transaction, though again the potential for material error increases if deal fever has set in or if the deal team is not speaking with one voice.
Krischcautzky: A lack of clear rules and an overly regulated and unstable economy have played a major role in diminishing, if not eliminating, M&A activity by listed entities in Argentina. The underlying reasons can be found in external factors rather than specific transaction components. In Argentina’s new business environment, we are already seeing these external barriers begin to disappear, or at least be lowered significantly. A positive sign is that several transactions involving publicly listed companies are currently under way or are in the pipeline, which confirms that we are about to witness a new era in public M&A in Argentina.
FW: To what extent is shareholder activism impacting the M&A space? With activists gaining more support and prominence across the board, how should companies respond to their intervention in proposed deals?
McCourt: Shareholder activism often creates more M&A opportunities, but this can often be for the wrong reasons. Investors who consider themselves ‘activists’ often stir-up problems within a company in order to bring light to areas where they think the company’s management are not doing their jobs or not realising the maximum shareholder value. A lot of times activists and management teams alike will use M&A activity as a way to shift focus away from fundamental problems that may be occurring within the company, which common sense would tell you is the wrong reason to engage in M&A.
Krischcautzky: Back in the 1990s, Argentina created a private pension system where pension funds invested in the Argentine stock market. In general terms, the pension funds followed board recommendations and shareholder activism was rare. In 2008, the pension system was redesigned to be controlled entirely by the Argentine state. All stocks held by pension funds were transferred to the government, which ended up owning stakes of up to 25 percent in some of the largest companies in the country. This implies that in the subsequent seven years, shareholder activism meant governmental activism within the board, which negatively impacted M&A activity. Needless to say, boards and majority shareholders have been prudent in not overtly confronting the state as a shareholder. It is too early to understand how the new government will act as a shareholder of listed companies – or if it is interested at all in keeping its holdings – but we expect a friendlier scenario. If the government ends up disposing of its holdings in public companies, we will most likely see increased shareholder activism in line with more developed markets.
FW: When it comes to the post-acquisition integration stage, what strategies should parties deploy to ensure that the merged organisation is in a position to deliver expected value?
Devgun: Most critically, an acquirer should consider having an institutional integration function to ensure proper knowledge management, and to promote development and continuity of best practices. It is also a good idea to appoint a deal specific integration lead early on in a transaction, to ensure that someone is accountable for a successful integration. Building the integration team early in the transaction process and making sure its members are engaged in the process itself can also help to ensure a proper knowledge transfer from diligence team to integration team – and help avoid any surprises down the road. Finally, in any integration it is necessary to assess what degree of integration is appropriate to preserve value – whether to leave the target operating largely on a standalone basis or whether to integrate it more fully into the acquirer’s pre-existing operations. For example, a target with a novel business model or a uniquely talented employee pool might be best left to operate semi-autonomously, even if for a limited time.
Krischcautzky: Post-acquisition integration depends on several factors, such as the industry, the nature of the integration, whether the acquisition is local or cross-border, and so on. As a general rule, the acquiring organisation should understand the culture of the target to avoid a disruptive integration which destroys value. The target´s management should also be aware from the start about their rule and objectives in the combined organisation. Uncertainty, as we know very well in Argentina due to recent experience, destroys value and deters good business.
McCourt: The key to any M&A deal is integrating two companies into one aligned strategy. But this cannot be an afterthought. The strategy needs to be well thought-out from the outset so you know what you are going to buy, how you are buying it and how you are going to integrate it into your existing operations. You can’t look at these areas as separate strategies. When you take the approach of, “Now that we’ve bought this, let’s think about how we are going to integrate it”, you are going to find yourself destined to fail.
FW: What overarching advice can you offer to acquirers in terms of developing and implementing an effective strategy to manage transactional risks and satisfy shareholders seeking value?
Krischcautzky: As the world walks an irreversible transparency path, I would advise acquirers to bring their shareholders on board. By that, I mean the board should take a very active role in devising an acquisition transaction and fully explain to shareholders the value underlying it and how they will benefit from that. In Argentina, we need to leave the model where one or two shareholders decide on behalf of everyone else through the majority rule.
McCourt: Transactional risk increases if you do not have an experienced team. If you have lawyers and accountants within an M&A team, who you have used before and trust, it should not be an issue. My advice is to stay true to very strict due diligence guidelines and avoid downplaying potential risks because you are so excited to get things done. Face up to risks and try to resolve them, then your transactional risk should not be where the big risks lie. The big risks are going to lie in integration and operation, with transaction being the least of your worries.
Devgun: Of key importance to managing risk in the transaction context is for an acquirer to define a process for managing acquisition activity and to adhere to it as closely as possible. By its very nature, M&A transactions are unwieldy and complicated, and M&A activity may not seem like a feasible candidate for process development. However, the most successful acquirers do develop effective processes, both to manage risk and to build shareholder value from acquisitions. At the outset, it is also important to acknowledge that there will always be the occasional exceptional situation which requires departure from the process. However, that does not take away from the need to have a process in the first place.
FW: Looking ahead, do you expect boards to continue using M&A to create shareholder value? What trends and developments do you expect to see in this space?
Devgun: With internal research and development budgets under pressure, it is inevitable that companies will continue to see M&A as a P&L-friendly way in which to create shareholder value. The reasons for M&A activity will continue to be varied, from transactions driven by strategic, business or geographic considerations to those driven by more purely financial considerations. In certain industries, such as healthcare, as companies become larger and more diversified and branch into new areas of activity, there will be an increasing need to manage antitrust or competition law risk in M&A. Finally, in the post-completion context, there will also be an ongoing emphasis on refining approaches to integration and on developing metrics to measure transaction success or failure.
Krischcautzky: Due to the current features of the Argentine market, we expect to see an evolution in the next few years toward international standards. As a result, a shift of real decision-making power from controlling shareholders to the board would be desirable. As it happens, along with the renewed possibility of sourcing funds through international financing, boards will be more inclined to find, independently, value creation methods, including M&A transactions. After many years of quietness, there are many opportunities to exploit, especially in the energy, infrastructure, telecom and agribusiness and biotechnology sectors.
McCourt: Companies will of course continue to use M&A, but it’s the CEOs job, not the board’s, to find acquisitions that will help to grow the business. They must have a strategy of whether they are looking for a small bolt-on acquisition with which they can grow the business and bring some value to the table, or transformational ones. The board’s job, if at all, is to seek out more transformational mergers, such as the deal between Hershey’s and Cadbury. Trends, of course, change as markets continue to evolve. Many companies are caught up with not being able to change with the times and not being able to keep up with competitors, and therefore they find themselves falling behind. They use M&A as a way to catch up. Over time, they may have become older and slower, and feel the need to buy younger and more aggressive companies, especially in the tech space, to make sure they stay ahead.
For over 25 years, David McCourt, chairman and chief executive officer of Granahan McCourt Capital, has been an innovator, entrepreneur and business leader across the technology, media and telecoms industries. He has founded or bought 20 companies in nine countries, and is widely recognised as a transformational force in the telecommunications business. The Economist described him as having “impeccable credentials as a telecom revolutionary”. He can be contacted on +353 6127 4000 or by email: firstname.lastname@example.org.
Diego Krischcautzky has been a partner in Marval O’Farrell & Mairal’s Buenos Aires office since 2006. His practice is focused on commercial, corporate and insurance law. He has broad experience in M&A transactions, structuring and financing of private equity investments, corporate governance, counselling and structuring of insurance products, advising major international companies and investment funds. He is fluent in Spanish, English and Italian. He can be contacted on +54 11 4310 0195 or by email: email@example.com.
Derek Devgun is an in house M&A lawyer at Medtronic, with over 20 years’ experience managing legal teams in transactional and business settings. Mr Devgun’s wide-ranging M&A experience includes large transformational M&A (Medtronic-Covidien, the largest inversion transaction ever completed), transactions supporting med tech ‘white space’ strategy, and innovative transaction structures such as fully-negotiated acquisition option agreements. He is also adept at operating in global settings, having closed transactions in North America, Europe, the Middle East and Asia. He can be contacted on +1 (763) 505 0094 or by email: firstname.lastname@example.org.
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