Newsletter – February 2011
2011, or the perils of M & A
Forecasters seem to be in agreement: 2011 will be a year of economic recovery, but it will be a weak one for developed economies while the major developing countries will continue on their strong growth path. Within the “rich” countries, the outlook for enterprise will be significantly determined by the exposure, direct or indirect, to developing economies.
In this context, the uncertainty that lead many companies to hoard cash rather than invest it in 2010 is not fully removed. However, with slightly improving prospects and the elapsed time since the last significant investments were made, the pressure on top executives to make use of their war chest will be significantly increased this year.
What is at stake is the company’s competitiveness and its ability to secure future growth. The challenge is to identify the available options and to choose the best one. The result of such a process will be unique to each company, its situation and the industry it operates in, but today’s environment provides food for some thought.
The first major arbitrage to be made here is between investments that lead to external growth (mergers and acquisitions) and those that support the company’s organic growth. Going for the first alternative is often attractive (post-acquisition integration issues apart) as it means that the investment will lead to an instantaneous increase in the size of the business. Merger or acquisition, healthy or vulnerable target companies, all possible scenarios will be contemplated and executed. That said, in 2011, as the economic crisis is in its third year, potential investors will have to be particularly wary of a phenomenon that is prevalent in the slow recoveries that follow deep downturns: that of “Zombie” companies.
Deep economic downturns severely test all market players, but they also put an end to companies that had lost relevance before the crisis hit. These companies then only survive as long as their reserves and those of their shareholders hold out. Acquiring a company that has reached that stage of decay will at best weigh on the performance of the newly constituted entity, but it may well go as far generating value destruction on a grand scale for the acquiring side.
Of course not all companies facing difficulties are “Zombies”. Elements that are specific to the industry that a company operates in or that are linked to its environment may very well explain a vulnerable position at this stage of the recovery. Nonetheless, basing the acquisition of a weakened target company in this environment simply on optimistic and rashly developed rebound scenarios will not do. It will be essential to develop a clear understanding of the causes of the target company’s decline, and to submit every “post acquisition synergy scenario” to the sharpest critical review.
The other alternative, which is that of investment into organic growth, is a challenge of a completely different nature. At the end of the day, the overall performance of any company is determined by the quality of its productive activities – from the definition of its offering – to its operational set-up – to the deployment of its commercial activities. That opens up a vast range of possibilities to create a competitive advantage.
Investments made into organic growth initiatives do not have the « instant gratification » qualities of those that go into acquisitions, and they are often considered burdensome since they require those within the company to question, rethink and change the way they operate. One encouraging point for those who choose this path in 2011: if it is true that great leaps in the ways companies operate are made during recessions, then one has to recognize that when the big post dotcom bubble crisis hit early in the new millennium, the IT revolution had by no means deployed all its effects. That fact alone, challenging the way in which all market players work and interact with each other, contains numerous opportunities that most companies have not had time to explore in the last decade.
As the pressure to act increases, and with a global business environment in marked evolution, investment decisions are likely to be ranked highly on 2011 business agendas.
Edgar Brandt Advisory
