Mergers and Acquisitions Research: Target Identification

How do you identify targets?

For the sake of simplicity, let’s say that the act of acquiring or merging with another company follows the same procedures and shares the same set of objectives.

If you have determined that your strategy is to grow by merger versus organic means, then you must create a set of guidelines or criteria to be met.

• What industry or industries, products, markets,or regions served should be considered?
• What type of ownership (private/public, minority, veteran or woman-owned), work culture or management styles are preferred?
• What size customer base or sales revenue is desirable?

You can begin to compile a list of companies with whom you are currently doing business — either those you sell to or those you buy from in your supply chain.  Having an existing relationship and contacts facilitates identification of appropriate targets.

• Your customers may be purchasing products or services from other companies that are used in conjunction with yours, and thus be able to suggest appropriate targets.
• And if suppliers are providing products or services to other companies or industries, they may also be able to provide an introduction to key contacts at targets.

Next, you can consider your competitors. If you are selling to many of the same companies, a merger should provide many synergies and cost saving opportunities. However, joining forces with certain former adversaries is difficult and might lead to the removal of one management team.

No matter what, if you are planning a merger of acquisition, find out if that target business already has plans to sell, the intention of its management to stay involved, and for how long. Also, try to determine why they are selling.

Outside Support

However, if the foregoing approaches are not satisfactory, enlisting the aid of an intermediary makes a lot of sense.

• There are brokers who are eager to make a match between clients with whom they already have a relationship.  But their lists are limited in that regard.
• A consulting firm may be better able to contact and interview potential candidates, but more so, identify and call upon far greater numbers of prospects that meet specific, predetermined criteria.
• If merger candidates are in other countries, a firm with knowledge about, and contacts within such regions can be of great value.

Assistance from a neutral, objective source can also be in the form of impartial feedback and guidance in clarifying the profile of the ideal target. And in some cases, such an outside third-party might suggest merger candidates from other industries or markets that had not originally been considered.

So while you can perform much of the assessment of a target company yourself, there is a role that only an experienced outside agency can provide.

Due Diligence

Among other things, due diligence involves verifying that claims made by a target are correct. Whether done by one’s own legal or financial staff or not, certain fact checking can be done by a third party. For example, they can

• confirm that the target business owns key assets such as property, equipment, intellectual property, copyright and patents
• determine the status of any past, current or pending legal cases
• check the background and profiles of key executives
• perform analysis of financial statements
• validate sales projections

Why do companies pursue M&A?

Among other strategies, growth by merging with a competitor offers an excellent way to gain customers, increase market share and revenues while decreasing overhead and other redundant expenses.  Merging with a supplier offers the benefits of vertical integration plus the expansion of your market.

In addition, here are a few reasons why companies pursue M&A.

Operating Synergy.  Companies can realize gains in Economies of Scale and Economies of Scope.  The motivation is that a company can lower fixed cost / unit for a single product.  Another advantage is lower total across the company.

Diversification.  A company can position itself in higher-growth products or markets with:

• New Products in Current Markets
• New Products in New Markets
• Current Products in New Markets

Strategic Realignment.  A company can acquire capabilities to adapt more rapidly to changes in the Business Environment, Technological Change, Regulatory and Political changes.

Financial Advantages. A company can lower its WACC (Weighted Average Cost of Capital).

Tax Considerations.  A company can obtain NOLs, tax credits, and asset write ups

Pros and Cons in Growth Strategies

Mergers and Acquisitions need to be considered carefully.  Alternative options for growth outside of M&A may exist.

Organic Growth gives the advantage of control, but the downsides of growing organically are limited Capital Requirements and Speed of growth.

Companies can also choose to create Partnerships for growth.  Examples include Marketing and Distribution alliances, Joint Ventures, Licensing and Franchising.  The advantages in partnerships are limited Capital Investment Requirements.  Partnerships can also be a pre-cursor to an acquisition.

The disadvantages of partnerships are:

• limited control in the partnership
• potential for diverging company objectives
• potential for creating a competitor
• integration issues

Minority Investments are an alternative.  The advantages are limits in capital investment requirements and no integration issues.  However, the disadvantages are a lack of control over decision making and time.

Acquisitions or Mergers provide the advantages of speed and control over decision making.  However, disadvantages can include large capital requirements, potential earnings dilution and integration issues (though control may exist over company processes).

Considerations in M&A

Below are factors to consider in consider M&A transactions:

• Price. Is a control premium paid?  What is the Reference Price?
• Legal Structure: What are the disadvantages of the target’s legal structure?
• Treatment of ESOPs: Cash out? Re-write? May be subject to Options contracts
• Governance Issues: Are there issues with the CEO, Board or Organization structure?
• Marketing Issues: Will the deal result in changes in Brand Value?
• Closing Date: How long will the deal take?
• Pricing Protection: Could there be changes in stock price before and after?
• Financing Requirements: Will cash be financed?  Is security needed?
• Working Capital: Are there protections for the buyer from a seller bleeding the company of capital?
• Termination Fee: If deal “breaks” after announcement to closing, will compensation be needed?
• Representations & Warranties: Are protections needed due to the limitations in the Due Diligence process?
• Material Adverse Changes:  Are protections needed in the event of a MAC between announcement and closing.

Market and Competitive Intelligence

An independent consulting or market research firm can help with the conduct of MI and CI. They can gather background information on such items as:

• market conditions and changes
• factors affecting pricing, sales and profits
• the condition and future health of the business
• identifying the target’s key competition

In addition, such a company can help to identify and interview both customers and suppliers of a target without mentioning your company or its intentions. By using an outside firm, you can learn more about the strengths and weaknesses of a target and its reputation/image as perceived by both buyers and sellers who do business with it.