Unlocking Growth for Tech Companies: The Power of Strategic M&A

In the world of business and finance, it is not uncommon to come across news of one company acquiring another. Often, the deal size reaches astronomical figures, and the transaction itself is shrouded in rumours and scandals. But why do companies embark on such risky adventures? Are these endeavours ultimately advantageous for shareholders? Can the modern economy, particularly dynamic industries like the tech sector, function without these deals? Let's delve into these questions.

To gain a better understanding of the subject, let's first establish a clear definition of terms. M&A stands for Mergers and Acquisitions. Although these two terms are often used interchangeably or as a single concept, their meanings differ. Mergers occur when two companies, usually of similar size, merge to form a single entity. Acquisitions, on the other hand, involve one company, typically a larger one, purchasing another company or a controlling stake that allows it to influence key business decisions. In this article, we will primarily focus on the latter context of M&A.

So why do companies engage in M&A deals? Well, there are two main driving forces behind their actions: financial and strategic rationales. An example of a purely financial rationale can be observed in private equity (PE) and venture capital (VC) funds. Their sole purpose in conducting deals is to buy assets at a lower price than what they can sell them for in the future. PE/VC funds may acquire minority stakes since having control over business decisions during the ownership period is not their primary concern.

Another reason for pursuing M&A deals lies in a strategic perspective. The key distinction from financial motives is that the acquiring company, in this case, does not plan to sell the acquired company in the future. The objectives of such deals may include:

• Growth - the desire to enter new markets, whether through product expansion or geographic expansion or to achieve non-organic growth in the core market. This is particularly crucial in fast-growing 'winner takes it all' markets, where maintaining momentum is essential to prevent loss of market share and potential failure.

  
  

• Efficiency enhancement or classical vertical integration. In this scenario, a company realizes that by acquiring its service or product supplier, it can improve its profitability and gain control over more stages of the value chain.

  
  

• Defensive purposes. In this case, if a deal is not made, there may be a risk to the acquiring company's business. A classic example is Facebook's acquisition of WhatsApp in 2014, driven by the fear that WhatsApp could create a product that would completely disrupt social networks. As a result, Facebook acquired WhatsApp for a staggering $19 billion at that time.

  
  

While the second reason is more typical for production and other asset-heavy companies, “growth” and “defence” deals are widespread in the tech industry. But why do tech companies choose M&A as a means to achieve these objectives when, having armies of IT developers, product managers and designers, they could accomplish them organically through internal R&D and business development?

1. Time-to-market and execution risk

Despite the fact that, in 95% of cases, the costs of creating a product or entering a new market organically are lower than those of M&A, there is a higher probability of failure compared to acquiring an existing company's ready-made business. Additionally, even if a company manages to develop the product itself, it will take significant time, during which competitors may have already surged ahead. In tech markets, where the first-mover advantage is highly significant, this becomes crucial.

2. Unique technology or expertise

If a product is based on unique technology, it may be impossible to develop it independently through one's own R&D efforts. In such cases, M&A becomes the only available tool. Additionally, sometimes such technology may not be materialized in something tangible like a patent or software but resides solely in the minds of the company's founders and management team. Deals aimed at acquiring a team are known as "acquihires" and are very popular among big tech companies.

3. Removing a competitor

Furthermore, acquiring a company eliminates a competitor from the market, giving the acquirer a competitive advantage, whereas developing a product internally would require competing against an existing market player.

While M&A may appear to be an ideal tool for driving growth, like everything in real life, this strategy has its own set of drawbacks and risks.

• As mentioned earlier, acquiring an existing business is a costly investment, and management that is not accustomed to non-organic growth often struggles to make the decision to proceed with the deal when comparing its cost to the alternative of organic development. The situation becomes more challenging when the acquired company has surplus businesses or products that are irrelevant to the acquirer's needs, adding unnecessary burdens. Moreover, it is obvious that a product specifically created and tailored to your needs is always better than a purchased one that needs to be redesigned.

  
  

• Integration of the acquired business is essential for maintaining the strategic value of the deal. Failed integration results in a lack of synergy and alignment between the acquired business and the acquiring company. However, integration can be challenging, costly, and sometimes unfeasible due to many factors ranging from different tech stacks to cultural differences between companies.

  
  

• Managing acquired companies. If the acquired business retains a certain level of independence rather than simply merging with the acquirer, an additional management structure should be established (like Alphabet in the Google group). It creates inefficiencies and entails additional costs.

  
  

The realization of these risks has contributed to the negative reputation of M&A. There is an abundance of articles and statistics highlighting the failures of M&A deals. Notable examples include the ill-fated acquisition of AOL by Time Warner and Nokia's mobile division by Microsoft. However, when utilized effectively, M&A can become a powerful growth tool. Below are four tips on how to leverage this instrument and mitigate associated risks.

1. Consistency - M&A should become a common instrument for growth

Often, management turns to M&A as a last resort when growth has been completely exhausted or when they have already lost competition in the market. In such cases, the deal becomes a major transformative element in the company's strategy. Usually, at this point, the company lacks experience in M&A transactions, particularly in the integration of acquired companies. Without viable alternatives for growth, the company becomes prone to grasping any deal and overpaying.

Another scenario is when companies attempt to make "opportunistic" deals without a clear understanding of the strategic rationale, perceiving M&A as a mere toy rather than a tool. However, such deals rarely end up successful. As a result of both situations, unsuccessful deals occur, which subsequently become the subject of tabloids and science articles debating that M&A "destroys value".

To avoid these mistakes, M&A should be regarded as an everyday and consistent instrument for growth. The company and its management should become accustomed to the thinking frameworks employed in M&A deals and grasp their value and limitations.

If we examine the companies comprising MAAMA (formerly FAANG, with Microsoft replacing Netflix and updated names), we can observe that all of these companies adhere to this principle and effectively utilize strategic M&A as a means of achieving growth and executing their strategies. Take Apple, for instance, which maintains a preference for keeping its strategic plans confidential by avoiding major and high-profile deals. Nevertheless, as disclosed by Tim Cook in 2021, Apple has successfully completed 100 acquisitions in the past six years, averaging approximately one acquisition every three weeks.

2. Strict financial discipline

The acquiring party is often eager to justify the high price by emphasizing the strategic importance and potential synergies. While these synergies can indeed yield positive effects, it is crucial to exercise caution to avoid overpaying for them. There are two key considerations to keep in mind.

Firstly, the deal price is typically paid upfront, whereas the realization of synergies carries a certain level of uncertainty and may take time to materialize. It is essential to assess the likelihood of achieving these synergies and factor in the associated risks when determining the appropriate price.

Secondly, it is important to remember that it will be the acquiring company, not the seller, that bears the responsibility for realizing these synergies. Significant resources and efforts will be required to extract and integrate the synergistic benefits, which can overshadow the initially anticipated positive aspects. Careful evaluation of the costs and efforts involved in capturing synergies is crucial to ensure that the overall value proposition of the deal remains favourable.

By maintaining a realistic and measured approach to valuation and synergies, companies can avoid overpaying and ensure that the expected benefits are effectively realized.

3. Integration - a key element of the deal

As mentioned several times before, effective integration is a key factor in determining the success of a deal. Sadly, many deals falter or fail due to the lack of proper integration of acquired assets. Without a well-executed integration process, the strategic objectives behind the acquisition cannot be fully realized. The acquired company's value may stagnate or even deteriorate, resulting in a missed opportunity.

To maximize the benefits of an acquisition, it is essential to prioritize integration planning and implementation from the early stages of formulating the strategic goals of the deal. Integration should be viewed as a proactive and ongoing effort that begins well before the completion of the transaction.

4. Dedicated Internal M&A and Corporate Development Team

When pursuing strategic deals, it is crucial to establish a specialized internal M&A and corporate development team within the company. This team plays a vital role in driving successful M&A transactions and ensuring alignment with the company's long-term objectives.

Having an internal M&A team offers several advantages. Firstly, they have a comprehensive understanding of the business, its unique needs, and its strategic direction. This knowledge enables them to identify suitable acquisition targets that align with the company's strategic vision. Additionally, the internal members of the team have a vested interest in the long-term success of the company, as their incentives are tied to its capitalization and value creation.

In contrast, external consultants and investment bankers may have different motivations and objectives. Their focus is often on completing the deal and maximizing fees, which can create divergent goals and incentives.

To ensure effective collaboration and decision-making, there should be open communication and a strong sense of trust between the internal M&A team and top management. The top management's involvement in the decision-making process fosters a more informed and aligned approach to M&A activities.

In conclusion, it is time to dispel the stigma surrounding M&A as a tool solely for enriching Wall Street while destroying businesses and shareholder value. In today's rapidly evolving economy, particularly within fast-paced sectors like technology, strategic M&A plays a vital role in fueling innovation, driving growth, and enhancing competitiveness. Rather than being seen as a negative force, M&A should be recognized as a necessary and valuable instrument for companies to stay ahead of the curve. By facilitating access to new markets, expanding product portfolios, and leveraging synergies for increased efficiency, M&A enables organizations to adapt, thrive, and lead in a dynamic business landscape.