Vol. 10, No. 6, June 2012
Operating nationally and internationally, FOCUS currently is working with buy- and sell-side corporate clients, private equity groups, holding companies, and late stage venture capital firms in 23 areas:
We have executed dozens of transactions in a range of market segments, but the same fundamentals apply across all of them. Our on-going transaction process provides us with up-to-the-minute market knowledge in these sectors that may be of corporate development interest to you.
What precisely distinguishes companies with a record of M&A success? The Spring 2012 issue of Strategy+Business,* proposes an answer based on a 2011 Booz & Company study:
“Successful acquirers make M&A deals that either enhance their distinctive capabilities systems, leverage those capabilities systems, or do both. These companies have been rewarded with deals for which the compound annual growth rate (CAGR) averages 12 percentage points more in shareholder return than M&A deals by other buyers in the same industry and region. Even during the difficult years since the 2008 economic crisis, deals linked to a capabilities-driven strategy have tended to increase shareholder value for the acquirer…”
In the study, Booz focused on an eight-year period from 2001 to 2009, identifying 40 of the biggest deals in eight sectors: chemicals, consumer staples, electric utilities, healthcare, industrials, information technology, media, and retail. In total, the study measured the performance of 320 deals, comparing an acquiring company’s total shareholder return (stock price plus dividends) two years past acquisition with the same metrics of the large-cap index in the acquiring company’s country.
The study defines a capabilities system very specifically as including “three to six mutually reinforcing, distinctive capabilities that are organized to support and drive the company’s strategy, integrating people, processes, and technologies to produce something of value for customers.” As envisioned, these capabilities systems require vigilance and investment, but once in place can guide a company’s process for creating and maintaining value in the market.
The Walt Disney Company applies a spectrum of capabilities in content development, experience design, channel management, etc. to diverse business interests including animated film, theme parks, broadcast, apparel, and retail. Amazon.com Inc. and Proctor & Gamble Company also supply similar examples of well-managed companies with highly distinctive capabilities. All three companies are known for their successful use of M&A. According to the Booz study:
“The capabilities orientation is particularly valuable in M&A transactions, when time is often short and the stakes high. Executives who understand their companies’ capabilities system end up with a reliable and rapid guide to sound judgment… When a deal fits, they have a more solid basis for evaluating the right price. And during the execution of the merger, they are in a better position to gain value.”
Is There a Correlation between Capabilities Fit and Deal Success?
In order to isolate potential M&A success factors, the Booz study divided the deals by their stated intent, using five classifications of intent:
- Diversification—enter a new or unrelated sector.
- Consolidation—take advantage of synergies and economies of scale.
- Geographic adjacency—expand into a new location rather than a new sector or category.
- Product and category adjacency—buy a business with a product or service related but not identical to existing categories.
- Capability access—appropriate a capability the target company has that the acquirer wants.
To look at the deals from a capabilities fit perspective, the study cross-categorized deals using three classifications—enhancement, leverage, and limited fit:
Some deals enhance capabilities. For example, when Disney acquired Pixar in 2006, Pixar’s digital animation innovations significantly enhanced Disney’s traditional strength in motion pictures. Beginning with Toy Story, Pixar’s unique features also reinforced Disney’s capabilities in marketing merchandise and theme park exhibits.
Other deals leverage capabilities. In 2008 when Novartis acquired Alcon—the world’s leading contact lens business—Novartis applied its science-driven businesses capabilities to develop products complementary to its existing portfolio.
Sometimes the result is a limited fit. When Kmart Holding merged with Sears in 2005, the idea was to combine the two businesses for improved performance. However, the chains remain separate, leveraging few capabilities, as financial performance continues to decline.
In the Booz study, nearly two-thirds of the transactions made good use of capabilities, through enhancement or leverage. However, that also meant that 37 percent of the deals were concluded with capabilities as an afterthought. The study next analyzed deal performance by examining the acquisition’s impact on shareholders:
“…shareholder returns held up considerably better among the acquirers that paid attention to capabilities than among those that did not. On average, the biggest premiums went to the “leverage” classification —deals that made use of the acquiring company’s capabilities system… Enhancement deals had the next-biggest premiums… Limited-fit deals fared the worst… as a group, their performance is far below that of deals that take capabilities into greater account.”
Lesson Learned: Evaluate Every Deal from a Capabilities Perspective
Looking at every M&A deal from a capabilities system perspective can make the difference between success and failure—for both buy and sell side transactions. The value of a company’s capabilities system and strategy may supply the foundation for the firm’s success. During the M&A process, a capabilities assessment can guide participants in determining long-term value. When a business case is being made, the following questions are relevant:
- Is the target company’s capabilities system unique?
- How does the company create value for customers?
- What is the difference between the capabilities systems of the target company and the acquiring company?
- Will the target company’s products and services survive and thrive within the acquiring company’s capabilities system?
- Will the acquiring company be able to preserve and integrate the capabilities system of the target company?
- How will the newly merged company execute the combined capabilities system?
- What key elements from the target company are critical to succeeding with the combined capabilities system?
M&A with a Capabilities Orientation Produces Sustainable Returns
We may be progressing toward a time when companies gain market advantage by leveraging their own capabilities systems, focusing on the specific things of genuine value they uniquely supply to customers. A coherent capabilities system can differentiate a company from their rivals. It also can supply intelligent guidance in making smart decisions about making deals. According to the Booz study, “M&A with a capabilities orientation… puts assets, products, and services into the hands of companies that can make the most of them. It can therefore produce a more sustainable long-term return than arbitrage-oriented transactions.”
Carl W. Raggio, III has joined FOCUS as a Managing Director in its Washington, DC office. Mr. Raggio has been an executive in the banking industry for more than 30 years specializing in bank sales and business turnarounds.
Prior to joining FOCUS, Mr. Raggio maintained a consulting practice and has spent the last 15 years in business turnarounds, growth management, M&A due diligence, and court expert testimony.
According to Doug Rogers, FOCUS Managing Partner and CEO, “Carl’s expertise is broad and especially deep in the community banking sector. His experience and credentials will allow FOCUS to launch a Community Banking Advisory practice, initially serving banks with total assets under $1 billion. We believe this is a large underserved market which we expect to consolidate and to transform itself in reaction to the current regulatory and capital markets environment.”
In February 2006, Mr. Raggio opened a new commercial bank as the founding CEO. As part of the opening, Mr. Raggio raised over $14 million in capital and the bank became one of the fastest growing of California de novo banks, achieving profitability in the eighth quarter.
In addition to starting one bank, Mr. Raggio has been the CEO or C level officer at six additional banks. He provided consulting services to many clients, including turnaround, strategic planning, growth, and fiscal management. Due to his experience in banking, commercial real estate, crisis, and problem loan management, he often is engaged as an expert witness.
Recently, Jeff Hooke, FOCUS Managing Director and head of FOCUS Corporate Valuation Services, spoke in Paris to members of CFA France. His address, “Replicating Private Equity Returns with Public Securities,” included discussion of the latest research on private equity returns in the US that focus on leveraged buyouts. He noted the increasing presence of private equity firms in both US and European M&A markets, following a steep decline in activity.
According to Mr. Hooke, with debt, the collective buying power of private equity funds is over $2 trillion, making the funds an important factor in finance and business. While industry hype and media reporting suggest otherwise, the fact remains that the average LBO fund does not beat S&P 500 returns for its clients. He also discussed recent studies on LBO fund returns, the perplexing continued popularity of LBO funds, and a computer program that mimics LBO fund attributes through public stock selections, and thus potentially reduces the need for institutional investors to pay high LBO fund fees.
Attendees had numerous questions and were interested in US practitioner views on the European debt crisis and in the likelihood of private equity funds returning to their previous lofty status as M&A leaders.
CFA France (formerly known as French Society of Investment Professionals) promotes ethical and professional standards within the investment industry, encourages professional development through the CFA® Program, and facilitates the open exchange of information and opinions. It is the local French society of CFA Institute, consisting of portfolio managers, investment advisors, educators, and other financial professionals.
The stocks in FOCUS’ Enterprise-Focused Telecom Technology Index (EFTTI) delivered a strong but not frothy performance in the most recent twelve month period. The EFFTI gained 5.8% in the past twelve months compared to a 2.7% gain in the S&P 500 and a 6.4% gain in the NASDAQ… Furthermore, on a year-over-year basis, the EFTTI managed to outperform the S&P 500 while only slightly underperforming the NASDAQ. With respect to multiples, year-over-year, the revenue multiple for the EFTTI index declined from 2.3x to 2.2x and the EBITDA multiple declined from 9.6x to 8.8x. Download now
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About FOCUS, LLC
Founded in 1982 in Washington, D.C., FOCUS, LLC provides a range of investment bank services tailored to the needs of middle market businesses and their executives. Today, we are a national firm serving clients from offices in major cities across the United States. FOCUS specializes in serving business units with revenue or transaction sizes between $5 and $300 million, serving entrepreneurs, corporate owners, and various types of investors. FOCUS clients include large corporations and private equity firms that engage the firm for middle market transactions.
FOCUS has achieved a very high close rate on accepted buy side, sell side, and corporate finance mandates because of the unique resources, processes, and perspective that we bring to middle market investment banking. FOCUS has developed a systematic, research driven, open, and proven transaction process. It is the driving force of our firm and distinguishes us from other investment banks serving the middle market.
With extensive investment banking transaction experiences and a group of seasoned operating and financial executives, our firm provides a unique value proposition. We bring a strong operating perspective, a wealth of practical experience, and a proven research and transaction process to our middle market clients. Our knowledgeable resources include seasoned partners, managing directors, principals, senior advisors, research staff, internal databases of national and international contacts, and deal experience in a range of industry sectors.