Creating value through acquisitions
Stuart E. Jackson, (2007),'Creating value through acquisitions', Journal of Business Strategy, Vol. 28 Iss: 6 pp. 40 – 41
A caution to readers who like nothing better than a headline-grabbing, out-of-the-blue acquisition: Irsquo;m not one of you.
In fact, as a rule, I am an advocate of organic growth, of growing out from the core of the business in ways that build on established strengths. That strategy is at the heart of a discipline that I call lsquo;lsquo;strategic market positioning,rsquo;rsquo; or SMP, which is about defending and growing your companyrsquo;s weighted share of the strategic market segments that define competitive advantage within your industry. This may be defined by geography, customer demographic, channel focus, and so on – the critical dimensions of scale for your particular business. It is not about lsquo;lsquo;growth for growthrsquo;s sake，but about combining the fundamental principles of customer preference and producer economics with the goal of achieving strong market positions and higher profitability through the goal of achieving strong market positions and higher profitability through selective growth.
.Stated simply, you are far more likely to increase the value of your company if you can find a way to expand your existing business and achieve increased benefits of scale or scope within your existing strategic segments.
One huge problem with most of those headline-grabbing deals: it is hard to create value for shareholders given the price of acquisitions today. Every successful corporation is feeling the same growth imperatives, so almost all of them are looking for growing, profitable companies to add to their portfolios of businesses.
Meanwhile, would-be acquirers face stiff competition from financial buyers. equity firms looking for good companies to buy. These financial buyers were not in the game 20 years ago, or even a decade ago. It can take only one or two such buyers with an inflated sense of their own management capabilities to drive the cost of a potential acquisition past what you should be willing to pay for it.
The combination of these factors means that valuations of good companies, and even some not-so-good companies, have been steadily creeping upward since the market recovery began in 2001. The upshot? You may have to pay ten times cash flow or 20 times net earnings, or even more, to acquire a good property. This means that, even if you ignore the time value of money, you need many years of profits at the current level to get your money back.
So that is the bad news. The good news is that there are definitely situations in which, from an SMP perspective, acquisitions make good sense. The point is to use the discipline of SMP to figure out whether it is worth paying the acquisition premium that todayrsquo;s competitive Mamp;A environment requires. You need to ask: What strategic segment are we entering through this acquisition and who is the competition in that segment? Will the new business strengthen our SMP in segments where we already compete? If we are entering a new strategic segment, can we leverage our SMP in adjacent segments to ensure that we achieve a strong SMP in the target segment? Bottom line, will the new business make the weighted average SMP for our overall company better or worse?
One of my favorite examples of an SMP-savvy buyer is Northrop Grumman, which since the late 1990s has used a number of targeted acquisitions to strengthen its SMP and, by extension, its profitability and value.
Northrop by the early 1990s was a50-year-old major defense contractor looking hard for further growth. In1994, it paid $2.1 billion for Grumman Corporation, a premier electronic systems firm and the prime contractor for the lunar excursion module used in the Project Apollo moon landings. The acquisition gave the company (now called Northrop Grumman) a strong technological position in airborne surveillance and electronics warfare systems. Nevertheless, results in the late 1990s were disappointing. Northrop Grummanrsquo;s margins in important programs remained anemic and revenue declined from $8.6 billion in 1996 to $7.6 billion in 1999.
The central problem for Northrop Grumman was that it had failed to achieve scale through the Grumman acquisition and other recent purchases. Great technology alone was not sufficient. Being the fourth-largest military supplier, without a particularly strong niche in any of its strategic market segments, appeared to be a recipe for further decline.
So the company took conscious steps to improve its SMP. In May 1999, it announced that it would buy Ryan Aeronautical from Allegheny Teledyne for $140 million, with the express goal of expanding its reach into key niche markets, including the emerging industry of lsquo;lsquo;unmanned aerial vehicles,rsquo;rsquo; or UAVs.
Even within the tight-knit defense-contracting community, there were those who asked, lsquo;lsquo;Ryan who?rsquo;rsquo; The San Diego-based Ryan had only300 employees and annual sales of about $100million – under 2 percent of the acquiring companyrsquo;s size. Critics of the deal suggested that Northrop Grumman had overpaid for Ryan by a factor of two or three. But let us apply the four-question lsquo;lsquo;SMP testrsquo;rsquo; outlined above and scrutinize the deal from the parent companyrsquo;
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Creating value through acquisitions
Stuart E. Jackson, (2007),'Creating value through acquisitions', Journal of Business Strategy, Vol. 28 Iss: 6 pp. 40 – 41
A caution to readers who like nothing better than a headline-grabbing, out-of-the-blue acquisition: Irsquo;m not one of you.
In fact, as a rule, I am an advocate of organic growth, of growing out from the core of the business in ways that build on established strengths. That strategy is at the heart of a discipline that I call lsquo;lsquo;strategic market positioning,rsquo;rsquo; or SMP, which is about defending and growing your companyrsquo;s weighted share of the strategic market segments that define competitive advantage within your industry. This may be defined by geography, customer demographic, channel focus, and so on – the critical dimensions of scale for your particular business. It is not about lsquo;lsquo;growth for growthrsquo;s sake，but about combining the fundamental principles of customer preference and producer economics with the goal of achieving strong market positions and higher profitability through the goal of achieving strong market positions and higher profitability through selective growth.
.Stated simply, you are far more likely to increase the value of your company if you can find a way to expand your existing business and achieve increased benefits of scale or scope within your existing strategic segments.
One huge problem with most of those headline-grabbing deals: it is hard to create value for shareholders given the price of acquisitions today. Every successful corporation is feeling the same growth imperatives, so almost all of them are looking for growing, profitable companies to add to their portfolios of businesses.
Meanwhile, would-be acquirers face stiff competition from financial buyers. equity firms looking for good companies to buy. These financial buyers were not in the game 20 years ago, or even a decade ago. It can take only one or two such buyers with an inflated sense of their own management capabilities to drive the cost of a potential acquisition past what you should be willing to pay for it.
The combination of these factors means that valuations of good companies, and even some not-so-good companies, have been steadily creeping upward since the market recovery began in 2001. The upshot? You may have to pay ten times cash flow or 20 times net earnings, or even more, to acquire a good property. This means that, even if you ignore the time value of money, you need many years of profits at the current level to get your money back.
So that is the bad news. The good news is that there are definitely situations in which, from an SMP perspective, acquisitions make good sense. The point is to use the discipline of SMP to figure out whether it is worth paying the acquisition premium that todayrsquo;s competitive Mamp;A environment requires. You need to ask: What strategic segment are we entering through this acquisition and who is the competition in that segment? Will the new business strengthen our SMP in segments where we already compete? If we are entering a new strategic segment, can we leverage our SMP in adjacent segments to ensure that we achieve a strong SMP in the target segment? Bottom line, will the new business make the weighted average SMP for our overall company better or worse?
One of my favorite examples of an SMP-savvy buyer is Northrop Grumman, which since the late 1990s has used a number of targeted acquisitions to strengthen its SMP and, by extension, its profitability and value.
Northrop by the early 1990s was a50-year-old major defense contractor looking hard for further growth. In1994, it paid $2.1 billion for Grumman Corporation, a premier electronic systems firm and the prime contractor for the lunar excursion module used in the Project Apollo moon landings. The acquisition gave the company (now called Northrop Grumman) a strong technological position in airborne surveillance and electronics warfare systems. Nevertheless, results in the late 1990s were disappointing. Northrop Grummanrsquo;s margins in important programs remained anemic and revenue declined from $8.6 billion in 1996 to $7.6 billion in 1999.
The central problem for Northrop Grumman was that it had failed to achieve scale through the Grumman acquisition and other recent purchases. Great technology alone was not sufficient. Being the fourth-largest military supplier, without a particularly strong niche in any of its strategic market segments, appeared to be a recipe for further decline.
So the company took conscious steps to improve its SMP. In May 1999, it announced that it would buy Ryan Aeronautical from Allegheny Teledyne for $140 million, with the express goal of expanding its reach into key niche markets, including the emerging industry of lsquo;lsquo;unmanned aerial vehicles,rsquo;rsquo; or UAVs.
Even within the tight-knit defense-contracting community, there were those who asked, lsquo;lsquo;Ryan who?rsquo;rsquo; The San Diego-based Ryan had only300 employees and annual sales of about $100million – under 2 percent of the acquiring companyrsquo;s size. Critics of the deal suggested that Northrop Grumman had overpaid for Ryan by a factor of two or three. But let us apply the four-question lsquo;lsquo;SMP testrsquo;rsquo; outlined above and scrutinize the deal from the parent companyrsquo;
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