Acquisitions and Return on Capital
By GPMIP Partner, Christophe Van Gampelaere
Simplifying Key Performance Indicators (KPI’s)
As companies strive towards simplifying and optimizing their financial KPI’s, the optimization of capital allocation quickly (re)surfaces. An acquisition typically ties up significant amounts of capital – and we’re not just talking purchase price: apart from the deal fees paid to an array of advisors, more capital is still needed after closing to bring the acquired company into the fold. Just think of integration costs and working capital needs.
Yet, with the right processes, diligent risk control and a consistent effort, an acquisition can be instrumental in increasing the return on the invested capital by unlocking acquisition synergies and improving overall performance.
Measuring Return on Invested Capital (ROIC)
Leading companies continuously measure their ROIC. The information obtained helps to guide them in any decision on their capital allocation: to keep, sell, improve or buy certain activities. Such clear metrics not only allow proactive management, but also improve credibility with lenders and investors alike.
Rubik’s Cube and ROIC
In order for ROIC to make overall sense, it needs to make sense in any number of dimensions. Capital is allocated throughout the portfolio of activities and assets, across geographies, product cycles and platforms, and over time. Like a Rubik’s cube, slicing and dicing those dimensions will reveal the interdependencies that exist between them. This is where management gets a chance to excel: to identify where cash can be released from underperforming activities, and to know where to allocate it in order to obtain a higher yield. You may decide to allocate money to an acquisition.
So you’ve identified an acquisition target
How do you know if acquiring it will be accretive or dilutive to the overall ROIC? Suppose you’ve done your homework. Management agrees on the strategy. The target seems to fit that strategy. You decide to go for a financial due diligence. That is a solid start. Normally you will obtain normalized figures. However, is there a top-down quantification and qualification of the synergies with your specific business? How about the costs involved? Does your valuation model allow you to play with the various synergy scenarios and assumptions?
If the answer to the above is yes, you may well be armed with the necessary tools to decide if the acquisition will improve your capital allocation.
Acquisition Synergies Have an Impact on Your ROI
You may have outbid your competitors because you knew the impact of the synergies – and they didn’t. You may have won the deal because you had a more holistic view of the combined picture. Anyway, the Purchase Agreement is now signed, it’s time for champagne. Let the corks pop! Months of hard labor have come to fruition. It’s time to finally go back to business as usual. Or is it?
100 Day Plan – Pre Closing
It’s not. First of all, there’s a period between signing and closing. Any number of obstacles may still derail the deal. The due diligence may continue, going into more depth. There may be regulatory issues. There may be issues with transition service agreements between the target and its parent company.
Achieving the synergies begins during the 100 days prior to closing. Contrary to a widespread belief, management from both the buyer and the seller can already be involved in this planning, taking into account deal-specific restrictions. It will at the least allow you to deepen the top-down assumptions made during the data room phase.
Both buyer and seller can start to prepare for a flying start, taking into account these six elements:
- Focus on customers, prospects and strategic relations
- Involve key personnel on both sides
- Map the cultural similarities and differences
- Establish a clear and logical organizational structure for the combined entity
- Create a focused environment to obtain synergies and realize the integration
- Measure and report on the progress of the integration effort.
100 Day Plan – Post Closing
You now have achieved closing. Money changed hands. It’s time for the next step.
A quick return on investment after the acquisition is possible only if there has been careful planning beforehand, and if the plans are then implemented in a disciplined way with clear indicators to track initiatives and keep a finger to the pulse.
The first 100 days after the closing are critical to maintain momentum, and solidify the project structure behind the integration effort. If you have been able to work on a 100 day plan pre closing, you have a head start. You will have to redo the whole effort however, now from the bottom up.
In any acquisition, there are a number of quick-win areas where easy gains may be obtained. Negotiation power with customers and suppliers, reduction in overhead costs and an increased turnover by consolidating activities are a few examples.
However, the stability of the company always remains central. Customer feedback and financial indicators will help to identify problem areas early on, and will ultimately be proof that synergies are obtained.
I would love to hear comments from others with their thoughts on unlocking acquisition synergies. Comment and “Like” this post on LinkedIn by clicking here.
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