Purpose is the heart of strategic M&A

Purpose is at the heart of strategic M&A

As I’ve said for many years: “Bad M&A almost always fails, good M&A seldom fails.”

The reason is that mergers and acquisitions that simply seek to combine assets to reduce costs, build size or provide a windfall to buyout funds through the use of debt engineering do almost nothing to sustainably improve a business or create sustainable competitive advantage.

The purpose of bad M&A is usually (though not always) to engage in an incremental swag which selectively benefits a certain class of stakeholder, whether that be to achieve a management incentive or just to kick a bigger can down a longer road (i.e., zombification).

But what of those companies that want to plan and execute M&A that turbocharges growth and competitive advantage for the business, and in the process create sustainably superior outcomes for all of their stakeholders?

Well, that’s the attitude and culture that you typically find at the heart of a successful merger or acquisition.

And success in M&A today is critical with technological, biological and geo-political disruption seeking to undermine even the most clever business models.

Disruption in retail - a quick example.

Picture a bricks and mortar retailer that sells a non-fungible product, like designer gloves.

Let’s first have a look at the pre-ecommerce disrupted economic model of the bricks and mortar only retailer.

We assume the business generates a gross profit margin of 65% and enjoys 4 stock turns in a year. That makes for an impressively profitable business with a high gross margin return on investment (GMROI).

Let’s also assume rent is cheap and there is 7 days trading with plenty of transport available and no supply chain bottlenecks.

Good business? Yep. But then comes amazon, Alibaba, LVMH online, and changing consumer tastes for accessing consumer and/or luxury goods. In other words, retail disruption comes to town.

Double disruption. Ouch.

GP drops to 40% (inventory more expensive due to bottlenecks and limited supply as well as pressure on price point due to online alternatives) and stock turns fall to 3x, the beautiful GMROI meets the law of gravity and the business enters survival mode, again!

And then access to people dries up as physical stores go dark. No footfall. Ouch.

For a time, owners move their floor stock through the online platform, if they have one, and this feeds the online craze that’s now a necessity. Then stock becomes hard to get as COVID rips through Vietnam and Taiwan and factory workers are sent home.

Now 21 months into COVID, with the spectre of future variants and different viruses in future years, it becomes clear that online and omni-channel retail models have established a permanent foothold.

In light of that, there’s more pressure due to lower revenue and GMROI and conversations with the bank don’t go so well.

Furthermore, there’s no going back to bricks and mortar only retail, even for non-fungible goods like designer gloves and other products that cannot be commoditised and sold online by way of specifications and images (like certain furniture ranges, as one example). Millennial and Zoomer consumers now demand 24/7 access from anywhere and anytime. And older gens don’t have the disposable income they once had (thanks to QE) and want to feel safe, so they stay at home a lot more and spend less.

Simply put, bricks and mortar alone just doesn’t cut it.

So, what can the traditional retailer do to improve its economics and thrive?

There could be a number of ways to try and survive, including some or all of:

1. Go private label

2. Expand range and chase new demographics

3. Sell on market places

In many cases, this will be slow, expensive and risky because disruption will not stop and wait for businesses to experiment.

Plus, thrive is a number of levels above survive. So, a merger or acquisition is recommended.

Enter, strategic M&A.

Here’s an example of a strategic deal where the combination of businesses goes to purpose, and not to a selective agenda:

1. Player one: Online only designer fashion market place with great cx (customer experience) but lacking in scale and exclusive products.

2. Player two: Brick and mortar retailer with private label/home brand designer gloves and physical network, but low/no online presence.

3. Deal style: Merge or acquire.

4. Strategic purpose: Offer consumers access to exclusive products at sustainable price points to anchor higher GP averaged product mix. Reduce competition from online marketplaces that compete on price. Rationalise distribution channel (and potentially alter store formats) to drive down cost of goods sold and appeal to more consumers, and improve access and potentially utilise 3PL (third party logistics) to reduce cost to serve and/or drop shipping. Spend more on R&D to create sustainable new product platform. Access new customer catchments. Access more flexible funding packages.

5. Economics: Primarily, higher average price point, lower cost of goods sold, more consumer buying tastes and buying methods/channels catered for, higher stock turn and overall higher GMROI. Secondarily, higher EBIT margin resulting from de-duplication of costs. Most likely leads to more sustainable financing and stronger balance sheet. Future monetisation options increased.

Assuming chemistry in culture and people, this recalibration of the economic model allows the retailer to deliver on its purpose in a heavily disruptive and intensely competitive market.

That is what good M&A looks like. If it’s not strategic, take a pass.

On the other hand, bad M&A would be player 1 merging with or acquiring another online only retailer in a different category, which will deceptively tempting, is unlikely to create an advantage in either business. Another form of bad M&A would be player 2 merging with a similar network for size, but as we know there’s hardly ever safety in numbers, as it normally just multiplies the same problem by two.

Purpose is the key.

If the purpose of your deal has nothing to do with delivering your corporate strategy and objectives, widening your moat, reinventing a more resilient economic model and/or generally making your business better, you should ‘pass’. Valuation is secondary.

There’s already a clone army of bad M&A happening right now, so you don’t want to add to it.

You only have to look at the daily press to see examples of bad M&A. Companies or assets merging purely on the basis of potentially realising massive cost reductions through synergy, over a ten year period, is bad M&A. Replacing a low or depleted contract or asset with a ridiculously leveraged long-tail purchase that will come unstuck when corporate borrowing/bond rates eventually rise, meh.

Doing a deal for a sugar hit rerating? Bollocks.

If you’re going to do M&A, do strategic M&A and make your business better.

See you in the market.

Mike

Next Level Corporate Advisory is a leading M&A and capital markets advisor with a 20 year track record of delivering the highest quality of independent financial advice as well as strategic transactions to help our clients level-up.

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