Gearing M&A to Meet 21st Century Demands: In the next decade, m&a will marry the old and new economies, morph technologies into paying businesses, and help globalize key industries. (Honing Supp)

If rapid technological advance has sundered global business into an “old economy” and a “new economy,” mergers and acquisitions may very well unite them as the 21st Century moves forward. For all of their star treatment and glamorous stock prices, say dealmaking professionals, many of the Internet-related, exotic technology, and cutting-edge health care companies that populate the “new economy” can’t convert promise into solid performance before their cash is burned up. Yet, the old-economy pluggers – bricks-and-mortar merchants, distributors, metal-benders, food packagers, and even the makers of yesterday’s hot products that have been relegated to commodity status – are, for the most part, thriving in obscurity The irony isn’t lost on dealmakers who sense the opportunity to marry the old economy’s resources with the new economy’s potential. The traditionalist companies, shunned by the stock market and castigated by new-age gurus as no-growth discards, actually have demonstrated a staying power that puts them in position to acquire new economy assets they need – often on the cheap. “I think it will become a melting pot for both sorts of businesses,” says Jeffrey A. Gonyo, managing director at private equity firm Wind Point Partners. Over time, he sees the Internet shifting from a pure delivery mechanism into “another distribution channel for older-line companies.” “In three to five years, when the business-to-business and business-to-consumer Internet companies run out of cash, what will they do with those assets?” he asks. Logically, the older-economy companies, whether they are retailers or manufacturing companies or catalog businesses, will gravitate toward picking up those assets and some of the technology they have, as well as their customer lists, and integrate them into their own distribution, production, and marketing capabilities.” Before the crossover picks up steam, Gonyo reminds, “the valuations [of the Internet firms] have to come way down.” “I think there will be more types of distressed m&a situations, because these companies will run out of cash and they will be forced to make decisions,” he adds. Robert A. Filek, transaction manager at PricewaterhouseCoopers, also sees a convergence but notes that “the new economy company has things going for it.” “One is the market,” he says. “Two, they have people – who came on board sometimes because of the promise of immediate wealth – who know how to operate on the new turf. The old-economy companies, although they been valued less in the last couple of years, also have some good assets. One is a brand that means awareness and trust. “What you will see is a combination of the so-called new economy’ and old economy’ where they are taking business models that are effective, established brand names, and other business attributes to create a new force,” he says. Filek forecasts that some of the combinations might take the form of strategic alliances in which the old-economy company provides funding or other resources for a partnership. “It might make a lot of sense in some situations not to do a traditional takeover but a modified version of it,” he says. “The best attributes can be combined in an entity that makes sense.” Jack D. Prouty, senior strategic planning consultant at KPMG Peat Marwick, projects that many convergence deals, as well as acquisitions purely within the new economy, will be driven by the pressure to provide technology on a global scale. “In the new economy, if I want to be number one, I’ve got to be a global player,” he says. “A key issue is how to achieve globalization if I’ve been a German-based company or a U.S.-based company. Statistics have shown a large number of cross-border deals in technology. All of that is because the pond that you play in is now global as opposed to local.” Increased numbers of bridge-building transactions, whether rescue missions or natural strategic adaptations, will be conspicuous because they haven’t been done much in the past. But they will represent only one facet of m&a, which dealmaking pros expect to continue at a torrid pace at least through the first decade of the 21st Century. In fact, companies in so many industries are answering such a diversity of drivers by merging, acquiring, and selling that there is no overarching theme to the coming wave of dealmaking, except the way in which m&a has evolved into a highly functional mode of choice for the execution of corporate game plans. Peter McKelvey, managing director at L.E.K. Consulting, points to the adaptability and versatility of m&a for its sustained popularity among companies trying to counter the sea changes in their industries and markets. “Different industries are in different stages of development, so the rationales for acquisitions are different than they used to be,” McKelvey says. “Will overall m&a activity be less over the next 10 years than it was over the last 10? I say no. I think it will be just as hot.” Aside from the need to move swiftly, notes Mark Sirower, m&a practice leader at Boston Consulting Group, buying companies also are emboldened by the ability to use high-priced stock as acquisition currency. “More and more of the large deals today are stock-financed,” he states. “So, why are deals happening? One reason is that we have the currency to do the sorts of deals we couldn’t have imagined, say, 10 years ago, or even five years ago. That’s a unique part of the current merger wave that we haven’t seen before.” Along with the coming prominence of convergence deals, the principal drivers of m&a in 1990s – industry consolidations, technological innovations, globalization, restructurings, shareholder value-creation, etc. – should remain potent this decade. That, say the dealmaking pros, should intensify use of the m&a option to weather an increasingly turbulent business environment. They look for such resulting trends as: * Increased usage of acquisitions to add products and technologies as opposed to slower in-house developments, both in the old and new economies; * More frequent acquisitions by experienced purchasers and expansion of the buying ranks by companies that historically shunned external development; * Acquisitions aimed principally at growing a company, including top-line growth as well as earnings; * More acquisitions to obtain technology, talent, and ideas; * Greater willingness to place bets, especially in technology, with full knowledge that all deals won’t work out; * An upsurge in cross-border deals as larger numbers of both old economy and new economy markets go global; * Wider use of m&a, divestitures, and restructuring methods to remodel companies and create new players; * Increased acquisitions by companies, including young firms in the new economy, at earlier stages in their life cycles; and * Proliferations of sell-side and going-private transactions, largely by old economy companies that can’t hack it in the new economy-obsessed stock market David Braun, president of Virtual Strategies Inc., an intermediary and consulting firm based in Washington, D.C., sees internal R&D often being soft-pedaled in favor of acquisitions in both technology and non-tech areas. Technological innovation, he says, is “less and less being developed entrepreneurially or intrapreneurially within companies that are tending be more focused operationally.” “So, instead of outsourcing a lot of their development, they are buying it,” he reports. “They are saying that we are going to go out and we’re going to buy, in effect, winners – the people or the technology that we think have the highest likelihood of being successful and winning.” Savvy acquirers also are leveraging their deals to recruit top-notch talent “instead of going the traditional route, which is hiring a headhunter” whose candidates might not fill the bill, Braun adds. He says that while people-centered acquisitions have been used mostly in the private equity area, large public companies are doing them more often, especially through their in-house venture capital and minority investment projects. “They are focused on strategic investments in small companies to get people and to get ideas,” he asserts. “You just can’t get those people by hiring a headhunter. That’s where I see acquisitions playing a different role. Whether it’s people or whether it’s technology, they really are after idea generation.” Edward M. Rimland, managing director at Bear Stearns, notes that the small, young targets with more scientific than business smarts also benefit because the deal offers a faster track to commercialization of cutting-edge breakthroughs. “On the technology side, we are seeing acquisitions of companies that have decent ideas but are having trouble getting them distributed,” he says. “Established companies with software sales operations are saying, I’ll take that product and put it in my distribution system’ – and magic is created.” Rimland points out that similar linkages of product development and distribution have been driving pharmaceutical industry deals. “The pharmaceutical company management says, Our pipeline has run dry of drugs and we have a huge detailing force that we need to pay to keep them going. Therefore, we need a new drug. When we look down the pipelines of other companies that have blockbuster drugs coming, we sense we can put them together.’ So, we’re seeing that type of strategy in technology, in which people think about the importance of distribution.” McKelvey figures that acquisitions will play a key role in the future of the biotechnology industry, which is starting to turn out successful products after nearly two decades of development. “The larger companies have a whole host of people with regulatory, marketing, and development skills who want to bring drugs to market through their pipelines,” he says. “So, they are looking at acquisitions so they can take someone else’s discovery and draw it through their pipelines.” Those goals underscore the impetus for very youthful companies, even those not much beyond their birth dates, to swing acquisitions. But McKelvey, like Sirower, thinks that richly priced stocks also instill courage in a lot of startup managers. “The public markets are recognizing companies at much earlier stages in their development,” McKelvey says. “The companies that never had the currency to make acquisitions now have the currency at stages of development that were never possible before. That’s one reason why companies make acquisitions at a much earlier stage in their life cycle than they used to.” Supersonic developments that “can obsolete technology overnight,” says Prouty, have made acquirers more willing to roll the dice. “What a lot of companies, even companies like Microsoft and Cisco, are saying is they don’t know which technologies are going to be tomorrow’s panacea,” he remarks. “They also are saying that they don’t know which companies within these technologies are going to be winners. So, they place a number of bets and do a number of acquisitions, almost like a portfolio picker. Five things that they pick might go belly up, three may do okay, and two are going to be wildly successful. Those will more than pay for the ones that failed.” For the more established companies, Filek says, there will be a priority for growth acquisitions to satisfy Wall Street’s insatiable appetite for non-stop earnings gains. The stock market, he says, won’t tolerate stumbles, even if the company is in a slow-growth industry. “The solution is acquisitions to generate growth in earnings and, in many cases, revenues. In a mature industry with relatively small revenue growth, you are going to see gobbling up of smaller players or regional players, taking out the costs, and keeping the growth going,” he predicts. “You can’t get that by organic growth.” In that setting, smaller to mid-size companies will become more pivotal, according to Linda Mertz, head of Milwaukee-based m&a intermediary firm Mertz & Associates. She sees those kinds of companies both as acquirers seeking growth, global spread, and modern distribution and as targets with assets like a “nice base of business that somebody else can use and leverage.” “The smaller companies are getting more and more attention from a number of places,” she says. “The bigger companies are looking for strategic fit and private equity groups are looking at smaller companies, because the bigger companies are so picked over.” But if strategies suggest a go-for-broke mentality among acquirers, dealmakers also warn of some possible red flags urging caution, especially on the financial side. Ron E. Ainsworth, managing director of Trenwith Securities Inc., a Newport Beach, Calif.-based investment banking boutique, expresses concern that deal financing credit is not quite as plentiful as it was a year ago and says that capital curbs already are starting to impact deal structures and which companies are being bought. Manifestations include a tighter focus on returns and performance as well as a need for LBO groups to put more equity into their deals. “We’re spending more time out in front looking at the capital structure to see it’s whether something that’s going to work,” he says. Strategic acquisitions in the middle market could be hit hard. “There’s not a lot of efficiency to be gained by these transactions,” Ainsworth says. “When you look at the value run rates over the last three to four years, there is a lot of forgiveness there. But when you start having a tighter credit period, and people are focusing on really returning capital, it’s going to be much more difficult to do strategic acquisitions.” Sirower warns that a stock market slump on the order of 20% could chill deals, notably the more ambitious stock-based transactions. “There is no question that if you saw the market drop 2,000 points, the deal flow would, at least in the short term, say, the three-month period following the dive, almost come to a halt, at least for the stock-financed deals,” he says. “Part of the reason is that deals get frozen because they have been negotiated at a certain price, and now they’re not at that price anymore.” A barrage of unsuccessful acquisitions that fires up managerial fear also threatens activity. “One of the things that tends to slow merger waves is when you have lots of failures,” Sirower says. “We don’t have that now because so many things are being done with stock that no companies are defaulting. But if you start to see more Conseco/Greentrees, it would put a damper on activity.” Sirower says that there have been a few deal fizzles but “they are such a tiny speck with all the other activity going on, so they haven’t had much of an impact.” However, with the penchant for pushing the envelope, more failures may be inevitable. Sirower says that no matter how boldly or swiftly the buyer is impelled to move, it can narrow the odds by thinking like an investor. “No matter what we go through, it’s now clear what the economics of acquisitions are,” he says. “If you accept that markets are really a collection of investors, if you are not thinking about your investments like an investor does, it’s unlikely that you are going to be rewarded by investors. If you start with the premise that there are a number of fundamentals involved, and you see a lot of companies not paying attention to those fundamentals, it won’t be surprising what the results will be.” Reprinted from the September 2000 issue of Mergers & Acquisitions Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com