Mapping the Hunt For Prized Targets: How a systematic search-and-screen process pays off

Merger and acquisition activity is often a critical component of growth and diversification. In advising a broad range of companies throughout the M&A process, L.E.K. Consulting has found that many do not have a systematic screening process in place to ensure that their M&A efforts support their corporate growth strategy. Potential deals are often initiated informally – via a telephone call or a personal conversation with an investment banker, a business broker, or a business development executive at another firm. This approach to identifying opportunities is frequently paired with a screening process that can be best described as “ad hoc,” in which screening criteria are informal or undefined and are applied inconsistently to potential opportunities. Not surprisingly, this can result in sub-optimal outcomes. Companies and products that do not have a good fit with the overall corporate strategy may be considered, and due diligence may be undertaken – all drawing on limited resources. Furthermore, when sub-par opportunities are considered, management time may be wasted and unnecessary costs incurred. While time and resources are devoted to these potentially less valuable opportunities, the “right” deal may go unexamined. On the other hand, a proactive, systematic approach to the M&A process, including a well-defined screening stage, creates substantially greater potential for success. An orderly, comprehensive screening process arms companies with a structured methodology that enables fast, effective responses to sound opportunities, and supports more effective research to find even better ones. Whether for in-licensing products, acquiring a company, or seeking a merger partner, a proactive screening process is a crucial step in the M&A process. The overall M&A process has several major stages. Acquisition screening immediately follows the first stage of strategy development and sets the foundation for the rest of the process. Consequently, designing and implementing a well-thought-out approach positively impacts every subsequent stage. In this article we discuss in detail the benefits of utilizing a systematic approach to screening M&A opportunities and share identified best practices that can be applied as companies seek to improve their success rates in M&A, product acquisition, in-licensing, and other types of deals. Those companies that rigorously engage this type of proactive screening process are positioning themselves to be competitive in both the short and long term as well as increasing the likelihood that their efforts will improve shareholder value. Benefits of Proactive M&A Screening Companies that adopt a proactive M&A screening process have an advantage over ones that target their acquisition prospects using the common “over-the-transom” approach, in which M&A researchers may only consider targets that have made it clear they’re in the market. We’ve identified five key benefits that a company can derive from a formal and more proactive approach to the M&A process: Enhanced strategic consistency – M&A is often a critical component of corporate strategy. Companies that use a systematic and proactive screening process know that their business development efforts are targeted at opportunities that help fulfill that strategy. Similarly, if an “over-the-transom” opportunity arises, management can quickly and efficiently assess it and move forward, if appropriate. Most attractive deals targeted first – Developing a proactive approach enables an acquirer to target the most attractive companies or products first, increasing the overall likelihood of deal success and minimizing time and effort wasted on less optimal opportunities. Furthermore, a competitor may learn of an impending deal and react. By approaching the screening process proactively, a company can establish and maintain a competitive position by being first to engage, by being more informed, and by being prepared to move on a deal more quickly. Efficient use of limited resource – The time that executives spend on sub-optimal opportunities prevents them from focusing their attention on other, possibly more valuable opportunities. Ensuring resources are consistently focused on the highest-priority opportunities maximizes the return on a company’s time and effort. Reduced politics – When taking the “over-the-transom” approach to opportunity assessment, personal and professional relationships and individual preferences for given deals can strongly influence how potential deals are viewed and internally promoted. This can lead to bias and politics, both of which may serve to complicate the process and undermine strategic objectives. Adopting a proactive approach to acquisition screening -one driven by strategic goals, a comprehensive list of opportunities, and clear screening criteria – can significantly reduce bias and help the process proceed with minimal politics. Framework for ongoing analysis – Keeping track of multiple opportunities is both critical and challenging. Using a formal screening process can help companies maintain a clear paper trail of the decisionmaking process, helping business leaders keep track of why target companies have been included or excluded over time and enabling ongoing analysis as opportunities and circumstances develop. A framework or system to manage this flow of information may, in fact, become the most important single resource in a business development program, particularly if it’s maintained as a “living” system that’s regularly updated to reflect ongoing changes in the marketplace. This framework may be as formal as a database or as basic and informal as a key individual who mentally organizes, manages, and communicates essential information. Components of the M&A Screening Strategy There are four essential steps in the M&A acquisition screening process, which we outline below. We then give examples of how companies have successfully implemented this process as part of their overall M&A strategy. Step 1: Establish and define screening criteria A well-designed M&A strategy clearly articulates the company’s goals and highlights the factors that make an opportunity attractive. This in turn drives the development of the most appropriate set of screening criteria. As research is conducted and opportunities are assessed, more details can be added to clarify and refine the criteria necessary to fulfill the M&A strategy. Components of a company’s business strategy that might drive screening criteria include: * If a strategy involves leveraging an existing sales force, what new products are optimal? * If a strategy requires entering a new market segment, which segments are most attractive and what companies can help enter these segments? * If a strategy calls for low-cost manufacturing capability, which companies can provide it? With strategic objectives in place, the company can develop a set of clear criteria to evaluate deal opportunities. The criteria used to judge M&A opportunities will typically fall into one of three categories: inclusion, exclusion, or prioritization. Inclusion and exclusion criteria are relatively straightforward. They apply specific elements from the corporate strategy to quickly include or exclude prospective targets without expending a significant amount of resources. This is especially important when an company is evaluating a long list of companies. In general, L.E.K. has found that 50% to 80% of prospects can be excluded early on in the evaluation stage by employing inclusion or exclusion criteria. Some examples include: Geographic Criteria – “We’re looking to acquire businesses that have U.S.-based headquarters and 90% or more of their sales within the continental U.S.” Product or Customer Criteria – “We want to acquire currently marketed pharmaceuticals that can be prescribed by a cardiologist.” Size Criteria – “Only companies that have revenues of more than $20 million will be considered.” Capabilities Criteria – “We’re looking for companies that can provide us with low-cost manufacturing capabilities in China.” Prioritization criteria, on the other hand, require a different type of judgment because a range of options may need to be considered as part of the acquisition opportunity. Examples might include prioritization by: Time or Date – “Ten years of patent protection is better than five, but how much better?” Size – “$100 to $500 million in sales is best, but $50 million to $100 million is sufficient.” Product Position – “The leading brand in the target’s segment may be best, but the No. 2 product will also be attractive.” Step 2: Build a comprehensive candidate list The second step in the process is to build a comprehensive list of companies from which to begin the screening process. The size and scope of this list depend primarily on the company’s particular industry, strategic intent, and how rigid the acquisition criteria are. The initial list should be assembled from multiple sources, such as SIC codes, industry databases, trade associations, mailing lists, and industry journals. Casting a wide net to gather a range of potential prospects has distinct benefits. Pulling information from diverse sources reduces the probability that a favorable candidate will be overlooked. In addition, when multiple or conflicting opinions exist, a more comprehensive list facilitates consensus building and results in more objective decisions. Once a comprehensive list has been created, a system can be built to store key data on an ongoing basis, such as which companies have been included or excluded for consideration and why. This provides a valuable tool that can be updated over time as the business situation changes for the enterprise and the prospective targets. If a company decides to change its geographic inclusion criteria, for example, sorting through companies with a significant European operation while excluding those that are headquartered outside of the U.S. could be accomplished quickly and efficiently. Step 3: Prioritize the comprehensive list Inclusion and exclusion criteria can now be applied to the comprehensive list, helping a company to quickly and efficiently eliminate those opportunities that do not meet the basic threshold for inclusion and identify those that should be considered further. Once the list has been truncated, additional data can be collected and the prioritization criteria can be applied to the remaining companies. Data may come from secondary sources such as SEC filings, articles, corporate websites, or market research reports. Primary research, such as contacting the company, speaking to sales representatives, or interviewing established customers, may also be necessary at this point. Some clients utilize a numerical rating system. For example, a company at the “ideal size” of $100-$500 million in revenues might be given 10 points. A company with a slightly “less attractive size” of $50-$100 million in revenues might be given five points. Adding up the points across all the criteria allows for prioritization of the opportunities. An alternative approach is to allocate weightings to each criterion. For example, management talent might be rated a 10 while revenue might be rated a 5. The score in each prioritization category is then multiplied by the weighting and the total for each candidate summed. Some companies prefer to perform this assessment stage on a more qualitative basis, without formally quantifying the criteria. Step 4: Develop profiles Once the final list of potential targets has been refined, it is critical to develop a profile representing each of the candidates. These profiles can range from a page to several pages in length depending on the needs of the company. Some aspects of these profiles may include: * Key company information such as size, location(s), and organizational structure; * Background and contact information on target company decisionmakers; * Management team background; * Ownership structure; * Company or product history; * Product and patent information; * Customer and market data; * Current business alliances; * Competitive situation; and * Segment trends. With these profiles in hand, decisionmakers have enough information to make an initial approach to a prospective target. While profiles should not be considered sufficient due diligence to move forward with a deal, they do provide a good summary to begin the process. The following case studies illustrate how two clients have used this process to facilitate and hone their M&A strategies. While their industries are vastly different, they were able to apply the same methodology and process to help achieve their overall corporate and M&A goals. Case Study Biopharmaceuticals Firm Identifies Products for In-Licensing We worked with a biopharmaceuticals company that used the proactive acquisition screening process described here to identify new products for in-licensing. At the time, the company had one successful product on the market and employed an underutilized sales force. The company’s executive team embarked on an in-licensing strategy to search for products that met the following inclusion/exclusion criteria: * Established in specific therapeutic areas, such as the cardiovascular or respiratory segments; * Primarily focused on the U.S. market; and * Sales potential of $500 million. As a further refinement to the basic inclusion/exclusion criteria, the company wanted to target products that had not been approved by the FDA but were far enough along in clinical trials that a product launch would be possible within the next two years. To prioritize the products, additional criteria were applied. For example, were the target products in certain segments of the therapeutic area? If so, which ones? How long was the patent life on the products? Were the types of doctors predominantly primary care physicians or specialists? What was the level of differentiation for each product? Figure 1 illustrates one method for graphically summarizing how well the products being evaluated fit the specified prioritization criteria. We developed a comprehensive list of more than 2,000 products that was then refined using the inclusion/exclusion criteria. This resulted in a list of 250 product candidates, which was further refined using the prioritization criteria. Each product was evaluated and the data recorded so the research could be updated going forward. Thirty high priority products were identified and profiled in depth. The research that was used to develop the profiles resulted in 10 products being highlighted as the most attractive. Figure 2 summarizes the process of truncating the full universe of potential candidate companies to a highly refined list of targets through the use of a comprehensive screening system. Efficiently reducing the list from 2,000 products to 10 highly qualified products avoided wasted effort and resources. Armed with its M&A strategy, screening criteria, research findings, rankings, prioritizations, and profiles, the company was prepared to approach the owners of the target products. The firm opened preliminary discussions of a possible deal with the confidence that it was in the best position possible to rationally and methodically explore the most valuable opportunities, and was able to complete a deal with one of its top selections. Case Study IT Staffing Firm Grows Its Business First, a set of criteria was established for potential targets in terms of the size of the company in revenues, geographic location(s), capabilities, and skill sets. Next, a broad target list was created using a variety of sources, such as member lists from industry trade organizations, to establish a universe of over 900 potential candidates. Duplicates were removed and basic information was captured on each of the companies. Through use of the inclusion/ exclusion criteria, the list was pared down to 120 companies. The 120 companies were researched in greater depth to prioritize them into A, B, or C tiers. Ultimately, additional information was gathered on the A tier companies – most of which were privately owned – to create more detailed profiles. In approaching these candidates, the client let each know that it had been carefully chosen from a field of nearly 1,000 candidates. By demonstrating in-depth knowledge of the target companies, the client made a favorable impression on the companies’ owners that left them more open to considering and accepting an offer. The company ultimately acquired several of these targets, adding a new and profitable line of business to its existing operations. Taking steps to implement a proactive screening system can contribute significantly to the success of a company’s M&A strategy, saving considerable time, effort, and resources and resulting in positive bottom-line results and increased shareholder value. Steven Rosner is a Vice President in L.E.K. Consulting’s Boston office. This article was adapted from its original form in the firm’s Shareholder Value Insight publication. (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com