Why Alliances Are Gaining Momentum

For much of the past few years, companies basically shunned M&A and focused hard on governance and risk mitigation issues. But now Wall Street is demanding growth – by any means. The exercise of cleaning up corporate governance and controls has made companies boards’ far more cautious about okaying transactions, but they realize they can’t stay out of the deals arena forever. Many companies accumulated hefty cash reserves during their years of cost cutting and internal housekeeping, and they must put that money to work by funding growth initiatives, despite any reluctance they might have. Dampened M&A levels in recent years opened a window for corporate development professionals to pursue growth opportunities by forming alliances or joint ventures – often used as a substitute for mergers or acquisitions. In fact, a survey recently released by KPMG LLP shows that in the next two years, 64% of U.S. executives plan to increase their use of alliances and 52% plan to enter into more JVs. The survey also found that respondents expect to increasingly use alliances or JVs in high-growth global markets, such as China, where partnerships with local companies can help foreign firms gain a toehold in unfamiliar markets. The survey results were based on a poll taken in March of executives at U.S. public and private companies, with at least $500 million in revenue, who had been involved in alliances or JVs in the previous 12 months. Elaborating on the survey results, Rob Coble, KPMG’s Southeast Area Partner in Charge of Transaction Services, says that market demands and shareholder calls for growth are urging survey participants to form more partnerships in the near future. Partnerships on the Rise “Yes, alliances are back. They are a hot strategic vehicle for new business development and geographic expansion,” says David Ernst, a Partner at McKinsey & Co. Studies that his firm has done also indicate that most executives expect to use more joint ventures and partnerships over the next few years, and he says the reason for that is clear: “It’s all about premium-free growth and innovation. JVs and alliances provide a good way to grow into new markets, to access technology, to co-develop products, to shape industry standards, etc., without having to pay an acquisition premium.” Larraine Segil, a Director at negotiation and relationship management consultancy Vantage Partners, agrees, noting, “In many respects you can almost gain the same value of what you’re interested in by forming an alliance, at a far lower cost.” As markets, regional and global economies, and technologies have changed, companies have been seeking new ways to work together toward a shared goal, and for many firms, partnerships appear to be a viable alternative to costly acquisitions and internal development. Alliances and JVs have recently surged in popularity since they can be a great way to gain access to new products, technology, expertise, and customers – all while spreading the risk by collaborating with another firm. When a merger or acquisition fails, the buyer must assume the entire loss. Partnerships are generally less costly than acquisitions and are a good tool for boosting revenues, diversifying into new markets, augmenting capabilities, and strengthening relationships with existing customers and suppliers. Even with a scarcity of capital, a company can form a JV or alliance. These relationships provide the partner firms with access to additional resources such as talent, technology, and distribution systems. And by sharing costs and risk, the partners are free to pursue other growth initiatives, which can create better odds for overall financial success. The advantages of alliances will certainly lead to more teaming. Yet, despite their compelling financial and strategic advantages, these types of business relationships are always risky business, experts note. And the risk continues after the partnership takes shape and begins operating, especially if the partner companies are unhappy with the results. JVs and strategic alliances are created for a specific purpose, but sometimes the creators are not in tune regarding the alliance’s aim. The unspoken truth of many JVs and alliances is that the partners’ expectations often differ considerably. Far From “No Big Deal” Experts have noted that many companies tend to consider alliances and JVs as no big deal, but nothing could be further from the truth. Kip Clarke, head of M&A at KeyBanc Capital Markets, believes that KPMG’s survey findings reflect executives’ “initial intrigue” with alliances and JVs, but notes, “I would agree that we’re seeing clients consider JVs and alliances more often, but nine times out of 10, they’re dissuaded once they get into it a little deeper. At first, they appear to be lower-risk propositions – and that’s one reason we think lots of CEOs are intrigued by them – but they’re very hard to structure. A lot of companies, once they start rolling up their sleeves, say they’re way too complicated. That’s what we see happening much more with clients, especially the small- and mid-cap public companies. They don’t want the complications.” The reality is that JVs and alliances are much easier to form than to manage. Without deft management of the integration, coordination of resources, and building of trust between the partners, even the most strategically solid partnerships may be headed for disaster. Partnering has a mixed track record: The success rate for JVs and alliances is about as low as that for mergers and acquisitions. Over the years studies have frequently found that nearly 50% – perhaps even more – of alliances fail to meet expectations. For all of their advantages, alliances can be risky prospects that founder if the partners don’t deliver on promises and start disliking each other. In addition to disagreement over a partnership’s aim, other concerns facing JVs and alliances include culture clash and power struggles, which creep into mergers and acquisitions as well. Sarbanes-Oxley’s Effect on Alliances A new wrinkle in the “alliance versus acquisition” decision, notes Clarke, is the effect that Sarbanes-Oxley may have on partnerships. The problem with many of Enron Corp.’s partnerships was that they “involved contracts that skirted the old accounting disclosure rules,” he says. “They were set up more as murky, off-balance-sheet partnerships, and I think that today boards ultimately are going to be a lot more comfortable with more transparent arrangements.” While that may be an issue for some companies, most dealmakers would agree that for the small number of companies that were doing alliances for the wrong reasons, i.e., to take advantage of off-balance-sheet approaches, Sarbanes-Oxley may be an issue, but the vast majority of companies form partnerships for business not accounting reasons. Clarke further believes that Sarbanes-Oxley could “steer companies more toward traditional mergers or acquisitions with full disclosure and transparency.” “Once you start talking about alliances, the accounting is a lot less transparent than in a straightforward investment or acquisition. I think boards today are much more vigilant about transparency. What we’re hearing from directors in our governance practice is that transparency is the key, and direct investment or straightforward mergers or acquisitions are a lot more transparent, although they may appear to be higher-risk than a partnership.” Boards have become more active in many corporate functions following the enactment of Sarbanes-Oxley, including oversight of a company’s alliances and acquisitions. In fact, KPMG’s survey shows that 94% of the respondents said that their board and the executive management team are at least “somewhat involved” in their partnership activities, while more than 60% said they are “very involved.” Too Many Eyes? But is this extra layer of supervision adding to or detracting from ventures’ successful management? It depends on “how far they get their noses into it,” says Segil. “If the board is overseeing alliances in terms of micromanaging them, that would certainly detract from their performance. But if they’re overseeing them from a strategic, return-on-investment point of view, I think that’s healthy,” she adds. Sharing a similar view, Ernst believes that many JVs and alliances could benefit from “more-demanding performance management and more engaged boards.” JVs have gotten much bigger and more complex, he notes, so it “makes sense that boards should be more involved in shaping strategy, evolving the partnership, asking the challenging questions about performance, and helping to get resources from the partner companies when needed.” Segil, who serves on a Fortune 500 board, adds that she is witnessing more interest in alliances coming from CFOs. “JVs and alliances used to be viewed more as a sales or marketing function. Now they’re seen as a mechanism that can deliver growth or higher earnings potential for the whole company. When the CFO is involved, the likelihood that alliances are going to come to the notice of boards increases. And when that’s the case, the scrutiny these partnerships will endure should be healthy.” Despite their complexity, alliances and JVs have certain advantages going for them, the experts say. Alliances have always been a popular – and sometimes a better – growth vehicle in fast-moving industries and for entering emerging markets, notes Ernst, so they have been used intensively in China, Latin America, and India, despite the fact that acquisitions in emerging markets are more doable these days. The Way to Go in Certain Sectors Coble agrees, adding that despite a growing trend toward investments and acquisitions in China, partnerships are attractive growth vehicles in the country, and are often preferred by investors who have limited experience in that market. Alliances provide access to manufacturing capabilities, distribution systems, supplier networks, local management expertise, and government contacts, he notes, and allow foreign investors to gain access to restricted industries, such as financial services and communications. On the “buy versus partner” question, Segil notes, “Because of cultural and political issues in some countries, alliances may be more readily accepted than an acquisition. But there’s always the issue of whether you really do better when you have a control position in the country. I think that in China, you might do better if you have control, but in India that may not be the case.” Pointing to research that McKinsey & Co. has done on deal announcement effects of alliances versus acquisitions, Ernst notes that there are some industries where alliances tend to be better received than acquisitions, including high technology, media, and pharmaceuticals and health care. Conversely, energy, retail, and transportation acquisitions tend to be better received by the market than alliances in those sectors. On a similar note, his firm’s research found that alliances have a higher degree of success than mergers and acquisitions when used to enter new business areas, and a slightly lower success rate when used in a company’s current market. In the pharmaceuticals space, for instance, alliances and JVs have been a traditional way of spreading the risk of drug development or sharing the risks of major R&D projects. As drug discovery costs rise and cost-cutting pressures increase, biotechnology and drug companies are creating more alliances to bring products to market at a lower cost. Clarke has noticed more JVs and alliances in certain technology and health care markets but notes that in “old economy” manufacturing, distribution, and service industries, “you’re probably going to see intrigue in partnerships but not a huge increase in numbers.” In addition to creating new alliances, Ernst notes that partner companies can reap value in better management or restructuring of existing deals. “About five to 10 years ago, the alliance explosion started and today there are hundreds of big, complicated alliances and JVs, many with more than $1 billion in revenue and assets. Many of those are now in mid-life crises and are being re-shaped, in part because of Sarbanes-Oxley but more because of shareholder pressure and market changes.” Although a restructuring exercise may sound like a fix for a troubled operation, Ernst notes that the most successful alliances and JVs are the ones that evolve; they are three times as likely to be successful as those that fundamentally stick with their original purpose, he states. (c) 2005 Mergers and Acquisitions Journal and SourceMedia, Inc. All Rights Reserved. http://www.majournal.com http://www.sourcemedia.com