Monday, August 19, 2019

Buy it rather than build it - The calculus driving tech M&A

Research and development consumes considerable time and resources and can have a high rate of failure, while the OECD has confirmed smaller firms particularly struggle to get the funding, talent pool and technology needed to drive internal innovation.

It’s a reason the acquisition of technology — and often the technologists themselves — has become a major driver of innovation, representing a growing proportion of M&A transactions.

Michael Sonego, the Baker Tilly network’s Global Lead for Corporate Finance says businesses searching for a  technological edge often face a choice.

On one hand, they can choose to invest years in research and development, hoping to come up with a product or process that meets their needs. On the other, they can seek out a smaller businesses that already has something that fits their requirements or is part-way there.

“If you're looking to build it yourself, you have the risk of whether you can attract the talent required into your incumbent business, to build what is effectively a technology start-up,” Sonego explained.

“There's the time it takes to hire that talent and then build something and also the risk that you might not get it right, the first time. All that has to be taken into consideration against the opportunity cost for acquiring something.

“I could build it myself, with the risk of budget blowouts and in three years’ time we’ll probably have a product that actually works.

“Or I can go out and buy a product and it takes six months to do the deal and then we’re up and running with the technology, a customer base and a track record. “

Sonego said the technology-fuelled identify-and-acquire model was providing the impetus for a flurry of merger-and-acquisition activity around the globe.

Some of the deals have been easy to understand. Amazon’s long-speculated about purchase of transportation network company Lyft, for example, would seal final-kilometre delivery options for its services, while there was obvious contract-sealing potential in DropBox acquiring electronic signature company HelloSign.

Others have seemed less obvious at the time but no less successful in the long run. People scoffed at Facebook forking out US$19bn for WhatsApp in 2014 but five years later it looks a bargain. Not only did Facebook absorb a potential competitor to its own Messenger service, it gained a platform that has grown from 450 million monthly users to some 1.6 billion.

“On face value, you might not really understand why two businesses are coming together,” Sonego said.

“But if you're privy to the strategic rationale, there's a lot of incumbent businesses out there at the moment who in order to catch up, and perhaps get ahead, find other businesses that are more technologically advanced, and are rolling them in.

“So, while it might look like two peers coming together, sometimes the strategic rationale is about catching up and getting ahead.

"That doesn't necessarily come through when we're looking at transaction data - it might just look like two similar businesses coming together but it’s possible the business that is being acquired has a better platform for their e-commerce or some other technological advantage.”

Both acquirers and targets need to think about the bigger picture, Sonego explained.

For a smaller, developing businesses that involves appreciating the value you can bring to possible acquirers.

“You might only be a small business generating, let’s say, US$5m profit,” Sonego said.

“But if another company can use your technology and it improves their business by 10 per cent and they are a US$500m profit company, that’s an extra US$50m you have delivered for them to the bottom line.

“If you’re an acquirer, your M&A strategy should always be built on your business strategy.

“What is it your business needs? Where is it your businesses is going? And therefore what acquisition helps you get there?”

According to Sonego, there is one vital and intangible factor that always needs to be considered when businesses come together: culture.

“Cultural alignment is critical in any M&A transaction, regardless of the industry,” he said.

“If you're trying to revolutionise your business, you need to be aware of the different cultures and it might be that you structure things post-acquisition to keep the two parts separate – that you don’t just fold the acquired business into your existing one, because you know it won’t work.

“You might leave them as a bit of an add-on, almost a service-provider to the rest of the business.

“If you merge businesses together, you can risk taking away what was unique – maybe they were quick decision makers or really energetic in developing products or engaging with customers.

“If you just drop that into a bureaucratic incumbent business and remove it then you’ve actually lost a key part of the business you bought.”

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The quest for a technological edge is sending many high-profile companies down the acquisition route, as they push to keep pace with their rivals.