Five Ways to Find Value

By HARVEY SCHACHTER
Special to Globe and Mail Update

Improve the target company's performance

You buy the company, and then radically reduce costs to improve margins and cash flows, or perhaps initiate changes to stimulate revenue growth. This is the most common value-creating strategy, a staple of private-equity firms.

"Among successful private-equity acquisitions in which a target company was bought, improved, and sold, with no additional acquisitions along the way, operating-profit margins increased by an average of about 2.5 percentage points more than those at peer companies during the same period. This means that many of the transactions increased operating-profit margins even more," the authors write.

They advise you to keep in mind that it is easier to improve the performance of a company with low margins and low returns on invested capital than ones with high margins and a high return on invested capital.

Consolidate to remove excess capacity

As industries mature, they typically develop excess capacity, as the higher production of the original firms and new capacity from recent entrants generates more supply than demand. After an acquisition, companies are more willing to close plants across the larger combined entity than they were previously when that would have meant ending up a smaller firm.

The consultants note that consolidation in the pharmaceutical industry has significantly reduced the sales force and research and development expenditures. However, they warn: "While there is substantial value to be created from removing excess capacity, as in most M&A activity, the bulk of the value often accrues to the seller's shareholders, not the buyer's."

This is different from roll-up strategies, which are far riskier, as a company consolidates a highly fragmented industry where current competitors are too small to achieve scale economics. Often it proves impossible to realize the substantial cost savings expected, and copycats move in, bidding up acquisition prices.

Accelerate market access for products

An acquisition can help a relatively small company with innovative products reach the entire potential market for their products. This often happens with small pharmaceutical firms; they are purchased by the giants, which have the large sales forces to take new products to physicians. It also happened with many of the 70 tech companies IBM purchased between 2002 and 2007; IBM estimates it increased those companies' revenues by almost 50 per cent in the first two years after each acquisition, thanks to its global sales force.

Get skills or technologies faster or at a lower cost than they can be built

In the 1990s, Cisco Systems used acquisitions to close gaps in its technologies, allowing it to assemble a broad line of networking products, moving a company with a single product line into the key player in Internet equipment.

Pick winners early and help them develop their businesses

A company can acquire other firms early in the life cycle of a new industry or product line, long before competitors sense the possibilities. Johnson & Johnson managed this with early acquisitions of medical-device businesses Cordis in 1996 and DePuy in 1998, both of which grew at 20 per cent annually afterward.

But the consultants advise the strategy requires a disciplined approach. You must be willing to make investments early, long before others see the company's potential. You need to make multiple bets, since some will fail, and you also need the skills and patience to nurture the acquired businesses.

source: http://www.theglobeandmail.com/report-on-business/managing/morning-manager/five-ways-to-find-value/article1896835/