All posts in Corporate Development

We developed this blog entry to answer questions some of our clients had about describing the value of the company we were acquiring on their behalf.

Since most people are familiar with the construct of a home purchase and a mortgage the easiest and most general explanation is that the value of a home is the price you paid for it. If you borrow money from a bank to fund the purchase then that debt plus the amount you put towards the purchase equal the home’s value:

Purchase Price = Amount put down + Amount of mortgage

We can translate that to the value of an acquisition in much the same way:

Enterprise Value of a company = Equity + Debt

Headlines will often read that a certain company is the most valuable in the world. Reading more closely that value will be referred to as either market capitalization or enterprise value.

The market capitalization of a publically traded company is the value of its current share price multiplied by the number of shares outstanding.

The enterprise value of a company is the market capitalization of a company plus its outstanding debt. For simplicity, we omit the discussion around cash and excess cash.

Enterprise Value of a company = market capitalization (equity) + Debt

So in practice consider this situation. The enterprise value of a target company is established at $30 million. The company holds $10 million of debt. Therefore:

Enterprise Value = Equity Value + Debt

$30 million = $20 million of equity + $10 million of debt.

At a hypothetical deal closing the acquirer could show up with $20 million in cash and assume the debt of $10 million or the acquirer could show up with $30 million where the seller would use $10 million of the cash payment to extinguish the debt outstanding. In either case the acquirer would own an asset that was at that moment valued at $30 million dollars.

When acquiring other businesses, it’s easy to overlook vulnerabilities within their supply chain. However, if your growth strategy depends on acquisitions, the strength of the supply chains you acquire is as critical to your success as the overall health of the company you are acquiring. Here are a few ways to protect your interests when your growth strategy involves acquisitions that depend on material supply chains.

Investigate Beyond Tier 1 Suppliers

Tech giant Apple has been ridiculed by the press, labor rights groups, environmental groups, and human rights activists several times due to vulnerabilities within their supply chain. Recently, an internal investigation revealed serious human rights violations involving Apple’s lower-tier suppliers in China. Other reports indicate that Apple may not be able to meet market demand for their new smartphone release due to supply chain vulnerabilities.

If a large entity like Apple can’t identify and address supply chain issues before they hit the news, imagine how vulnerable smaller companies are. Make sure you know who the tier 2 and 3 suppliers of your acquisitions are, where they are located, the working conditions in those factories, and the logistical conditions associated with getting critical parts and equipment to production.

Appoint Someone to Stay on Top of Suppliers’ Business Climates

Many of the countries where tier 2 and 3 suppliers operate are in political turmoil, some are in areas vulnerable to natural disasters, and almost any supplier can get hit with fire or other unforeseen problems. This is especially true if the supplier operates in a country with sub-par building codes.

Once you’ve mapped out the supply chains of your acquisitions, have someone internal monitor the news in any parts of the world where lower-tier suppliers operate. This allows you to get ahead of delivery problems that might derail your supplies and find an alternative solution before you are unable to meet production goals.

Develop a Code of Conduct for Foreign Suppliers

In addition to Apple, Wal-Mart and several U.K. retailers have faced public outrage when reports of dangerous and inhumane working conditions in third world countries came to light. The public doesn’t see the difficulties associated with monitoring a complex supply chain — they merely blame the corporate giant who contracted the work.

The smart way to operate in today’s complex global climate is to develop a code of conduct for all suppliers working outside the protection of solid governmental safety codes, and conduct regular inspections of all suppliers. This is especially important to do for a newly acquired supply chain.

Your vigilance before making an acquisition involving a supply chain pays off when operations run smoothly without the hassle, expensive downtime, and media scrutiny caused by an inappropriately managed supply chain you took over from another company.

Contact us for more information on growing your business through acquisitions.

A successful acquisition increases not only the economic capital available to your company, but also the strategic capital available to it. Ideally, the acquiring company and the acquired company together are worth more than the sum of their parts. The additional strategic capital created during an acquisition is commonly termed a synergy or a set of synergies.

For the purposes of developing an acquisition strategy, it can be useful to treat acquisition synergies as a real option that the acquiring company would gain during the acquisition. Synergies add measurably to the overall profit gained from an acquisition. By valuing the possible acquisition synergies that would be gained from different acquisitions, an acquiring company can develop a smarter, more circumspect acquisition strategy.

Synergies do not spring out of inaction on the part of either company in an acquisition; like other real options, synergies require an investment and come with risks. What these investments and risks will be depend on is the kind of strategic capital you want to gain from your acquisition synergies. Frequently, an acquiring company will have the opportunity to invest in several different synergies as part of the acquisition process. Choosing which synergies to invest in–and which synergies to avoid investing in–is an important decision that will determine what kind of strategic capital your company gains from its acquisitions.  An example of a synergy may be leveraging a distribution channel of one company to sell the others’ products or combining intellectual property to launch a new product.

Just as investing in synergies can be treated as a real option that comes with risks and benefits, the option not to invest in synergies can be seen as a form of strategic capital. Maximizing the value of an acquisition frequently depends on your company’s ability to recognize opportunities for valuable synergies, as well as synergies which would be a less profitable and more risky investment.

For a more in-depth discussion of the the strategic value of acquisition synergies, you can refer to “Acquisition Strategy and Real Options” by Mikael Collan and Jani Kinnunen. Their paper includes a defense of valuating synergies as real options as well as a discussion of the strategic effects of an acquired company’s non-core assets.

Garrison Street is dedicated to helping companies grow through intelligent strategy; contact us to find out more about our services.

Multidimensional organizations need multidimensional approaches to succeed. Often firms focus their strategies on a few key themes, for instance, delivering cost leadership by providing the lowest cost manufacturing and distribution, yielding higher profit margins than their competitors. Other companies focus on differentiation by designing and developing new products that offer a unique customer value proposition. Yet, many will miss the role of services in corporate development.

In today’s globally competitive marketplace, services can make the difference between stellar success and “me-too” competition. In a classic Harvard Business Review article (Quinn, et al, Mar/Apr 1990), the elements of a service-based strategy are laid out concisely. Despite two plus decades of intervening time, a service-based strategy can still deliver growth and profit to the corporate bottom line. In fact, with technological advances, one could argue that services are even more important today.

For example, manufacturers of tangible goods should still consider the role of service in their operations. Services such as design and engineering allow for the production of the manufactured good. Technology services allow customers to identify the products and assist in selling goods in the internet economy. Market research, another service, helps the manufacturing firm identify product improvements and build relationships with customers.

Moreover, many companies rely solely on services for their business model. Consider insurance, web design, and health care, for instance. Each of these industries is driven by and growing from enhanced service delivery.

Corporations cannot ignore the role of services in their strategic growth plans. Yet, service development can be more complicated than product development. Services are evaluated immediately by customers and a bad experience can negatively impact the long-term relationship with that market segment.

On the other hand, service development is tested much easier than new products under development. For example, a new service that allows an automobile driver to file an insurance claim by mobile phone can be tested within a small, regional market. Improvements in the new service offering can then be quickly scaled and implemented for future roll-outs.

Corporate development relies upon a multifaceted approach, including strategic product and service development. For more information on strategic corporate growth, please contact us.