M & A – The most preferred option to grow in uncertain times

It is a typical Monday 9 AM! Ready to kick-start another challenging week! Fine day in Chennai !! Not so hot like a typical Chennai climate. But, for first generation entrepreneurs it is an ordeal to pass thru weekly pressures of Cash flow, Attrition, New business and opportunities etc. etc. This experience is collectively described as “Monday Morning Blues”.

The growth dilemma

There has always been a great dilemma for entrepreneurs during fund raising exercise especially when it comes to taking the company to the next level of growth. The dilemma does not stop by simply raising the money for growth, but it goes on till such time one is able to strike a balance between how much stakes to dilute and the tangible benefits that the venture will get.Then comes the business and revenue models. The previous eras have brought countless innovations in the theory and practice of running businesses. Many are now staples of contemporary management, but others were ephemeral distractions that led companies down the wrong roads. Too often, leaders have sought the appearance of success rather than its reality – size for the sake of size, book-keeping profits as opposed to intrinsic value, earnings growth manipulated to please the stock markets. This era’s changes are already redefining management theory and practice. Raising competitiveness intensity forces a return to basic again. Going down to basics today means first and foremost focusing on how you can create intrinsic or fundamental value for your business. Your ability to create fundamental value rests on how good you are at finding the right balance between your external and internal realities and your financial aspirations; in other words, how skilfully you develop and use your business model. The major reason to focus on the fundamentals is that growth won’t come easily. Organic growth will not often produce the double-digit gains that were routine and even obligatory in the last era.

Leaders who hope to grow their way to success through mergers and acquisitions in the present market scenario are left with umpteen no of options. Needless to mention that M & As promises to increase economies of scale and yield efficiencies from synergy – or at least show the kind of revenue growth that looks like progress. And some players thrive by picking up battlefield causalities on the chips and hammering them to shape. Many people viewed General Electric’s acquisitions in the late 1980s of troubled RCA as a misconceived diversifications ploy. But after selling off RCA’s consumer electronics and aerospace businesses, GE wound up with NBC for a song, turned it around and went on to build it into a network powerhouse. NBC generated significant profits year in and year out, and with the addition of Vivendi Universal’s entertainment assets which greatly helped GE’s future growth.

The courage to change

Many first generation entrepreneurs lack with the intelligence to recognize that they have reached a crossroad but don’t follow through and head down the new path. Their inner core isn’t tough enough to allow them to acknowledge and deal with an unpleasant reality, whether it is closing a loss making division or taking realistic look at the business model and tweaking to market expectations. Many would like to continue in their comfort zone of their familiar managerial routines and protecting their pay checks. They may be afraid: change means taking risks and taking risks raises the possibility of failure. The fear failure occupies most of entrepreneur’s growth dilemma of raising money, divesting their stakes and working under a different management culture.

These entrepreneurs often don’t recognize that failing to make a shift can be riskier than making none. The entrepreneurs who have the appetite for tough actions have the inner strength. They are willing to look at clearly at the business model that has been highly successful and is no longer relevant.

To raise funds for growth or get merged is a difficulty and at times too difficult to get consensus from founder/ promoters. This leaves the emerging organizations with fewer options such as the following:

  1. Tag along with a bigger player and pitch for bigger contracts – on a case-to-case basis
  2. Dilute promoters’ stake heavily and raise money from PEs or VCs at the cost of losing control of the company in your eyes and also not knowing the business outcome after fund infusion
  3. Be a captive IT Partner for a big group and get acquired by them eventually once a decent value is built. The flip-side to this approach is that one does not know the time it will take to realise decent value

The current era of business offers promising option than the usual organic growth for entrepreneurs.

M & A – The most preferred option to grow in uncertain times

While an acquisition may have higher risk of failure than any other expansion strategy, it also provides a much superior return profile in comparison to organic growth strategy. M & As is intrinsically risky and predicting the aftermath of any acquisition is almost impossible. The fact remains that predicting the aftermath of any business plan execution is also an impossible task. But there are learnings from the past that can mitigate the risk of failure. Most M& A s fail due to inadequate articulation of two key enablers of a deal: transaction management, which is all about paying the right value, conducting a thorough due diligence and appointing the right transaction adviser; and integration management, which is about devising a detailed integration strategy ahead of the buy decision to keep the rationale of the acquisition intact. The fact of the matter,however is that any corporate strategy can go bad despite putting safeguards against any possible fallout in future. And so can simple business decisions related to marketing and research and development will lead to unpredictable business outcome.

If there are precedents where shareholders’ wealth has been written off as fallout of ill-planned M & A, there are more than a handful of cases in history through well executed M & A strategy that delivered immense value to share-holders:

  1. IBM’s market value of USD 227 Billion has been created virtually through acquisitions. It has acquired 187 companies since 200 for about USD 200 billion
  2. SAP has made 5 major acquisitions since 2001 for a whopping sum of USD 20 billion to reach its current position of Euro 17 Billion
  3. Cisco built the current sales turnover of USD 47 billion from USD 4 billion in 1996. Cisco has acquired more than 450 companies since its inception. Cisco’s fundamental growth strategy has been M & A
  1. GE has acquired more than 18 companies since 1952 ranging from Aerospace, Process Industry, Financial Services , Healthcare for whopping sum of USD 14 billion to reach its current revenue of USD 150 billion
  2. Exxon Mobile, It is what today on the back of a merger between two energy giants which clearly didn’t happen without the risk of failure in 1999. Exxon Mobile has surpassed Apple’s market cap and reached the USD 385 billion in April 2013.
  3. Maersk has acquired P & O Nedlloyd in 2005 to create one of the largest shipping lines in the world.
  4. P & O and Nedlloyd were merged together in 1996 which was yet another record in the history of shipping lines.

It is all about convincing the company’s management on the risks associated with a strategy like M & A on the back of statistics of successful transactions.

The entrepreneurs who are looking at raising money must do the following reality check and decide whether M & A is an option.

  1. Research and evaluate your competition
  2. Measure share-holders value year-on-year and see whether it is increasing
  3. Your ability to raise funds and offer significant returns within a short period of time e.g. 3 years to 5 years
  4. Ability to devote time on innovation and offer more customer value

The IT/ ITeS industry are moving towards consolidation and better economies of scale and efficiencies.The market is swamped by competition and the technological advancements are determining new way of delivering customer value. Therefore, IT services companies have to seriously consider M & A as their growth strategy to protect investor’s wealth, IP, customers, business.

Guest Post Contributed by Rangarajan Sriraman. The views expressed in this article are personal. The author is a serial entrepreneur, mentor and strategic advisor to start-ups in IT and ITeS segment based in Chennai and has been involved in 2 start-ups so far from the concept to execution stage and later on successfully exiting.