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It’s a fair question, with a complicated answer. I can do a back of the envelope calculation and determine the enterprise value of a company today based on 12 months trailing revenue or perhaps a multiple of EBITDA (earnings before interest, taxes, depreciation and amortization). But the real value of a company is based less on its past performance than on its potential worth to a future owner. What the buyer can bring to the party and how well its management believes it can execute the acquisition and business strategy going forward is where a company’s true value resides and where the domain expertise or strategy comes into play.
Case in point: In 1996, IBM bought Tivoli Systems for $743 million, paying about 10 times trailing revenue. Many analysts concluded at the time of the sale that IBM grossly overpaid for the asset. Within a year, IBM was able to leverage Tivoli into almost a billion dollars in revenue. Just like beauty, value is in the eye of the beholder. Tivoli had more value to IBM than Tivoli had to itself at the time. So did IBM pay 10 times revenue or less than one times revenue for Tivoli?
Unfortunately, I don’t have a crystal ball. So I don’t know what potential buyers can do to leverage a company’s value. And a calculation on the back of an envelope almost always fails to satisfy.
Here is something else the owners I talk with really don’t want to hear: Chances are they have taken actions that over time have eroded — or even destroyed — the value of their company without even realizing it. In my last post for GigaOM, I wrote about “5 things that destroy a company’s value.” In this post and in future posts, I’m going to examine these value killers one at a time in greater detail.
Today, my topic is opportunistic acquisitions. And to be clear, my message is for owners of midmarket companies who are interested in making acquisitions designed to increase their own value. In doing so, they hope to become attractive acquisition candidates to buyers in the future.
Acquisitions fail 70 to 90 percent of the time
If you search for the phrase “acquisition failure rates,” you’ll be treated to study after study that peg failure rates at somewhere between 70 percent and 90 percent. Dig a little deeper, and you’ll find articles enumerating the many reasons most acquisitions don’t work.
Nearly all of these reasons can be boiled down to two:
- The acquisition was a bad match between what the seller had and what the buyer could do to create value. The bad match often occurs because the buyer was fooled, misled, or overlooked key points of the deal, or the buyer simply suffered from hubris.
- The buyer did a poor job of integrating the acquisition and executing on the business strategy designed for its new asset.
In both situations, acquisitions fail because the buyer doesn’t really know what or why it’s buying — let alone what to do with the acquisition.
Think about when HP bought Compaq or when Time Warner bought AOL.
Of course there are companies that are successful with acquisitions. Cisco has acquired 150 companies since its first acquisition in 1993. In fact, acquisitions are a core competency of Cisco — few companies are better at it.
Cisco’s purchases are fueled by the desire to speed up the rate at which the company can offer new technologies in a market that is hyper-competitive and evolving rapidly.
Not all of Cisco’s acquisitions are hits. Remember the Flip video camera that Cisco shut down in 2011? But many were successful, especially in the early days. At the peak of its acquisition activity in 2001, Cisco’s purchases were widely credited with laying the foundation for about half of its business at the time.
The secret to Cisco’s fruitful acquisitions is its ability to successfully onboard companies. Cisco employs a full-time staff solely focused on integrating new companies into the fold — instead of haphazardly assembling part-time transition teams whose members are all busy with their regular jobs.
In terms of strategy and execution, Oracle is even better at acquisitions. The company has spent billions on about 90 companies since its acquisition of PeopleSoft closed in 2005. Oracle’s chief skills are identifying companies that fit well into its longterm business strategy at the front end of the process, and its ability to integrate and act on these strategies at the back end. In 2011, readers of The Deal Magazine recognized Oracle’s track record with an award for most admired corporate dealmaker in information technology for deals completed from 2008 to 2010.
Until late in 2011, Oracle’s acquisition drive was to create the broadest portfolio of traditional enterprise software applications in the industry. With the company’s $1.5 billion acquisition of SaaS CRM applications provider RightNow Technologies (announced in September 2011 and completed in January 2012), Oracle now hopes to work its magic in the SaaS market. Oracle paid more than seven times trailing revenue for RightNow. I bet that in the next year or two, Oracle will make that multiple look like a bargain — just like when IBM bought Tivoli.
Still, Cisco, Oracle and other exceptions to the rule underscore the difficulty of making acquisitions work. It’s even harder when an acquisition happens because a buyer is presented with an unexpected “opportunity” and management decides it’s just “too good to pass up.” These so-called “opportunistic” acquisitions often lead to disappointment or disaster.
The reasons for failure are obvious. Acquirers lured by such a passive approach often have no clearly defined goals, have not thought through the attributes of ideal acquisition candidates, have done little or no pre-acquisition planning, and suffer from a lack of choice.
It reminds me of people who go to Las Vegas for the weekend and end up married. Getting married in Nevada is quick, easy and relatively inexpensive. All you need is a marriage license — no blood tests and no waiting period. And there is a wedding chapel on every corner.
Of course, when you wake up the next morning, there may be hell to pay.
I know. I’ve been there. Not in Las Vegas on the morning after, but at an organization that for many years only bought companies that showed up on its doorstep. We had no strategy and no process for integrating acquisitions into the mothership. I’m convinced that if the owner of the neighborhood car wash had offered us a “good” deal, we’d have taken it.
So here’s my advice for owners of companies seeking to enhance their value through opportunistic acquisitions. Acquisitions can do a lot of good. They can add to your growth and earnings, speed your entry into new markets, allow you to acquire human capital or intellectual property more quickly, and lower your costs through economies of scale. All of these things have the potential to increase the value of your company to a prospective buyer.
But just like marriage, acquisitions should never be decided on a whim. And you should never buy a company just because it’s for sale. Frankly, companies that are not for sale offer juicier profits and are likely a better strategic fit. Better to take some of that money and go have fun with it in Las Vegas.
And if you go there, don’t get married.
Marty Wolf is the founder and president of martinwolf, a middle market IT M&A specialist. Since 1997, he has guided buyers and sellers in the IT services, business process outsourcing, supply chain and software industries through more than 100 transactions, including divestitures of Fortune 500 divisions.