Even for experienced deal makers, a first digital acquisition is bound to be an education. Companies acquire to accelerate their overall strategy and digital transformation, as Publicis Groupe did when it acquired Sapient for $3.7 billion in 2014 to help it make the leap from a traditional advertising company to a digital one. But when companies turn to mergers and acquisitions (M&A) to help them deal with digital disruption, they usually discover not only how different a beast digital M&A is compared with traditional M&A, but also that everything they thought they knew about M&A may actually not help. They’re also likely to be paying an even higher premium for the acquisition, betting on a fast—although uncertain—development.
Few executives appear prepared for the challenges of digital M&A. When we recently interviewed top M&A executives in Europe about their experience, fully three-quarters of them said that digital disruption has had a relatively large impact or even requires a complete overhaul of their M&A strategy. However, only 11% described themselves as being either “mature” or “advanced” on the learning curve.
So, what do you need to know to get up the learning curve? Doing digital M&A right means upending the way most companies approach financing, due diligence, and merger integration.
Let’s start with financing the deal. Determining the right valuation begins by understanding how the acquisition will affect your company’s equity proﬁle. The ultimate goal is to signal to the market that the digital acquisition is part of a series of moves that will help you adapt and win in the digitalization of your industry.
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Meanwhile, because digital targets tend to be expensive, acquirers are limited in their ability to use stock to finance a deal. The dilutive effect for existing shareholders would be too high. On the other hand, acquiring a risky digital target in a 100% cash deal may expose the company to overvalued goodwill and future write-offs. To mitigate the risk linked to the target’s high multiples, you need to evaluate all potential ﬁnancing solutions, considering adapted payment terms such as earn-outs or other deferred payment mechanisms. When your company ultimately becomes a more legitimate digital player, you can be more flexible in how you ﬁnance future deals.
In March 2016, Thales purchased Vormetric, the growing cybersecurity ﬁrm, for $400 million, which was 5.7 times Vormetric’s sales. The acquisition communicated to the market that Thales was shifting its ﬁnancial proﬁle to the high-growth business. Over time, Thales’ strategy, including multiple acquisitions in the cybersecurity space, will increasingly be captured in its price-to-earnings (PE) ratio and overall valuation, helping to attract growth investors. In fact, by the end of December 2016, Thales traded at a 21.8 PE multiple, a 15% premium over the aerospace and defense industry, which averaged 18.9.
Next, you need to understand how digital M&A turns traditional due diligence on its head. To get a good valuation, companies screen a target before value has actually been monetized, and must compensate for a lack of ﬁnancials. Unlike the way traditional due diligence usually works, acquirers need to be much more forward-looking, using approaches that evaluate the potential success of the business model under different scenarios. The best acquirers build and manage a community of external experts, relying on them heavily to support diligence in areas that are hard to assess objectively.
Diligence starts by asking a fundamental question: Is the acquirer capable of becoming a strong corporate parent? Many executives think first about how an acquisition will help them transform their own business, instead of how they can accelerate the profitable development of the digital asset they are acquiring, through financial resources, access to market, capabilities or technologies.
Thankfully, there are digital tools to complement the traditional sources of information. For example, some companies use tools that can assess the perception and market recognition of the target. For sector and company screening, the data provider CB Insights helps develop information-rich company profiles, visualize competitive dynamics and uncover nonfinancial performance metrics.
For diligence into a particular company, web scraping provides indicators of market share and growth momentum, such as web-traffic analysis and geographic coverage vs. competitors over time by extracting location websites. Sysomos offers social media site analysis that could help an acquirer understand what people are saying about a target. Web scraping by Quad Analytix pulls assortment mix and price point data from multiple retail sites to help acquirers understand market dynamics. Acquirers may also turn to Glassdoor or LinkedIn to assess the culture, or rely on tools that provide insights into the operating model of the acquired company— moves that help them mitigate potential integration issues.
Indeed, integration of digital assets is a huge, thorny problem fraught with cultural issues. How do you absorb the new entity you acquired without killing it?
If the deal is intended to expand your company’s scope with new customers, products, markets or channels, you are likely to require only selective integration. That means investigating where each company can beneﬁt from the other in technologies, customer proximity, go-to-market access and other capabilities. After Microsoft acquired LinkedIn for $26 billion in 2016, Micro¬soft’s CEO confirmed that LinkedIn would be kept autonomous, but that Microsoft engineers would be tasked with seeing how they could innovate with this new asset.
However, if your company faces a major business model disruption linked to digital and you have already done several acquisitions in the specific area, it may make sense to fully integrate the acquired company. You may also consider a reverse takeover approach, in which you give the leadership of the acquired digital asset a broader business or functional responsibility within the combined company — anticipating challenges of helping it adapt within a larger organization. After its acquisition of Sapient, Publicis effectively gave that company’s executives greater responsibility in developing the digital part of its business. A few years later, it also created Sapient Inside, a network of Sapient digital specialists who help its traditional advertising agencies benefit from best-practice methods and tools. Publicis now gets 50% of its revenue from digital—that’s ahead of its 2018 target.
In either case, acquirers need to carefully manage the transition in which leaders of the digital asset relinquish the entrepreneurial part of their jobs and become managers exclusively. Digital asset leaders are not always adept at navigating within the matrix organization of a large company, requiring specific coaching and support from the acquirer’s leaders. Acquirer’s must accommodate the inevitable differences in decision-making speed, and that may mean adjusting the acquirer’s own governance or putting a specific governance in place to deal with the acquired asset or the business area affected by the acquired asset. More broadly, acquirers may face the need to diffuse a digital acquisition’s risk-taking culture and mindset within their larger corporation.
Digital disruption will only intensify. As it does, companies in all industries will turn to M&A. But they’ll need to evolve their deal-making skills for digital. The best companies will implement a feedback loop, learning from their inevitable rookie mistakes to improve and build consistent, repeatable capabilities for the future.