Even for experienced deal makers, a first digital acquisition is an education. Companies acquire digital properties to accelerate their overall strategy, as Publicis Groupe did when it acquired Sapient for US$3.7 billion in 2014 to help it make the leap from a traditional advertising company to a digital one.
But companies often find that a digital merger and acquisition (M&A) is quite a different beast from the conventional process they are used to. Many end up paying a high premium for the acquisition, betting on a fast -- although uncertain -- development.
Few executives appear prepared for the challenges. When we interviewed top M&A executives, three-quarters of them said digital disruption had had a relatively large impact on their M&A strategy. However, only 11% described themselves as being "mature" or "advanced" on the learning curve.
So, how do you to move up the learning curve? Doing digital M&A right means upending the way most companies approach financing, due diligence and post-merger integration.
Let's start with financing. Determining the right valuation begins by understanding how the acquisition will affect your company's equity profile. You want to signal to the market that the digital acquisition is part of a series of moves that will help you win in the digitisation of your industry.
Because digital targets tend to be expensive, using stock to finance a deal rarely works; existing shareholders won't accept so much dilution. On the other hand, paying 100% cash may expose the company to overvalued goodwill and future write-offs.
To mitigate the risk linked to high multiples, you need to evaluate all potential financing solutions, considering adapted payment terms such as earn-outs or other deferred payment mechanisms.
In March 2016, the French aerospace and defence group Thales purchased Vormetric, a growing cybersecurity firm, for $400 million, which was 5.7 times Vormetric's sales. Thales is shifting its financial profile to the high-growth business. Over time, this strategy, including more cybersecurity acquisitions, will increasingly be captured in its price-to-earnings (PE) ratio and overall valuation, attracting growth investors.
In fact, by the end of December 2016, Thales was trading at a PE multiple of 21.8 times, a 15% premium to the industry, which averaged 18.9.
Digital M&A also turns traditional due diligence on its head. Acquirers need to be much more forward-looking, using approaches that evaluate the potential success of the business model under different scenarios.
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.
Thankfully, there are digital tools to complement traditional sources of information. For example, the data provider CB Insights can help you develop information-rich company profiles, visualise competitive dynamics and uncover non-financial performance metrics.
For diligence on a particular company, web scraping provides indicators of market share and growth momentum, such as web-traffic analysis and geographic coverage versus competitors by extracting location websites. Sysomos offers social media site analysis to help 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 understand market dynamics.
Acquirers may also turn to Glassdoor or LinkedIn to assess the culture, or rely on tools that provide insights into the target's operating model to mitigate potential integration issues.
Indeed, integration of digital assets is 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 may 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, Microsoft's CEO confirmed that LinkedIn would be kept autonomous, but Microsoft engineers would look at how to innovate with the new asset.
However, if your company faces a major business model disruption linked to digital and you have already made 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 digital asset a broader responsibility within the combined company. After it acquired Sapient, Publicis effectively gave that company's executives greater responsibility in developing the digital part of the business. It later created Sapient Inside, a network of digital specialists who help its traditional ad agencies. Publicis now obtains 50% of its revenue from digital, which is 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. But they are not always adept at navigating within a large organisation and will require coaching and support.
Acquirers must accommodate the inevitable differences in decision-making speed and risk-taking culture. That may mean adjusting the acquirer's own governance or putting a specific type of governance in place to deal with the asset or the business area the acquisition has affected.
Arnaud Leroi is a partner in the Paris office of Bain & Company and leads the firm's M&A practice in Europe, Africa and the Middle East. Derek Keswakaroon is a Bain & Company partner based in Bangkok.