M&A outside the core: challenges and solutions

Often the most appealing acquisitions involve competitors. Due to sector familiarity, synergies with the product or service and a potentially overlapping customer base, these are often high on the shopping list. However, there’s a growing trend for large corporates to move away from their core sectors and invest in companies in unknown areas. This could be for many reasons; to diversify into a high growth sector, to gain digital capabilities, or antitrust laws. All of these leave businesses faced with looking at sectors that they know very little about.

An example of truly going outside of the core is the Hong Kong-listed poultry business, Leyou Technologies. In July 2016, whilst we were all talking about Brexit, they bought British video game developer Splash Damage for $150m. This added to their earlier acquisition of Canadian developer Digital Extremes. So, what’s going on? Why is a Chinese poultry business investing in video games? You never quite know with Chinese companies.  However, it seems that Leyou Technologies had identified gaming in China as a rising sector. They had no capability in-house, so acquired a couple of foreign companies to take the plunge.

Google has also spent over $400m in alternative energy projects, predominantly wind farms. These have also been geographically distant from their many data centres which might have offered up a simple explanation.

Key Challenges

  1. Who should we target?

Companies typically know very little about companies outside their core sectors.  They often don’t even know who they are.  Almost always, the best targets are not actively up for sale, which makes the job harder.  The challenge is magnified if you’re looking internationally.

It’s essential that you can move quickly, but how do you separate those high potential companies from the duds?  How do you even identify them in the first place?

  1. How do we engage with them?

Once you have managed to wade through all the options and have highlighted your preferred option, what next? How are you going to approach this company and, more importantly, how do you value it?

A mistake well-known companies often make is assuming targets will be flattered to be approached and easy to engage.  Sometimes this happens, but they’re just as likely to have concerns about alignment of objectives, cultural fit and, ultimately, being bullied.

  1. What do we do with them post-purchase?

You’ve finally managed to buy the company you wanted. What do you do with them now? As they are outside of your core sector it’s likely that they are not a natural fit with your existing businesses and therefore you might have to run it standalone and not integrate it into your portfolio. Or you might not.

What can be done?

Overcoming these challenges is actually very simple: take pre-due diligence really seriously.

Companies usually do pre-due diligence in-house, and then spend a fortune on external advisors to get deals done.  This is OK when you know who you’re buying.  When you don’t, internal strategy and finance teams usually lack the knowledge and research skills to do the job.  This job typically involves:

  1. Scanning multiple countries to identify suitable targets
  2. Talking to people who know whether these companies are actually any good
  3. Interviewing their customers. Have they even got any customers?
  4. Prioritising 4-5 companies to approach
  5. Developing an engagement strategy for each of them

I once worked for a British professional services company looking to enter Mexico.  They had no idea who to buy, but wanted someone who served big corporates out there, so they could cross sell into them.  Mexico’s self-proclaimed ‘market leader’ seemed like a good option.  Then we spoke to their customers, who really disliked them.  Not such a good idea, if you want to cross sell.  We spread the net further, and found out who customers really like.  These were smaller and lower margin, but much better bets for cross sell (and cheaper to buy).

As this example shows, pre-due diligence is key.  When looking outside of the core, it’s critical, and needs to be prioritised accordingly.