The first quarter of 2023 saw global mergers and acquisitions (M&A) activity continue to shrink as rising interest rates, high inflation and recession fears dampened deal-making. In Asia-Pacific alone deal volumes fell 29% from 2022 to $176.1 billion, according to Dealogic.
Despite dwindling deal numbers, lucrative M&A opportunities continue to be available for those with the appetite and eye for lower valuations. The most opportunistic organisations may look for deals with a major focus on accelerating transformation, which allows companies to pivot, diversify or rapidly bring new offerings to better serve customers while gaining an edge over rivals.
Going “all-in” on transformation during deals
Many believe transformation after closing major acquisitions helps extract the full value of a transaction. While there are many benefits to transforming a business, it’s important to know when it is appropriate to execute such a plan – timing is critical. For strategic CFOs, a vital role can be played in this delicate balancing act of transacting and transforming at the same time.
Some deals have greater transformational potential due to their size, nature or impact. They become transformational by leveraging new technology, processes or operating models from one business into the combined business.
Some less common billion-dollar deals are even driven purely by transformation as the core rationale.
CFOs play a key role in managing these types of deals so that the impact on people, markets and shareholder returns is increased significantly.
According to EY, there has been a substantial increase over the last four years in the number of billion-dollar-plus deals that have transformation as a key driver. If one miscalculates the benefits of transformation alongside the transaction process, they may create confusion during the transaction and incur more risk. With billions of dollars at stake, it is important to weigh factors such as financial benefits, market expectations and risk to business continuity, when determining the feasibility of transformation while transacting.
Transact AND transform maximises value
Transformational deals can allow for incredible value creation on the buy side. An acquisition becomes transformational when it enables access to new markets and business models, new Intellectual Property (IP), new technology and digital strategies, or fundamentally changes the market dynamics, all of which can drive significant value creation.
Companies that establish a vision for a transformed state early on in a deal can initiate their transformation agenda alongside the acquisition and integration process. While in the past, corporations would see transformation as the next step after the successful integration of their acquired company, there is an increasing movement towards transforming alongside integration, taking advantage of the catalyst of a deal.
The key here is planning the transformation strategy during the diligence phase and aligning and engaging the key decision-makers and the execution teams, at the right time. If planned and executed well, this approach allows companies to realise synergies faster and can reduce one-time integration costs. It will also help avoid future capital spend by carefully considering what the deal brings to the table.
CFOs, in particular, play a critical role in the transformation process, provided they empower people working on the project and thoroughly engage in the transformation objectives. A recent research collaboration between EY and the University of Oxford’s Saïd Business School recommended that CFOs focus on providing teams with emotional support and upskilling opportunities.
This can allow them to think outside the box when working on complex deals. CFOs can also champion the cause of digital transformation and highlight the data and tools that their teams can, and should, use to protect and drive deal value.
We have seen examples among our clients where carefully negotiating the benefits of a merger of equals early in the process was beneficial to both parties. They were able to leverage a capital event to trigger a program of transformation, delivering not only significantly improved client-facing technology from one party’s earlier investments, but to drive process and culture transformation across the newly merged business.
Sell-side transformation considerations
However, the benefits of transformation do not always carry over to the sell side. In fact, it can cause havoc when trying to close a transaction and can also fail to deliver an increase in sale price.
According to EY's latest CEO Outlook study, 96% of CEOs are considering restructuring opportunities, such as divestments, in the next six months.
Often, many companies attempt to improve or transform underperforming businesses before divestment. However, there is no guarantee that the projected benefits will materialise, and the seller must bear the entire cost of implementing these programs. There are too many variables for sellers to control during the sale process, and it could be far more beneficial to allow the future buyer to transform the business, as they may have more complementary or value-creating elements – in other words, they’re a better owner.
However, if some element of transformation is needed prior to divesting, it should be done well before preparing financial and operational due diligence documents for buyers. Even if teams are able to identify and achieve quick wins, they still need to be sustainable and supportable to bidders. There may be untapped transformational potential in some businesses which should be captured in sell-side value creation due diligence reports, independently informing investors about the potential value creation and transformational opportunities post-acquisition.
If a seller is undergoing a transformation program during a divestment, teams should adopt the best practice of preparing buy-side due diligence reports examining a seller’s transformation program, assessing the individual initiatives, business case, risks, value and general quality of the transformation program. It is often the case that the savings projected in financials are discounted by buyers, as the support for maintainable earnings is just not there.
Again, while there are best practices to consider, there is no one-size-fits-all approach to every transaction. Transformation can be the key to deriving the true value from many transactions, with the timing, process and approach to be decided based on the factors outlined above. Companies must find the right balance between transacting and transforming to achieve the full value of both.
