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Acquiring innovation

Strategic deal-making to create


value through M&A

March 2014

At a glance
39 percent of US CEOs are
planning on an acquisition
in 2014 according to PwC’s
Global CEO Survey.

A PwC survey of tech


companies found that
76 percent of acquisitions
focused on buying
innovation met or
exceeded expectations.

With the right inorganic


growth strategy, buyers
in all industry sectors
can apply critical success
factors to their innovation-
focused pursuits.
As part of an ongoing series, PwC conducted a roundtable with a
Deal-makers number of Silicon Valley corporate development executives to explore
the subject of innovation-focused acquisitions. We drew the specific
talk deal-making topics of the conversation from the results of a survey of technology
organizations conducted in the months prior to the roundtable. The
corporate development leads from several technology-focused Silicon
Valley companies participated in the roundtable. In this article,
we draw on some of the key themes aired during the roundtable
discussion and offer some perspectives on leading practice that
PwC has observed in the market.

The discussion reinforced our view that innovation is becoming an


increasingly important motive for M&A. As one roundtable participant
put it, “Acquiring innovation will continue to be a necessity for
technology companies.” Faced with a competitive environment that
demands ever-greater speed to market, they have increasingly looked
to M&A to complement internal research and development (R&D).

Deals, however, are not assured of success, and innovation-focused


M&A presents sizable and unique challenges that must be understood
and addressed to realize the full value of a deal. If not managed
appropriately, acquisitions can hurt, not help innovation efforts.
The participants in PwC’s M&A roundtable focused on some of the
key challenges they face when undertaking innovation-focused
acquisitions. Several key questions dominated the discussion,
including:

• How do we educate and engage key deal stakeholders?

• How do we identify the right acquisition targets?

• How do we value and assess targets?

• How do we execute post deal and measure performance?

The article accompanying this sidebar captures some of the most


thoughtful responses to these questions, as well as PwC’s own
perspective, shaped by our extensive experience in the field of
technology M&A.

2 Acquiring innovation: Strategic deal-making to create value through M&A


Done right, M&A can help these

Strategic deal-making companies increase speed to market,


outflank competitors, and relieve
pressure from threatening disruptive
market forces. (See Exhibit 1,
“Innovation as a driver of acquisition
M&A is clearly a potent source activity over 36-month period.”)
of growth if guided by sound
strategic direction. Tech companies, As one participant in a 2013 PwC
for example, are under relentless roundtable on tech-company M&A put
pressure to innovate. They look to it, “We will not be able to achieve our
M&A to complement and enhance strategic intent in a timely manner by
innovation via internal research and organic means alone.” (See the sidebar,
development (R&D). “Deal-makers Talk Deal-Making.”)

Because of its reliance on M&A to fill


its innovation pipeline, the technology
Exhibit 1: Innovation as a driver of acquisition activity over 36-month period industry can provide a model to other
% of Deals industry sectors for using M&A to
invigorate, diversify, and accelerate
Innovation their search for breakthrough
innovations. By studying how leading
57%
companies develop inorganic strategies
Channels and market access around growth themes, search and
21% screen for target acquisitions, perform
Consolidation/cost reduction/market share commercial due diligence, and
integrate their acquisitions, senior
6%
leaders across all industries can use
Geographic expansion
examples from tech sector M&A to
12% better meet their own organizations’
Vertical integration/supply chain need for innovation.
2%
Defensive
3%

0% 10% 20% 30% 40% 50% 60%

PwC 3
Deal performance of the target company, which may ones, which are more complex and
operate at a considerable distance from resource-intensive. (See Exhibit 2,
According to the 2014 PwC Global
the acquirer’s core markets. Academic “PwC performance observations by
CEO Survey, 39 percent of US CEOs
research confirms that, if not managed deal category.”) A large portion of
plan to initiate a domestic acquisition
effectively, acquisitions can degrade these tuck-in deals involve technology
this year. To do so successfully, many
the innovation output of both target or talent acquisition.
CEOs are focused on improving their
and acquirer.1
organization’s ability to pursue M&A, A PwC survey of tech-company
joint ventures or strategic alliances. Over the course of our work in corporate development and IT
Thirty-five percent of US CEOs are the technology M&A sphere, executives reveals that more than half
considering M&A improvement PwC has observed that small, of innovation-focused acquisitions—
initiatives. Another 22 percent have “tuck-in” deals have a higher many of them tuck-ins—have at
change programs underway. probability of success than larger- least met expectations. (See Exhibit
scale transactions. Management is 3, “Innovation-Focused Acquisition
The challenges of successful
better able to manage and control Results Over the Past 36 Months.”) But
M&A execution are no easier
the post-merger integration process that performance has not come easily.
when making innovation-focused
with smaller deals than with larger
acquisitions. Creating value often
entails monetizing the intangible assets
1 Journal of Marketing, January 2005

Exhibit 2: PwC performance Exhibit 3: Innovation-focused acquisition results over 36-month period
observations by deal category
% of Deals

Far underperformed expectations


Innovative

2
11%
4 Underperformed expectations
13%
Met expectations
36%
Traditional

1 3 Exceeded expectations
35%
Far exceeded expectations
5%
Small Large
(“tuck ins”) (“transformational”)
0% 5% 10% 15% 20% 25% 30% 35% 40%
Note: Numbers represent observations of
deal performance with 1 indicating likelihood
of high performance and 4 indicating
likelihood of low performance

4 Acquiring innovation: Strategic deal-making to create value through M&A


Exhibit 4: Deal continuum

Strategy Deal execution Value capture

#1 Strategy #2 Options #3 Deal #4 Negotiation #5 Integration #6 Transformation


assessment evaluation evaluation and close

• Growth strategy • Financial/ • Core diligence • Financial packs • Functional • Portfolio analysis
• Market analysis accounting, (IT, financial, tax, and operational integration • Business
strategy, and tax HR, insurance, issues in the TSA support and performance
• Investment considerations operations) and SPA Integration
hypothesis analytics
• Deal structuring • Regulatory and • Preparation for Management (operations, IT,
• Alignment with (accounting compliance, capital raising Office (IMO) and financial)
corporate and tax) accounting/ planning, setup
development • Post-closing and governance • Target operating
financial purchase price model diagnostic
initiatives reporting, SPA structure
adjustments
• Assessment of • Target operating
potential • Employee model
acquisition agreements
• Customer,
targets • 100 day plans channel and
• Commercial • Target operating product
due diligence model strategies
• Synergy planning • Operating
improvements
and cost
reduction
• Financial
reporting
requirements

There are seats at the table for the • M&A integration team, responsible
following roles: for rapidly aligning the target’s
The deal team people, operations, systems, and
• Corporate development executive processes with the acquirer’s
In discussions with tech executives, to develop and communicate corporate structure.
we learned that success depends on the deal’s strategic rationale;
a dedicated deal team that owns the orchestrate the interactions between • Deal engineer, typically the
strategic development, acquisition buyer and seller; interface with the chief technology officer or other
and integration process and that seller’s investment bank; and set the senior technology executive tasked
is accountable for executing it on deal structure. with integrating the acquisition
time and to plan. The optimal deal onto the acquirer’s technology
team brings a diverse range of skills, • Deal sponsor, typically an platform and resolving software
functions, and expertise to bear executive from the business unit and hardware incompatibilities.
on a complex undertaking. that originally identified and
(See Exhibit 4, “Deal continuum: analyzed the target, who helps • External advisors, including
PwC’s perspective on key evaluations make the business case for the deal. third-party advisors, investment
necessary in each phase of the deal— bankers and legal advisors,
• Deal approver, often the CFO to support deal execution and
strategy, execution, integration.)
who scrutinizes the deal’s economic documentation. This team
impact on the company; this then draws on the skills of
individual may also help arrange specialists who can assist
financing and will lead a robust with all aspects of commercial,
review of strategic alternatives to operational, and technical due
an acquisition. diligence and integration.

PwC 5
Target identification Target identification does more than
just uncover possible acquisition
Successful acquisitions begin with
candidates. The very process of
the right target, and executives
exploring multiple channels and
explore numerous channels in their
M&A is only a tactic to search for companies with superior
touch points acts as a powerful
market-sensing tool that enables
execute strategy. It is not innovation potential. Most tech sector
potential acquirers to collect valuable
the strategy itself. executives place the most weight on
intelligence on competitor, market,
internal channels, primarily corporate
and product trends. “We speak with
development teams and R&D and
a number of players,” one roundtable
While the above roles are adequate engineering teams. They are willing
participant said, “and it is a hugely
for smaller, quicker “tuck-in” deals to explore unconventional channels,
valuable process whether or not we
that pose lower amounts of risk and such as venture capital funds, to
consummate something with them.”
complexity, larger transformative identify targets and increase deal
deals—where officers are “betting flow. They also use existing alliances
the farm”—require more up front and relationships with other
planning and scrutiny to succeed. organizations to perform informal
Well before any targets are identified, due diligence on potential targets.
companies need an inorganic (See Exhibit 5, “Survey results—
strategy that properly analyzes the identifying and screening potential
macro and microeconomic markets, innovation-focused acquisitions.”)
factoring trends and disruptive As one roundtable participant said,
market forces. M&A is only a tactic to “You may want to do a licensing deal
execute strategy. It is not the strategy to get warmed up and see if they are
itself. Companies need to have a the target we think they are and get
clear, well-defined strategy for their to know management better.”
specific business vertical. And that
strategy should be distinct from but
complementary to the organic growth
Exhibit 5: Survey results—Identifying and screening potential
strategy. The inorganic strategy should
innovation-focused acquisitions
identify areas of potential new growth
to evaluate for market entry, product
portfolio expansion, etc. • Proactive pipeline development within corporate
Commonly used development team
• R&D/engineering team

• Venture capitalists/private equity funds


Sometimes used • Investment bankers
• Customers

• Board members/executive team


Rarely used • Consultants/3rd party experts
• Sales team

6 Acquiring innovation: Strategic deal-making to create value through M&A


Very often, the acquirer has the necessary capability,
but the lead time to build the product or service is
Valuation prohibitive, and an acquisition can significantly
Valuation is a particularly thorny improve speed to market.
problem for innovation-focused
tech acquisitions. It is nearly
impossible to apply traditional
valuation techniques to companies product teams to determine the
in their early stages of development, cost—in terms of both time and
when operating histories are brief money—of building a product or
and there’s little or no historical service internally. Very often, the
or predictable future cash flow. acquirer has the necessary capability,
Acquirers therefore must resort but the lead time to build the product
to other measurements to build or service is prohibitive, and an
the case for a particular investment. acquisition can significantly improve
(See Exhibit 6, “Valuation speed to market. “I am confident that
techniques ranked by relevance in most instances our engineering
and effectiveness.”) Their executives team could build the solution,” one
typically consult internal R&D and roundtable participant said, “but it is
the time component that is critical
and makes M&A attractive.”

Exhibit 6: Valuation techniques ranked by relevance and effectiveness for evaluating innovation focused acquisitions

Less important More important

NPV analysis

Selling party expectations

Market comparables (public companies)

Market comparables (similar transactions)

Cost to build analysis

EBITDA and earnings multiples

Most recent financing round valuation

Revenue multiples

Option value analysis

PwC 7
Post-deal execution Measuring the outcome of an Because innovation-focused
innovation-focused acquisition acquisitions tend to have longer
Integration of any sort of acquisition
requires the development of a time horizons and highly uncertain
places significant demands on the
scorecard that captures and quantifies outcomes, successful acquirers build
acquirer’s capabilities and resources.
the deal’s value-creation rationale a great deal of flexibility and agility
But innovation-focused acquisitions
and enables executives to monitor into their post-deal plans. Some go so
are a unique challenge. “With
the target’s post-acquisition far as to develop a range of post-deal
innovative acquisitions, the real
performance. Because many targets scenarios to prepare for deal outcomes
challenge comes post-completion,”
have little or no revenue history that diverge from the original plan.
one participant in our roundtable
and may take several years to earn Other companies focus on critical
said. “It takes a significant level
out, the scorecard’s metrics must areas to improve the odds of
of commitment, patience, and
include both financial yardsticks and post-deal success. Our survey
ongoing investment to make these
a broader set of strategic milestones, of innovation-focused acquirers
deals work.” Indeed, such deals
such as product-development reveals several of those areas.
require commitment and focus from
targets, talent retention, degree (See Exhibit 7, “Survey results:
stakeholders that extend well past
of collaboration, and the level of Most effective strategies for
the first 100 days following closing.
technological uptake. “You can steer capturing deal value in innovation-
the deal off course if you place too focused acquisitions.”)
much emphasis on revenue,” one
roundtable participant said. “You For a more extensive focus on M&A
may artificially drive the business integration as it impacts the research
to produce short-term revenue that and development (R&D) function,
is inconsistent with the long-term see the PwC white paper, “R&D
strategic intent of the transaction.” Integration: Unlocking product
development opportunities in M&A.”

Exhibit 7: Survey results—Most effective strategies for capturing deal value in innovation-focused acquisitions

Clear Strategic Ownership by


roadmap integration sponsorship

• Clarity of objectives and • Team retention, integration, • High degree of involvement


articulation of roadmap and alignment with BU by acquisition product team
• Defined yet flexible product plan • Alignment of long-term strategic
• Defined go-to-market strategy vision between acquired team
from the beginning and acquisition sponsor

8 Acquiring innovation: Strategic deal-making to create value through M&A


Conclusion manage. The responsibility for
addressing these challenges extends
beyond the corporate development
M&A is an important weapon in team, requiring continuing
the arsenal of tech sector companies engagement by R&D, the product
whose success depends on producing development team, the strategy
a steady stream of innovations— function, and senior management
whether those innovations occur long after the deal has closed.
in products, processes, or business
models. As a result, the ability to The M&A process need not end in
identify and execute deals efficiently a transaction to be successful. It’s
and effectively is a critical competency also valuable as a tool for gathering
well worth studying by executives competitive and market intelligence
in other industries that depend that can be exploited strategically.
The ability to Capturing and sharing the intelligence
on innovation for advantage, such
identify and execute as healthcare, financial services, collected along the deal continuum can
deals efficiently and and retailing. be of significant value to organizations
effectively is a critical seeking to innovate and grow, and
The value of innovation-focused represents an opportunity that
competency well worth many organizations have not yet
technology acquisitions is often
studying by executives predicated on the ability to explored in full.
in other industries that monetize intangible assets. Moreover,
depend on innovation innovation-focused transactions
for advantage. often entail a long return horizon
and a high risk profile. These deal
characteristics create a number of
challenges that M&A leaders must

PwC 9
www.pwc.com/us/strategy

To have a deeper conversation


about how this subject
may affect your business,
please contact:

Roger Wery
Principal, Strategy
(415) 498 6401
roger.wery@us.pwc.com

Patrick Gordon
Principal, Strategy
(646) 471 7978
patrick.g.gordon@us.pwc.com

Chris Lederer
Principal, Deals Strategy
(646) 471 9878
chris.lederer@us.pwc.com

Martyn Curragh
Partner, US Deals Leader
(646) 471 2622
martyn.curragh@us.pwc.com

Rob Fisher
Partner, US Technology Industry
& Silicon Valley Practice Leader, Deals
(408) 817 4493
rob.fisher@us.pwc.com

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