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Why Strategic Buyers Often Pay More

Why Strategic Buyers Often Pay More: A Deep Dive into Accretion and EBITDA Contribution

In mergers and acquisitions (M&A), strategic buyers frequently outbid their financial counterparts. This phenomenon often perplexes business owners, especially those navigating the M&A landscape for the first time. Understanding why strategic buyers are willing to pay more involves delving into concepts like accretion, EBITDA contribution, and synergies.

Strategic Buyers vs. Financial Buyers

Strategic Buyers are typically companies operating within the same industry as the target. They seek acquisitions that can complement their existing operations, expand their market reach, or achieve other strategic goals. These buyers are focused on long-term value creation and often possess the operational expertise to integrate the acquired business seamlessly.

Financial Buyers, such as private equity firms, primarily focus on the financial returns of the acquisition. Their goal is to buy, improve, and eventually sell the business at a profit. Financial buyers typically have a shorter investment horizon and are more concerned with the standalone financial performance of the target company.

The Willingness to Pay More: Accretion and Synergies

One of the primary reasons strategic buyers are willing to pay a premium is the concept of accretion. Accretion refers to the increase in earnings per share (EPS) following an acquisition. When a strategic buyer evaluates a potential acquisition, they look at how the target’s earnings will contribute to their own EPS.

Strategic buyers consider the potential synergies — both revenue and cost synergies — that can be realized post-acquisition. These synergies can significantly enhance the value of the target company beyond its standalone worth.

Revenue Synergies: These arise when the combined company can generate higher sales than the sum of their individual sales. For instance, cross-selling opportunities, expanded product lines, or access to new markets can drive revenue synergies.

Cost Synergies: These are achieved by reducing operational costs through economies of scale, streamlined operations, or the elimination of redundant functions. For example, combining administrative functions, consolidating supply chains, or leveraging better procurement terms can lead to cost synergies.

EBITDA Contribution: Beyond the Numbers

EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is a key metric in evaluating the financial health of a company. It provides a clear picture of the operating performance without the influence of non-operational factors. However, for strategic buyers, the actual EBITDA of the target company is just the starting point.

Strategic buyers often look at EBITDA contribution, which can be higher than the target’s standalone EBITDA. This contribution takes into account the synergies and efficiencies that can be realized post-acquisition. Let’s explore this in more detail:

  1. Operational Efficiencies: A strategic buyer can often integrate the target company’s operations with their own, achieving higher operational efficiency. For example, a larger company may have more advanced technology or better processes that can be applied to the acquired company, enhancing its EBITDA contribution.
  2. Cost Reductions: By eliminating redundant costs, such as overlapping administrative expenses or duplicative functions, the combined company can achieve higher EBITDA. For instance, if both companies have separate marketing departments, these can be consolidated to reduce costs.
  3. Revenue Enhancements: The combined entity may be able to generate higher sales through cross-selling opportunities, improved market reach, or leveraging existing customer relationships. This additional revenue, which wouldn’t have been possible for the target company alone, contributes to a higher combined EBITDA.
  4. Improved Procurement: A larger company often has better bargaining power with suppliers. By leveraging this, the combined entity can reduce the cost of goods sold (COGS), thereby improving EBITDA.

Identifying Synergies and Enhancing EBITDA Contribution

A skilled advisor plays a crucial role in identifying synergies and highlighting opportunities that can enhance the EBITDA contribution, thereby justifying a higher valuation. The best sell-side advisors meticulously analyze both the target company and the potential buyer’s business models to uncover hidden synergies. They actively consider the buyer’s operational framework to find areas where additional EBITDA can be realized post-acquisition, such as through cost reductions, revenue enhancements, or improved procurement strategies. By demonstrating these potential synergies and higher EBITDA contributions, advisors can effectively advocate for a higher purchase price, ensuring that the seller receives maximum value.

The Strategic Buyer’s Perspective

From a strategic buyer’s viewpoint, the acquisition is not just about the current financial performance of the target but about the potential value that can be unlocked. This potential is reflected in the pro forma EBITDA — the projected EBITDA of the combined entity post-acquisition.

Accretion Analysis: Strategic buyers perform accretion analysis to determine the impact of the acquisition on their EPS. If the acquisition is accretive, it means the combined earnings will result in a higher EPS for the acquirer. This is a crucial factor as it directly influences the buyer’s stock price and shareholder value.

Synergy Realization: The ability to realize synergies plays a critical role in a strategic buyer’s valuation. They meticulously plan how to integrate the target company and achieve these synergies, often having dedicated teams and resources for post-merger integration.

Long-Term Value Creation: Unlike financial buyers, strategic buyers are less concerned with short-term financial metrics. Their focus is on long-term value creation, market positioning, and competitive advantage. This long-term outlook allows them to justify paying a higher price for the target company.

Case Study: Real-World Application

Consider the acquisition of Company A by Company B, a strategic buyer in the same industry. Company A has an EBITDA of $10 million. Company B identifies potential cost synergies of $2 million and revenue synergies of $3 million. The pro forma EBITDA of the combined entity is projected to be $15 million.

In this scenario, Company B is willing to pay a premium because the combined EBITDA contribution is significantly higher than Company A’s standalone EBITDA. Moreover, the acquisition is expected to be accretive, enhancing Company B’s EPS and overall shareholder value.

The Risks of Dealing with Strategic Buyers

While strategic buyers often present the most compelling offers in M&A transactions, dealing with them comes with its own set of risks, especially when these buyers are competitors. Understanding and managing these risks is crucial to safeguarding sensitive information and ensuring a successful transaction.

Risks Involved with Strategic Buyers

  1. Misuse of Confidential Information: Competitor strategic buyers may misuse the confidential information provided during the M&A process. This information can include trade secrets, customer lists, pricing strategies, and other sensitive data that could be advantageous if misappropriated.
  2. Competitive Intelligence Gathering: Some strategic buyers might enter the M&A process not with the intention of closing the deal, but rather to gather competitive intelligence. They may seek detailed information to better understand your business operations, market position, and strategic plans, which can be detrimental if used against you in the market.
  3. Disruption to Operations: The M&A process can be disruptive to your business operations. If a strategic buyer is a competitor, they might exploit the period of uncertainty to lure away customers, key employees, or to undermine your business in other ways.
  4. False Interest: Some strategic buyers might feign interest in an acquisition to delay your process or to distract you from pursuing other strategic options. This can lead to wasted time, resources, and missed opportunities.
  5. Leakage of Transaction Intent: When competitors are involved in the M&A process, there’s a higher risk of news about the potential transaction leaking to the market. This can create uncertainty among customers, employees, and other stakeholders, potentially harming your business.

Managing Risks with the Right Advisor

An experienced financial advisor plays a critical role in managing these risks. They employ several strategies and tools to ensure the process is conducted securely and efficiently.

  1. Buyer Qualification Process: Advisors conduct a rigorous buyer qualification process to weed out those who are not serious or might have ulterior motives. This includes evaluating the strategic fit, financial capability, and the track record of potential buyers. By thoroughly vetting potential buyers, advisors can filter out those who are likely to misuse the information or disrupt the process. Advisors will typically look for strategic buyers who have a dedicated “corporate development” team, which demonstrates that the buyer is committed to M&A, has team members who are experienced with the ground rules and has the wherewithal to execute. Not all buyers will have dedicated corporate development teams, during the buyer qualification process the advisor will need to pay close attention to the team who will lead the process, their experience in M&A, what functions may be outsourced and assess whether the buyer is indeed qualified.
  2. Non-Disclosure Agreements (NDAs): NDAs are a fundamental tool in protecting sensitive information. Advisors ensure that robust NDAs are in place before any confidential information is shared. These agreements legally bind the potential buyers to maintain confidentiality and restrict the use of the information solely for the purpose of evaluating the transaction. They typically also include provisions for non-solicitation of key staff, customers and suppliers and while negotiation of such clauses is complicated with strategic buyers, it should not be overlooked.
  3. Staged Information Disclosure: Advisors often use a staged approach to information disclosure. Initial stages of the process involve sharing limited, high-level information. As buyers progress through the stages and demonstrate serious intent, more detailed and sensitive information is disclosed. This reduces the risk of sensitive information being exposed to non-serious or opportunistic buyers. A two-round M&A process is helpful in staging disclosure.
  4. Controlled Data Rooms: Virtual data rooms (VDRs) are used to control and monitor access to sensitive documents. Advisors set up VDRs with stringent access controls and track who accesses what information and when. This helps in managing the flow of information and identifying any unusual activity.
  5. Strategic Communication Plans: Advisors develop strategic communication plans to manage the narrative around the transaction. This includes controlling the timing and messaging of any public announcements to minimize disruption and uncertainty among stakeholders.
  6. Engaging Multiple Bidders: Creating competitive tension by engaging multiple bidders can mitigate the risks posed by any single buyer. Advisors ensure that there is a competitive process with multiple interested parties, which not only helps in achieving better terms but also reduces the leverage any one buyer has.
  7. Regular Monitoring and Updates: Throughout the process, advisors provide regular updates and closely monitor the progress. They are vigilant for any signs of buyers deviating from the agreed-upon process or misusing the information, and they take prompt action if any issues arise.

Conclusion: The Strategic Edge and Managing Risks with a Skilled Advisor

Strategic buyers are often willing to pay more in M&A transactions due to their ability to unlock value through synergies and accretion. They look beyond the target’s current financials, focusing on the potential EBITDA contribution and long-term benefits of the acquisition. By understanding these dynamics, business owners can better appreciate the strategic buyer’s perspective and make informed decisions during the M&A process.

However, while the allure of higher bids from strategic buyers is strong, the associated risks cannot be ignored. Misuse of confidential information, competitive intelligence gathering, disruption to operations, false interest, and leakage of transaction intent are significant risks, especially when dealing with competitors.

Having an experienced advisor is invaluable in navigating these complexities. Advisors help identify the right strategic buyers, articulate the synergy potential, and maximize competitive tension to achieve the best possible outcome. They employ robust buyer qualification processes, enforce strict NDAs, control the flow of information, and maintain competitive tension to ensure that the transaction proceeds smoothly and securely.

A well-managed M&A process balances the potential benefits of strategic buyers with the necessary precautions to mitigate risks. This balance ensures that business owners can achieve the best possible outcome without compromising their competitive position or future prospects. By recognizing the factors that drive strategic buyers and leveraging this understanding with the guidance of skilled advisors, business owners can significantly enhance the value they derive from an acquisition, making it a win-win for both parties involved.

Source: Why Strategic Buyers Often Pay More: A Deep Dive into Accretion and EBITDA Contribution

Tags
Mergers and Acquisitions
Investment Banking
Accretion
Corporate Development