Andrew Greta's Business Development Blog

Valuation Overview:

One of the central questions of business development is “how much should I pay” for a business acquisition, partnership, asset, or piece of intellectual property. The answer isn’t something you can boil down to a one-size-fits-all computer model (a fact which keeps us BD professionals gainfully employed). But what’s always true is you’ll need to pay more than the stand-alone price (i.e. the current market cap for a public company, or the top bid in a competitive auction for a private one).

But if we pay more than the stand-alone value, how do we make a return on the deal? If it’s already “fairly” priced, where’s the upside? Since 70% of acquisitions end up destroying shareholder value, it’s clearly a question that CEO’s worldwide either don’t ask or just don’t understand. And I’m sure some of the others simply get lucky by playing the “greater fool” theory and re-selling their purchases to someone even more gullible or idiotic then themselves.

But if you believe that doing business is about more than rolling the dice on betting on random market outcomes, the real secret to generating positive investment returns is by operating an acquired business or asset in a way that’s more productive (faster, cheaper, stronger, or bigger) than anyone else in the market could and creating true economic value.

If you want to be one of the winners, a good valuation analysis should cover the following areas at a bare minimum:

1) Business Review

The first step to determining value is to understand the target business, what their fundamental drivers are and what the strategic fit as an acquisition or business partner really is (a good starting tool is the “business model napkin” as explained in an earlier post). Why are you uniquely situated to realize more value from the business than it currently generates or can be tapped by your competitors? This is your value hypothesis that gets tested and either confirmed or negated in the following steps.

2) Comparable Analysis:

One way of quickly gaining an appreciation for general valuation is the same one real estate appraisers rely on to value property – looking at the “comps”. While not a precise measure (due to variations between businesses and differences in how each buyer assesses economic value), this quick and dirty approach can give some idea of how the general market values companies and sectors to get an initial read. Appropriate metrics can vary by industries, but typically some combination of EBITDA (earnings before interest, taxes, depreciation, and amortization) and revenue multiples, along with price-to-book, and price-to-earnings are typical starting points to establish a reasonably robust range.

3) Financial Review:

Now it’s time to dig into the company financials, understand the ratios and revenue-expense trends to establish a baseline financial pro-forma model. Most rookie desktop analysis starts with the past 3-5 years of operating history and forecasts forward on an average trend line – and I’ve seen that approach accepted by execs as high as the CFO. The best financial analysts dig under the hood instead and ask the tough questions about current and future circumstances to develop a more robust approach? Is 2006 truly a banner year for truck manufacturing, or are buyers simply front-loading their orders ahead of changing diesel emissions laws? Are these high lease revenues sustainable for the next 5-years or do the contracts expire in 3-months?

4) Valuation Model:

Here’s where your value hypothesis gets integrated into your baseline pro-forma to determine the premium you can pay for an acquisition and still generate positive economic value. Are you consolidating back office operations and generating massive savings through headcount reductions? Or are you buying a ready-made distribution channel to boost revenues? A valuation model is only as good as the assumptions you make so be careful and make sure the synergies are grounded in reality and realizable. Output metrics can include return on equity (ROE), return on investment (ROI), and return on total capital (ROTC) over a reasonable investment horizon of 5-years or so. Discounted cash flow models (DCFs) and their ilk (IRR, NPV), can be useful as well, but be careful! It’s too easy to make small tweaks to a discount rate or perpetuity growth assumption and see wide (and unrealistic) swings in valuation. The rule of thumb is that if your terminal value is more than 60% of your total present value, go back to the drawing board.

5) Sensitivities:

Finally, once you’ve got a solid valuation model along with a good comparable analysis you should be able to start narrowing a reasonable valuation range. From here, stress test it by identifying the key assumptions that drive value and doing a worst-case scenario. Items like sales growth and synergy levels are good starting points, and a “recession” case isn’t a bad idea if your business is particularly impacted by the normal business cycle. Then be sure to articulate any non-quantifiable “special case” issues which might sway a decision. Does the acquisition look weak in isolation but prevent core business erosion as a defensive play? Is it a key piece of intellectual property or branding that will have spillover benefits to other areas of your business?

Walk away if the picture doesn’t work instead of force-fitting a bad, value destroying deal. There will be more opportunities along shortly, but don’t expect it to be easy pickings. Identifying and creating value takes hard work, creativity, and a willingness to make tough decisions. The low hanging fruit was eaten long ago and today’s nectar goes to those willing to search hard, be selective, and diligently execute truly unique value-creating ideas.

Labels: Business Development Basics, Valuation

posted by Andrew Greta  # 4:14 PM 0 Comments Links to this post

According to Reuters, merger activity in the United States dropped 29 percent in the second quarter as financial deals driven by leveraged private equity shops dried up from lack of lender liquidity. Meanwhile, strategic investors are seeing opportunities to snap up cheap assets, bidding for stalwart consumer staples like Anheuser-Busch Cos Inc (BUD) and Wm. Wrigley Jr Co (WWY).

But what’s this distinction between financial and strategic acquisitions? Aren’t all deals just deals and shouldn’t they all be driven by financial returns at the end of the day? After all, we don’t want to be like the misguided company president I once heard describe an acquisition that, “isn’t expected to make any money… it’s strategic”. Yes. Good deals create real economic value for the participants, but the distinction is often how that value is realized.

In the most general terms, financial investors tend to be hands-off money. They invest in opportunities at an arms-length and expect to reap their gains in a future sale, or recapitalization of their holding. Any Joe on the street who buys stock online through his internet broker is the epitome of a financial investor, as are Wall Street firms and other investment funds.

Financial Deals

Strategic investors, on the other hand, are more like the Monster Garage mechanics of the financial world. Their interest is in buying up businesses, properties, assets, and technologies they can integrate and use to build something better. Typically these are operating companies pursuing corporate and business development activities on their own behalf.

Strategic Deals

This is clearly a gross simplification and deals can involve complex hybrid approaches (e.g. it’s not uncommon for a private equity LBO shop to take an active role in a company’s operational turnaround after an acquisition) but it provides a general framework to understanding where deals touted in the press fit in terms of rationale.

We’ll cover each of these deal types in greater depth on future posts.

Labels: Business Development Basics, Strategy

posted by Andrew Greta  # 11:04 AM 0 Comments Links to this post

A solid deal process is roadmap for executing good transactions quickly and effectively while providing the framework needed to eliminate bad deals affirmatively. While some may feel that following any kind of process is cumbersome and takes the creativity out of deal making, the opposite is true. A good deal process provides structure and tollgates that can help move deals along faster and keep teams focused to eliminate red herring distractions. It also frees up the deal team to spend meaningful mental energy on the *real* sources of creativity and business development value – problem solving, overcoming obstacles, making strategic connections that others don’t see, and designing elegant structures to reach value-creating solutions.

The process starts out with strategy and planning. Some BD departments run the strategic plan itself or participate in this work. Other times it’s a hand-down from a visionary leader, output from a consultant, or the product of an annual corporate-wide strategic process. Whatever the origins, new “inorganic” growth paths (i.e. opportunities outside of the current core business) quickly break down into a Buy, Build, or Partner decision. Typically Build paths fall outside of the BD mandate and are taken up by the new product introduction process (NPI) with the appropriate departments contributing to the effort.

Buy and Partner decisions are the bread and butter of business development. From here, it’s up to the orchestrators of the deal team to marshal resources through the key stages. A typical proactive process includes the following steps:

Target Identification: Teams canvass the landscape of potential acquisition or partnership candidates, assessing size, strategic fit, and opportunity to do deals. Targets are prioritized based on a variety of factors which vary with the circumstances and rationale of each deal.

Originate: The target is approached and engaged in initial discussions. Typically non-disclosure agreements are executed at this time to enable greater information sharing.

Value: Once initial business and financial information is collected, a preliminary model is developed informing the internal team on viable bidding ranges, economic inputs, and business risks. Typically, a letter of intent (LOI) is issued at this tollgate indicating a preliminary range and deal structure with certain carve-outs or contingencies for items not fully assessed on a preliminary basis.

Due Diligence: If the LOI is accepted, it’s time to dig into the records, financials, operations, and assets of the target in depth to confirm assumptions and uncover deal-impacting issues. Due diligence can range from simple paper contract reviews when buying a portfolio of loans for example, to full site visits, environmental audits, systems reviews, and personnel assessments for large operating businesses.

Structure: Once due diligence is complete, revisions are made to the offer and – assuming no deal-killing items are discovered – a structure and terms are proposed.

Negotiation: Parties negotiate the final terms of the deal. Typically, the LOI terms would be codified into legal-eze, and any open items addressed. Contingencies like anti-trust reviews and shareholder approvals are identified and documents are signed.

Close: Assuming contingencies are met, pre-identified purchase-price adjustments may be made, funds change hands, and the seller “hands over the keys”.

Each step in the process requires different skills, competencies, and information. From what I’ve seen, it would be possible to devote an entire book or career to fully capturing and mastering the complexity of each step. We won’t attempt to boil the ocean here, but future posts will cover and discuss the individual steps in greater detail.

Labels: Business Development Basics

posted by Andrew Greta  # 10:02 AM 0 Comments Links to this post

Imagine taking a fine summer walk in the rolling countryside and coming across a landscaper digging trenches with a hammer while a nearby carpenter drives nails into two-by-fours with a shovel. Sweaty brows reveal each worker’s struggle to produce results and monetize their core talent while severely handicapped by the tools each has at their disposal. Output is low in our little micro-economy as houses are built and trees are planted at a snail’s pace.

As a thoughtful observer, you casually ponder how to do a better job of aligning the talents and tools of our hapless laborers. But how? One solution to is to retrain the workers. Teach the ditch digger to frame houses and school the carpenter in tree mulching and you’ve gone a long way toward unleashing each worker’s true productive potential. However, reeducation is costly and time consuming. And even if successful, it’s a fair bet that a retrained landscaper is probably going to be a far less productive nail driver than a lifelong carpenter.

But now imagine you step in to broker a simple tool swap. Exchange the hammer for the shovel at equal value and voila! Suddenly productivity skyrockets with no cost or delay. More houses are produced each month, hourly wages are higher, and the workers’ families enjoy a higher living standard filled with gadgets and vacation time. And this isn’t some kind of zero-sum game where one player’s loss of chips at the poker table is another’s gain. Both the carpenter and the landscaper are better off as a result of the deal and true value is created by a simple alignment of assets with those who can make the most productive use out of them.

Good business deals follow a similar model of value creation. Substitute the term “asset” for “hammer”, “operating cash-flow” for “worker productivity”, and use “dollars” instead of “shovel” for your medium of exchange and you start to see the picture.

But not all deals are good ones. In fact, a recent study by the Boston Consulting Group titled “The Brave New World of M&A” concluded that “less than half of deals create shareholder value”.

To see why, you first have to realize that a typical business deal requires a buyer to pay upfront cash today for a stream of future value riddled with risk and uncertainty doled out over a long period of time. Tangible, value-creating “synergies” like cost savings, higher productivity, new innovations, and broader distribution do exist but are hard to value in absolute terms on paper and even harder to realize in the concrete world.

In a competitive market, others bidders are likely to see the same obvious value that you do driving the price of a deal up to a breakeven level. Without any unique plan to realize value above and beyond the cattle herd of market estimates -- coupled with underestimating the risks and efforts required to extract those synergies -- it’s easy to see why companies get caught up in the hype of empire building, bid furiously against more viable suitors and simply over pay.

So should we hang up our hats, stick to our knitting, and shutter the business development function? Not so fast. Good deals DO exist, but it often takes some inner soul-searching to first figure out how we can uniquely profit by our own position in a way the market doesn’t see or can’t attack.

For example, if a guy in town has a bicycle for sale and every would-be paperboy in the neighborhood has bid up the price to $80, it’s pretty clear that I’m not going to realize any additional value on the deal by paying more and slinging the same newsprint on the same doorsteps. On the other hand, if I’m the only person in town with an ice cream cooler and could make double the rate per hour hocking Jumbo Bomb Pops, I could potentially pay $100 for the cycle and STILL make a good profit from the transaction.

Which just goes to illustrate the real value of business development – searching past the obvious answers, ignoring the crowd mentality, and seeking unique sources of value. Some call this approach assessing the “strategic fit” and it isn’t the kind of skill set you can teach by recipe in a textbook. But if more than half of deals go bad, that still means almost half are good. Someone is doing it right and there are fundamental skills and concepts we can learn from the winners to be as successful as they are.

Labels: Business Development Basics

posted by Andrew Greta  # 1:01 PM 0 Comments Links to this post

The term business development (or “BD”) means different things to different organizations. For human resource departments reluctant to saddle their highly compensated rainmakers with the same moniker employed by encyclopedia peddlers and car lot attendants, BD means “sales” – landing new business from new customers. For others, BD is synonymous with “account management” – generating new and continued business from existing customers. For still others, BD is an amorphous umbrella under which organizational misfits carry out a variety of fuzzy activities from cultivating internal bureaucracies to paying lip service to “strategy” and spending lavish expense accounts under the guise of “relationship building”.

For me and many others in the field, it’s a profession and a discipline charged with driving corporate growth through acquisitions, divestitures, strategic partnerships, and licensing arrangements.

A well-tuned business development function is a powerful engine to drive corporate growth by feeding the sales channel with new business lines, products, services, and distribution channels. BD can also contribute newly acquired or licensed intellectual property to the research and new product development teams.

What BD is NOT about is recklessly "buying growth" and racking up a credenza full Lucite deal trophies that end up ultimately destroying company value. The true BD professional is an advocate for true value creation. A trusted adviser committed to finding solutions to complex problems but also a healthy skeptic of faulty reasoning and value-draining propositions.

In upcoming posts, we’ll dissect the business development process from strategy through target identification, deal origination, valuation, structuring, and negotiations from a practitioner (as opposed to academic) perspective. We’ll explode some of the myths surrounding M&A work using real-world examples in the news today. And we’ll provide a forum for discussion and resource sharing in this exciting field.

Labels: Business Development Basics

posted by Andrew Greta  # 11:31 AM 0 Comments Links to this post