Acquisitions involve the takeover of one “target entity” by another entity (the “acquiring entity”). Their aim is to achieve value. Successful acquisitions play a significant role in business growth. Through them, businesses can expand into new markets, increase their range of products and services, and their competitiveness.
Not all acquisitions are successful. Given that they can be extremely costly, time-consuming and risky, it is very important to have a carefully thought-out acquisition strategy before entering into any type of acquisition transaction. The acquisition strategy will, in turn, help identify the type of acquisition transaction to pursue.
1. What is an Acquisition Strategy?
An acquisition strategy is a company’s approach to acquiring new businesses, products and services (having taken various factors into account). Successful acquisitions generally commence with a strategy made up of well-defined goals and objectives and rational principles for value creation.
Acquisition strategies are all about adding value to a business. This includes improving the overall performance of the target company or improving its market penetration.
2. Factors Considered with Acquisition Strategy
Several factors are taken into account when formulating an acquisition strategy. These include:
Consolidating to improve competitive behaviour: This involves reducing operations in an overcrowded market. If demand for a product is declining, reducing overall production by 10% could improve the market. One company cannot do this alone as it would impair that company’s value. However, by acquiring a competitor and then reducing operations, the short-term impact on value would be much less. The new, larger company could still enjoy increased profitability in the long term.
Exploit a business’s industry-specific scalability: Where the acquiring company’s activities are the same as the target company, the resources of the two companies could be successfully combined to achieve economies of scale. This would result in reduced costs and increased savings. This acquisition strategy must be carefully considered by the parties to ensure that the company resources are compatible.
Acquiring complementary resources: This is where a company with one product line looks to expand its markets by acquiring new products from a smaller company or acquiring resources to enhance its product line. This can be achieved by taking over another company that possesses them. This can often be easier and quicker to do rather than developing enhancements and skills internally.
Roll-up strategy: This involves acquiring several smaller companies in the same industry in order to merge them into one larger company. The goal is usually to pool resources, reduce operational costs and increase revenue. The larger company would also have a larger geographical reach with multiple locations, as well as a broader range of products available than any of the small companies could have provided individually.
Picking poor-performing targets: Acquiring companies often see poor-performing targets as good candidates for acquisitions in the belief that their management expertise could turn around the profitability of the target company. This type of acquisition is the most commonly used value-creation strategy that could improve profit margins and cash flows by increasing the efficiency of the acquired company.
Accelerating market access for the target or acquiring a company’s products
Small innovative start-ups can be a great acquisition target if they have exciting and innovative products but lack the means to commercialise them.
Acquiring assets, skills or technologies faster or at a lower cost: If a target company has assets, skills or technologies that the acquirer needs, it may be best to buy the company outright, rather than purchasing licensing rights for use of the assets or technologies, or acquiring and/or developing the skills. This strategy also keeps the intellectual property out of the hands of competitors. The developers of the intellectual property would be employed by the acquirer and could develop further intellectual property.
Buying Cheap: This strategy involves buying targets at a price lower than their intrinsic value. This strategy is seldom relied on as it is not common to find companies for sale at a price that is lower than what they could or should sell for.
3. Types of Acquisitions
Acquisitions take various forms. The form opted for will depend on the acquiring company’s acquisition strategy. There are four common types of acquisitions that are used in the business world.
Vertical Acquisition: This is a common type of acquisition and involves acquiring an activity or process related to a particular business. This type of acquisition is sought by an acquiring company that wishes to achieve synergy benefits and become more self-reliant. It could involve the acquisition by a wholesaler of retail stores, or the acquisition by a wholesaler of a manufacturing unit that produces the relevant commodity. For example, instead of a potato chips company buying its potatoes from a farm, it could acquire the farm itself. In this way, an expense, namely the cost of the potatoes, is turned into a new revenue stream.
Companies see value in vertical acquisitions because it’s both easier and cheaper to acquire a company than to create one anew, and buying companies along the supply chain could have cost-saving implications in the long run.
Horizontal Acquisitions: This is an acquisition where a fellow competing entity in a particular market is acquired by another entity in that same market. For example, Company A and Company B produce stationery. If Company A acquires Company B, Company A will get greater penetration of the stationery market. A horizontal merger leads to greater economies of scale in the market(s) in which the company operates. It is also likely to lead to lower operating costs, as the companies can share various resources. An example of this type of acquisition is the acquisition of Instagram by Facebook, both being social network platforms.
Congeneric Acquisition (‘concentric acquisition’ or ‘product extension merger’): With this type of transaction, the two companies involved in the deal have different product lines and services but sell to the same customers. This overlap between the companies creates synergies. This type of acquisition is used to offer a number of products under one roof. In turn, an entity will charge premium rates for the convenience afforded to customers through being able to purchase various products in one go.
Conglomerate Acquisition: This type of acquisition is concerned with diversifying markets. It occurs when one company buys another from a completely unrelated industry. Some examples of the world’s largest consumer product conglomerates are Proctor & Gamble, Nestle and GlaxoSmithKline. Being a conglomerate helps protect the owners from market fluctuations in that it’s unlikely that all businesses would suffer losses at the same time. The small business that is brought into a conglomerate gains stability and is able to benefit from the assets, resources and expertise of their holding company.
4. The Biggest Acquisition in History
As of November 2022, the largest acquisition concluded was the takeover of Mannesmann, a German-owned industrial conglomerate company, by Vodafone, a mobile operator based in the United Kingdom. This transaction occurred in 2000 and was worth $203 billion. This deal made Vodafone the world’s largest mobile operator and set the scene for dozens of mega-deals in the mobile telecommunications space in the years that followed.
Ultimately, an acquisition will only be as successful as the time and planning put into it. In addition to ensuring that all competition and other regulatory boxes are ticked, due care must be taken in the strategising, due diligence process, negotiation, interim period between signature and closing of the transaction, and the post-completion period.
Shaylyn McDonald
Shaylyn has an LLB (Cum Laude) from Wits and was admitted as an attorney in 2008 after having completed her articles at Werksmans where she rose to the level of senior associate. After joining Bell Dewar (now Fasken) she took up an in-house position at TransUnion where she rose to the level of general counsel. Shaylyn joined Caveat Legal in 2018, specialising in corporate and commercial work.
For more information about Caveat Legal or to contact the team, please visit the website at www.caveatlegal.com
