How to Deal with Digital M&A

In their quest to find new ways of delivering products and services and connecting with customers in today’s digital era, many incumbents are turning to M&A—that is, buying or partnering with startups—in order to integrate a much-needed digital component into their business operations. But, increasingly, these companies are finding that the M&A process itself has been impacted by digital disruption and that digital M&A requires a different approach and different considerations than those associated with traditional M&A.

When global management consulting firm Bain & Company recently interviewed leading European M&A executives, three-quarters of respondents said that digital disruption had strongly impacted their M&A strategy, even to the point of requiring a complete strategic overhaul. However, very few executives described themselves as prepared to meet this challenge; only 11% of interviewees self-identified as either “mature” or “advanced” on the digital learning curve.

So what do incumbents entering the world of digital M&A need to do if their efforts are to be successful?  A recent article from Bain & Company breaks down the process into the following four critical steps:

  1. Identify an explicit M&A strategy.

startupCompanies that have the most success with digital M&A are extremely clear about the precise role that digital M&A will play in supporting and enhancing their overall corporate strategy and objectives. A good place to start is by evaluating how the established value chain of the industry in question has been distorted by digital disruption, and then working out the specific ways that M&A would help the company to gain a strategic position within the new value chain—by enabling digital customer engagement, for example, or by protecting the company against the business models of digitally disruptive competitors.

Key questions that companies can ask themselves about digital M&A strategy include the following: Are both offensive and defensive M&A moves are being considered? Is the screening approach for digital targets forward-looking and value-based? What steps will be taken to help the company fill the role of thoughtful parent for the acquired digital company?

It’s also important for companies to be aware that M&A strategy is not a one-off solution. Rather, it’s an integral part of a global growth strategy, and is therefore something that needs to be consistent and repeatable.

  1. Be smart about corporate financing.

There’s no question that digital assets are expensive—many companies would say too expensive—so it’s important for companies to understand how a digital acquisition will affect their equity profile and the growth-value profile of their stock. Ideally, a digital acquisition will signal to the market that the acquiring company is committed not only to adapting, but also to becoming a digital leader in its industry; such a signal should serve to influence the market perception of the company and consequently its price-to-earnings (PE) ratio.

However, the question of how to finance a digital M&A deal remains a tricky one. The high price of the targets limits an acquirer’s ability to use stock (in order to avoid exposing existing shareholders to a high dilutive effect), but a cash-only deal could result in overvalued goodwill and future write-offs for the company. Acquiring companies must be prepared to evaluate and consider all potential financing solutions, including adapted payment terms or deferred payment mechanisms.

  1. Look to the future when doing due diligence.

timeIn some ways, digital M&A due diligence is a reverse version of traditional due diligence. That is, rather than evaluating the past business performance and current competitive status of a target, digital M&A acquirers need to look ahead, evaluating what the future success of the business model is likely to be under different scenarios, and screening the target before value has been monetized.

To help with this task, successful digital M&A companies build a strong community of external experts to serve as a vital connecting link between the company and the digital ecosystem it wants to be a part of; these experts provide invaluable diligence support in areas where objective assessment is challenging. Some areas that require particular attention in digital as opposed to traditional M&A include the capability of the acquirer to serve as a strong corporate parent and the scalability of the people, technology, and business models of the acquired assets.

  1. Use a “scope” model of merger integration.

In the vast majority of cases, digital acquirers are most successful when they approach digital deals with a “scope” mindset instead of a “scale” mindset. (Scope deals, as their name implies, increase a company’s scope through the addition of new products, customers, markets, or channels, while scale deals add similar products or customers, thereby increasing a company’s scale.)

Part of the reasoning behind this is that scope deals, for the most part, require only selective integration, thus preserving the autonomous, unique identity of each company and avoiding the problems that can arise when two highly different corporate cultures attempt to fuse. Nevertheless, smooth integration tactics, such as instituting cultural exchange programs between companies or including digital acquisition leaders in central governance forums, are a good idea even in scope deals.