In our previous article, we delved deep into the allure of corporate takeovers, highlighting how buyers—both strategic and financial—are perpetually hunting for golden opportunities from their competitors, whether that's acquiring a dynamic innovation, a key division, or even an entire company. As we pivot to dissect whole company transactions, several compelling reasons emerge for why specific businesses become targets. Let's unpack these strategies.
Why Do Takeovers Happen?
The primary reason for a strategic buyer to pursue a corporate takeover is that the business possesses a unique asset that the acquirer wants. This can sometimes be a defensive move, if the company is particularly worried about losing market share to an upstart competitor. One that immediately springs to mind is Adobe’s (NASDAQ: ABDE) recent proposal to acquire web-based collaborative design platform Figma for US$20 billion. This transaction was poorly received by investors, and appears to be purely an effort to protect its Creative Cloud platform, which includes the industry-dominant Photoshop product.
More often, however, the move is a positive one. The company is looking to expand its product or service or improve into a new geography, sell its customers a complementary product or service, or improve its operations with a strategic asset that reduces costs or that the company believes it can operate more efficiently. There are also purely financial reasons for a deal.
Saving Time and Money, with an Existing Brand
Consider the acquisition of FitBit by Google’s parent company, Alphabet (NASDAQ: GOOG). Google boasts the dominant mobile phone operating systems, Android, which has more than 70% market share globally (according to Statista). Yet unlike Apple (NASDAQ: AAPL), it has historically not operated a vertically-integrated hardware and software business (that is, Android typically operates on devices that were not manufactured by Google). While Google is a wildly profitable company and boasts one of the largest market values in the world, it is continually looking for growth, and vertically-integrated businesses typically have greater control and profit margins. As a result, Alphabet has increasingly launched a range of hardware devices, including mobile phones (e.g., Google Pixel) and the range of Nest devices.
However, it lacked a fitness tracker or watch product, which is a segment that has become increasingly in-demand by consumers. Undoubtedly Google could have developed a product internally over time (as it had with the Pixel and Nest devices), but there is a substantial cost to develop and market such a product–particularly time. Additionally, Fitbit already had an existing customer base, many of whom were satisfied and loyal to the brand. Alphabet’s management team likely weighed up these factors, and decided that the benefits of the acquisition far outweighed the US$2.1 billion purchase price.
Public-Private Valuation Arbitrage
Another reason that companies undertake acquisitions is the so-called public-private arbitrage. Generally speaking, the valuations for public companies are higher than for private companies. There are several reasons for this, the most important of which is probably liquidity. This means that investors are able to buy and sell a small amount of their investment on most trading days (unless the company is very small), at a clearly visible price. This is dramatically different from private companies, where the price is usually opaque and negotiable, and the investor would need to buy or sell the entire company.
This creates an opportunity for public companies. They are often able to use their own valuation (in the form of issuing shares) to acquire private companies in the same industry, at the cheaper valuation of the private markets. When the deal is complete, the public company’s valuation is credited with the profits from the private company. As an example, a public company might be trading at a market capitalisation of $160 million with annual net profit after tax of $10 million–equating to a price-to-earnings (P/E) multiple of 16 times. The company may be able to acquire a private company with $2 million in net profit for $16 million, or a P/E of 8 times. However, when the acquisition is complete, the company’s market capitalisation is likely to rise to $192 million–applying a P/E of 16 times to the acquisition (the same as its multiple), rather than 8 times it paid.
This is quite a popular method for companies to grow in the share market and the companies are often called “serial acquirers” or “roll-ups.” A company that our readers might be familiar with, Healthia (ASX: HLA), followed an iteration of this model to build a network of integrated allied healthcare organisations including optometry, podiatry, and physiotherapy clinics.
Cost Efficiencies and Superior Operators
In addition to the benefit from the public-private arbitrage, certain management teams are able to extract cost savings (often called “synergies”) and run acquired businesses more efficiently. One of the most successful in this strategy would be Danaher Corporation (NYSE: DHR), founded and operated by the Rayles brothers (Steven and Mitchell). The company operates what it refers to as the “Danaher Business System”, which is a form of the Kaizen method, a Japanese system of continuous improvement that involves keeping costs low. This has made Danaher one of the most successful businesses in history, and a number of conglomerates have tried to emulate its strategy.
Another related category to superior operations is superior access to capital. Large, public companies typically have better access to funding than smaller private businesses, including through capital raises, lower-cost debt (with better terms and conditions, including fixed rates and long payback periods) and the cash flow from other operating assets. These funds can be used to accelerate the growth of acquired business, division or asset. One such example would be Transurban Group (ASX: TCL), which can use the strength of its balance sheet and cash flow to continually expand its road network.
Breaking into a New Industry, Unique Technology, and More…
The examples highlighted above are by no means exhaustive. Companies are also on the lookout to acquire businesses in a new industry that it wants to break into, but that typically has high barriers to entry. This might be because of specific infrastructure (perhaps a cement plant and mineral resource) or an industry that is heavily regulated. Pharmacy chain CVS Health Corporation (NYSE: CVS) recently bought out Oak Street Health for US$10.6 billion, for example. Oak Street is a primary care business (what would be known as general practice in Australia), and it would undoubtedly be challenging to build out such a network without the knowledge of having run medical practices before. While this was a relatively large deal, buying a small operator can be a good way for a company to gain exposure and decide if it wants to expand into a new industry.
The company could also be on the hunt for a unique piece of technology. For example, the Walt Disney Company (NYSE: DIS) paid US$3.8 billion for BAMtech in multiple transactions between 2017 and 2022. This gave the House of Mouse access to a high quality platform to operate its streaming platforms, including Disney+.
Opportunities for the Investor
Big takeovers often make big headlines, particularly for well-known companies that have a lot of local employees. Yet these are just a fraction of the merger and acquisition (M&A) activity that is occurring between listed companies and their private peers. Companies will seek out M&A opportunities for a variety of reasons, including to accelerate the launch of a new product, break into a new geography, access a unique asset or piece of technology, to benefit from the discrepancy between public and private market valuations, and sometimes purely for management to build an empire. For both buyers and sellers, M&A can be a blessing or a curse depending on the strategy, valuation and execution, and for investors, there can also be opportunities on both sides of the equation.
Disclaimer: CVS Health Corporation (NYSE: CVS), Alphabet (NASDAQ: GOOG) and Healthia (ASX: HLA) are currently held in the TAMIM Portfolios.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.