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How to fire up your intangible capital to reap maximum M&A deal value
One of the constants amid the on-going economic chaos of the last few years is a continuing interest from business leaders in mergers and acquisitions. Successive falls in global stock markets mean that, for those companies with a strong balance sheet, growth through acquisition is an achievable strategy. >>
Dealmakers who analyze similarities and differences on key intangibles while prospecting for targets or at the due diligence stage will create more shareholder value than those who dont. But how can you assess an asset that has no physical form? We believe that the answer lies in identifying those elements that have the most significant impact on the value of intangible capital. While it is vital to close the gap between the intangible capital of the target and acquirer companies, management needs to devote its attention to the core drivers of intangible capital, rather than to intangible capital itself.
Dr. Andreas Raharso | Director of Hay Groups Global R&D center for strategy execution
Contents
Opportunities amid the chaos Grasping the invisible Constant state of flux time, value and volatility Leadership alignment a meeting of minds Cultural alignment agility and risk-taking The broader context the M&A life cycle 2 4 6 8 10 12
2 Touching the intangible: how to fire up your intangible capital to reap maximum value
Focusing on intangible capital will pay big dividends in the longerterm through increased shareholder value.
But buyers should beware. M&A deals are inherently risky and anyone planning a merger or acquisition needs to ensure that their substantial investment pays off. One of the most serious stumbling blocks is that typical methods of deal evaluation (based on GAAP2) are flawed because neither investors nor their advisors evaluate the intrinsic value of intangible capital the non-monetary assets that cannot be seen, touched or physically measured, and so are hard to quantify or value, but which include most of the key drivers of deal profitability. Academic research3 and Hay Groups work with clients over the past 10 years have repeatedly demonstrated the strong link between the intangible capital of a company and the future business performance of the merged entity. Hay Groups global R&D center for strategy execution completed a global research study in collaboration with Harris Interactive in the first quarter of 2011. Its aim was to identify elements of intangible capital that have the greatest impact on post-merger integration and the ultimate success of M&A transactions. The research found that:
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Business executives do not spend enough time assessing the value and fit of a targets intangible capital in the early stages of a transaction. Most M&A failures can be attributed to this lack of attention Those who do spend time assessing intangible capital fail to identify the risks attached to it. Consequently, they are unable to mitigate these risks effectively during post-merger integration The value of intangible capital is not fixed but fluctuates throughout the deal process. Those who have not identified the risks or planned to manage them pro-actively often see a corresponding fall in shareholder value Maximizing intangible capital is greatly enhanced by two key drivers that allows for better management of the intangible capital: leadership and cultural alignment Focusing on these two drivers not only improves the transaction success, but also simplifies the process of identifying potential targets and increases the effectiveness of due diligence activities.
Focusing on deal-related intangible capital will pay big dividends in the longer-term through increased shareholder value. In order to help executives understand where to place their bets on intangibles and determine where to focus their attention, Hay Group has taken a closer look at which elements have the greatest impact on integration success.
Source: GAAP: generally accepted accounting principles; a collection of rules, procedures and conventions that define accepted accounting practices; includes broad guidelines as well as technical procedures 3 Source: Galbreth, 2005, Green & Ryan, 2005
2
4 Touching the intangible: how to fire up your intangible capital to reap maximum value
Looking at the intangibles today is what will make the deal valuable tomorrow.
David Derain Global M&A Director | Hay Group
Organizational capital, such as management processes and organizational culture Relational capital, such as brand position, customer management, partnerships and networks Human capital, including knowledge, skills, leadership and employee engagement.
It is vital to assess these intangible elements in addition to tangible assets as early in the deal lifecycle as possible, as doing so helps to identify and manage post-merger integration risks. According to research carried out by Hay Group5, two-thirds of executives believe that an increased and earlier focus on intangible capital during the M&A process would have improved the success of their mergers. Furthermore, just over half of executives say that failing to audit non-financial assets such as governance, brand image and client relationships increases the danger of making the wrong acquisition6.
Source: Ocean Tomo Research LLC Source: Hay Group global research, The silver bullet of success,2010 6 Source: Hay Group European research, Dangerous liaisons, 2007
4 5
Two-thirds of executives believe that an increased and earlier focus on intangible capital during the M&A process would have improved the success of their mergers
Figure one: Hay Groups intangible capital model Organizational capital Culture and market convergence n Shared values, attitudes, beliefs and customs Governance Aligned business processes n Clear and effective governance
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Relational capital Brand External and internal image and reputation n All that touches the customer experience
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Human capital Leadership n Clear vision established and communicated n Conflicts of interests coordinated and balanced for all stakeholders n Team commitment and employee recognition Employees High potentials identified, developed and rewarded n Strong commitment, loyalty and valued by the organization
n n
Agility Capacity to manage internal business transformation n React quickly to new market demands
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Client loyalty Client satisfaction n Low turnover and high rate of referrals
n
Energy and clarity Communicated and understood business strategy n Clear direction for people to mobilize their energy
n n
External networks n Strong relationships with suppliers distributors and other partners or centers of influence Internal networks n Effective internal communication n High impact cross functional teams n Enabling relationships across organizational and geographic boundaries
Development and management New skills, knowledge, leadership styles acquired with training and coaching Engagement Employee empowerment and degree of attachment to the company Productivity Efficient management of costs, resources and time
6 Touching the intangible: how to fire up your intangible capital to reap maximum value
Executives often assume that intangible capital is static and retains its value throughout the lifecycle of the deal. In reality, intangible capital fluctuates in reaction to internal and external change. Hay Groups research has found that the value of intangible capital typically decreases during the course of a transaction. As illustrated in figure two, below, its value falls most sharply during post-merger integration. A number of analysts have estimated that between 50 and 90 per cent7 of pre-tax earnings are dependent upon intangible capital. A target firms intangible capital is usually at its strongest in terms of value and stability at the start of a transaction. However, as the market hears rumors of a potential buy-out, intangible capital such as client loyalty, brand image and employee commitment begins to destabilize, decreasing with each step of the pre-deal process. By the time the deal completes, intangible capital is at its most volatile and the proportion of shareholder value at risk is at its greatest. This is why so much of the ultimate success of any deal hinges on the willingness and ability of managers to look after the intangible capital before, during and after the transaction. But managers, themselves a key element of intangible capital, are not always so willing to play their part. Some 45 per cent of the executives we surveyed had opposed the mergers that they experienced, and 30 per cent said this was an active opposition8.
Figure two
Healthy
EBITDA value
Intan gible capi tal v alue
The success of M&A largley depends on how buyers manage intangible capital over time
Unhealthy
Timeline of M&A
Due diligence
Pre-closing
Post-merger integration
Source: Professor Baruch Lev, Stern Business School New York University
7 8
Source: Saikh 2004 Source: Hay Group European research, Dangerous liaisons, 2007
8 Touching the intangible: how to fire up your intangible capital to reap maximum value
The time to appoint a new leadership team takes an average of 74 days resulting in almost two and half months of leaderless operations; time too valuable to lose.9
What should the brand position be? Who owns the client relationships and how should client relationships be managed? On what basis should the new company compete for market share? What is the new governance model? Will decisions be made only in the corporate center, or devolved throughout the enterprise? How do we need to change business or operating models to deliver cost synergies? How can innovation and R&D centers be combined to help drive competitive advantage?
n n
Equally important is leadership decision-making behavior. Two-thirds of respondents to Hay Groups M&A pulse surveys said that slow decision-making was a key barrier to effective integration. When decision-making roadblocks occur, leaders need to display the ability to overcome these situations and quickly. In order to show colleagues and counterparts how the business will be run, right from the start leaders need to be clear about:
n n n
Who is responsible for which decisions How decisions will be made when executives cannot agree What approach will be used to analyze decision-making obstacles
Finally, post-merger integration creates uncertainty for customers and employees alike. Open and honest communication from leaders can help address this. The research findings reinforce the idea that leaders at every level should relay information accurately and in a timely manner. However, leaders have a natural tendency to protect staff morale, productivity and customer service by delaying communication or glossing over difficult issues, such as staff redundancies.
Source: Hay Group European M&A research, Dangerous liaisons, 2007 10 Source: Ibid 11 Source: Ibid
9
Figure four: The impact of a new leadership team Perception of value added by leaders 50% Companies take too long to get a new leadership team in place: On average 74 days 19%
For executives that did put in place a new leadership team, 50 per cent of respondents agreed that it had unlocked a significant amount of value.10
Old leadership
New leadership
Productivity
Executives that prioritized a leadership capability review were four times as successful in achieving their merger objectives.11
Due diligence
Deal announced
Post-merger integration
Time
10 Touching the intangible: how to fire up your intangible capital to reap maximum value
Source: Very, P. Lubatkin, M., Calori, R., & Veiga, J. (1997). Strategic Management Journal 13 Source: Hay Group global research, The silver bullet of success,2010 14 Source: Hay Group global research, The silver bullet of success,2010
12
Driving through cost and growth synergies requires bold decisions and business leaders cannot afford a risk-averse culture
11
Quality
Company A Company B
Individual autonomy
30 20 10 0
Operational e ciency
Innovation
Social responsibility
Intangible drivers
Hay Groups research suggests that the value of intangible capital depends heavily on the extent of alignment of the leadership of the two companies involved, and on the alignment of their respective cultures.
Leadership alignment There are three main features to leadership alignment:
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Forthright speaking the ability of individual executives to demonstrate open, honest and timely communication Decision-making behavior the speed of decision-making and the ability to overcome blocked situations Aligned views the extent to which leaders views on intangible capital (such as governance, operating model and organizational structure, client management and other management processes) differ.
Cultural alignment There are two elements that make culture a strong driver of merger performance:
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Calculated risk-taking if both organizations encourage a culture of risk-taking, important action plans can be fulfilled in times of uncertainty Timeliness of decisions and actions a merger is more likely to succeed if an organization is agile and employees understand the impact of timeliness on their decision-making.
12 Touching the intangible: how to fire up your intangible capital to reap maximum value
Recognise that intangible capital value fluctuates and actively manage it at every step of the deal Leadership actions including honest and open communication are key activities in ensuring intangible capital is properly managed Get the top team in place quickly and clearly assign roles and decision-making rights. Be really clear about how, when and by whom decisions will be made Prospect for companies that are similar in organization culture and management style Take the time to argue out the key business and operational issues such as brand positioning, governance and the operating model Make sure everyone is committed to creating one single, unified culture
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