For Cash-strong Businesses – the Acquisition Question Revisited

By Gary C. Harrell

 Ten years ago, the global economy seemed more than ready to fall on its sword. And there may have been good reason for the cynicism. According to the Government Accountability Office, the impact of the Great Recession totaled as much as $22 trillion in losses of both paper wealth and real economic output. In 2008, when this consultancy first visited this subject, writers like Matthew Karnitschnig of the Wall Street Journal were declaring that the Deal Age was dead, pointing out, with categorical accuracy, that “…the severity of the current downturn and the disappearance of credit is changing how Wall Street puts deals together.” Fortunately, for all of us, the doom and gloom were only for a season.

The global economy has recovered nicely over the last decade, and Wall Street seems no worse for any of it. Indeed, the good news abounds. Housing prices in the United States are robust, owing mostly to shortages of inventory in growing markets. Development in foreign markets from China to Turkey remains heady, as expensive megaprojects get underway. Energy markets remain stable. And notably, for the purposes of this missive, deal-flow through mergers and acquisitions has been impressive, as global M&A in 2017 exceeded $3.5 trillion in transactions for the fourth straight year.

Financial and strategic buyers found encouragement to do more deals in recent years for a number of reasons. For a time, while interest rates remained low, buyers were able to borrow more freely to execute their deals, and solid gains in the stock market gave many buyers the ability to use their own stock as attractive currency to complete deals. What’s more, shakeouts in industries like retail and the uptick in the number of cash-hungry startups meant that there was a bigger pool of acquisition prospects to choose from.

To be sure, the deal-making space is not where it was in the 1990’s or even before the financial crisis. In fact, of the $3.5 trillion in deals made in 2017, roughly $1.4 trillion of that number were transactions in the United States. That is a drop of roughly 16% in total value of transaction amounts. Still, a total of 12,400 deals were executed, domestically, with a significant number of them being the acquisition of small and midsized companies.

As we press onward from the scary days of the Great Recession, financial and strategic buyers have held on to one of the most invaluable lessons from those days: even as credit markets distance themselves from the past, and as more financing options avail themselves for would-be buyers, cash is still king. And that is particularly true in a landscape where the cost of capital is beginning to change.

There is perhaps no bigger influence on activity in M&A than interest rates. That’s because buyers love to use other people’s money to acquire the things they want, and up until recently, the cost of doing so was relatively cheap. The Federal Reserve kept interest rates low, in order to spur necessary economic activity, in the wake of the Great Recession, but lately, that posture has changed. Citing greater confidence in the overall economy, the Fed has begun to slowly raise the benchmark interest rate, now for the sixth time since 2015, with the goal of reaching 1.5 to 1.75%. Such hikes, even incrementally, add to the cost of capital, eating into forecasted returns, and buyers are left to retool their business case and wrestle favorable terms from a lender in order to justify borrowing for an acquisition.

Fortunately, incurring debt is not the only course available to some buyers. Utilizing piles of their own cash can be an attractive option that brings with it lots of leverage.

For the acquisitive spirits among us, this recovery has created some buying opportunities, replete with fresh prospects at better prices, and the same opportunities exist for cash-laden businesses who had been considering expansion projects of their own. Indeed, if companies with requisite capital (or with the ability to tap well-heeled investors) are willing to put those positions to use, they can produce long-term benefits.

The expansion of a business is, of course, never an easy process, inasmuch as it does require rigorous research, planning, budgeting, and management. But the environment remains hospitable for those seeking to execute their expansion plan. Building out new facilities, for example, can still come in under budget, as material costs and construction remain reasonable. Likewise, the pool of talented and skilled workers is larger, which means the costs of labor can be better contained. And in the buyout world, the price tags on target companies are not likely to induce sticker shock. Indeed, today’s environment still offers a chance for those dollars to go much further.

Even still, for a cash-strong business, deciding whether to build out new operations or to acquire the existing operations of another business can be as difficult a choice as any ever made. When faced with such a choice, some decision-makers believe acquisition to be an illogical path because, often enough, they can be messy and problematic. Indeed, amalgamating the business processes and integrating the supply chains of disparate businesses can take some time. There is also the matter of redundancies; all jobs, for example, cannot and should not be sustained in a post-merger business. And, if those were not enough concerns, some decision-makers would point to the inherent cultural differences of two companies as being a potential powder keg for destroying a merger, down the road. Hence, they consider it a safer bet to build their own operations.

The challenges notwithstanding, there are still some tangible benefits to making the acquisition of an existing operation. This consultancy would like to take this opportunity to point out just a few:

  • Acquiring an existing enterprise will give a buyer operationally-ready assets faster than buying all new assets and building out the necessary infrastructure to make them ready.
  • Rather than attempting to invoke competition, an acquirer will obtain the customers, personnel, brand name, market share, geographic positioning, intellectual property, and product lines of a target company.
  • By acquiring an existing enterprise, the cash-strong business will have access to additional production capacity, or service capabilities, and it will be able to spread more of its fixed costs over a larger customer base. What’s more, when the acquisition is vertical in nature—that is, when an acquirer is buying a supplier—the former has the ability to drive down costs and increase the profit margin on the ultimate goods or services that it sells.
  • With the acquisition of an existing enterprise, buyers will gain access to new markets either geographically or through its new product lines. This access typically provides diversification to the company’s revenue stream.
  • From a tax and accounting perspective, the acquisition of an existing business can be more beneficial than an expansion. That’s because the transaction costs associated with a buyout, in many cases, can be amortized over an longer period of years, in accordance with the IRS Tax Codes. (As an example, the Codes offer a “safe harbor” provision that, in some cases, grants acquirers a ratable amortization of fifteen years on intangible assets without consideration for the useful life of those assets.) Unfortunately, no such provisions readily exist for a company only wishing to expand. Instead, an expansion will only impact the assets of the company’s balance sheet, and the costs of the effort will only be expensed in that single year.

Will every acquisition work? Naturally, the answer to that question is not an entirely positive one. Acquisitions require thorough amounts of analytical due diligence, and the effort to integrate the operations of any two existing businesses must be meticulously planned and perfectly choreographed, in order for there to be post-transaction success. So, the process needs to tap leadership, resources, and genuine expertise, to make things happen.

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Gary C. Harrell is the managing principal of Axiom Strategy Advisors, LLC. For additional information, please write

© 2018, Axiom Strategy Advisors, LLC. All rights reserved.

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