It’s a no-brainer: Companies need to adapt to the Digital Economy (Platform Economy, Data Economy) – and if they are not yet there, then they better speed up: Large companies are launching innovation hubs, others are sending scouts to identify the rising stars amongst start-ups, and many companies are launching digital innovation projects one way or the other. In this article I would like to look at the option “Transformative M&A”: Could Transformative M&A be the answer to the need for digital transformation of companies? What are the risks, what’s the odds of success?

In many large companies M&A is daily business in order to strategically realign business activities. Siemens, for example, has acquired in recent years companies such as Enlighted, Building Robotics or Agilion in order to establish/expand the business unit “Building Management”. At the same time Siemens acquired the low-code platform Mendix to defend/strengthen its leader position in the promising area of Factory 4.0. SAP and Software AG have also been on a shopping spree, Software AG added the companies Cumulocity and Zementis to its portfolio and thus underlined its ambitions in the IoT market. Obviously, this list of M&A deals could be continued for quite a while, however, this would certainly overtax your attention. Therefore I will just bring to your attention a few Mega deals by US players: Microsoft acquired Skype, Google acquires the AI specialist DeepMind (2014), Facebook swallows WhatsApp and Instagram. IBM acquires the Linux/cloud specialist RedHat. In many cases the lavish purchase prices had caused astonishment (WhatsApp, RedHat).

The advantages of the Merger & Acquisition option are obvious. If you have defined a business area as strategically relevant, you can gain immediate access to this target market by taking over an established player (sometimes a promising start-up turns out a sufficient investment) or by purchasing relevant key competencies. Even for large companies, an in-house development in newly-established or infant markets is hardly an alternative: On the one hand, even with a high input of resources, the time-to-market remains a critical factor (especially in view of the lack of IT specialists), because digital markets in particular can develop very dynamically, late entrants are penalised; on the other hand, large companies (especially from the “Old Economy”) rarely succeed in orchestrating spin-offs with an agile start-up culture.

In particular in infant markets the M&A approach makes for an interesting advantage: You can wait and see whether a technology, a business model or an infant market takes off … or turns out a Marketing Bubble. This may require tactical patience or strong nerves: Because if you wait too long, a competitor or other investor may seize the M&A opportunity faster. In a “hot market” there will most likely be several bidders for promising players; The founder of the AI specialist DeepMind had not only offers from Google on the table – but also from Facebook and other companies with digital ambitions.

In principle, not every acquisition is based on a flawlessly rational strategic calculation, and not all acquisitions are backed up by hard-bitten business plans including synergies. Business leaders are under pressure to show progress in implementing a digital strategy or simply in sales growth. No wonder that valuation bubbles arise, especially in view of too much investment capital. There is hypes, there’s crashes. Take car sharing or the fake tech company WeWork. A mega-merger can also be spurred by a CEO’s desire to secure a place in the company’s history. All the above considerations explain, at least in part, why about 50 percent of acquisitions fail – either fail to meet expectations or, in the worst case, end in a de-merger (e.g. DaimlerChrysler).

We can, however, assume that most deals the parties do their homework: Finance due diligence, tax DD, legal DD, technology DD, HR DD. Of course, commercial or market due diligence is also often used, but there is often room for manoeuvre here, especially in young markets – and it is precisely such markets that M&A projects involving the digital transformation are often concerned with. It is not always possible to determine the technical feasibility with certainty (see Autonomous Driving), nor is it possible to reliably forecast the size of the market or customer acceptance (e.g. Smart Home). In many cases, the whole thing is simply a bet on the future, and here, of course, even the big players can be mistaken. The Smart Home start-up Revolv, a Google, went bust in 2016. Google Glass did not work (at least in the first attempt), Google+ failed, was discontinued; as you’ve certainly realized, these examples are not strictly M&A-failures – it’s rather about the difficulty to make reliable predictions about demand dynamics for digital products.

It is typically difficult to determine the synergies that could be achieved between the acquiring company and the target company; these synergies are often used to justify high purchase prices. If Siemens takes over the low-code platform Mendix, assumed synergies seem realistic: Siemens is the market leader in Industrial IoT / Factory 4.0, the innovation platform MindSphere is an established technology; in such context it appears plausible to assume that Mendix creates added value for customers. However, caution is usually advised when sales synergies are claimed: If a company has excellent relationships with the teams managing the company network of large companies, this does not automatically (rather: not at all) apply to the departments where the purchasing strategy of any Factory 4.0 initiative is decided. It is regularly underestimated to what extent siloed structures in companies still prevent cross-departmental information flow and thus cross-departmental sales synergies.

At any rate Post-Merger Integration (PMI) (in most cases rather rather “post-acquisition integration”) is eminently important with regard to the success / failure of M&A deals. Of course, it is. If you want to leverage synergies, there is no way past integration. Be it cost synergies (integration of IT systems, integration of accounting and finance, in short: overhead), be it sales synergies (adjustment of incentive structures, reallocation of key account responsibilities, adjustment of sales processes, etc.). This incurs time invest, this incurs monetary costs. This requires goodwill on the part of those involved. If the buying company was already “in the red” before the takeover, the chances for a successful PMI process are rather poor: there is neither the willingness nor the time resources to do so. All this must be taken into account.

There are also cases in which too deep integration is even a bad idea, and is consequently avoided. Such discussions on the degree of integration are common after the acquisition of a start-up by large corporations. Generally, large corporations hope that start-ups have the effect of a live-cell therapy, provide new ideas and an enrichment through an agile start-up culture; however, these expectations may be disappointed due to an excess of integration: The integration of the start-ups into the large corporation, the various reporting lines, the orientation towards compliance guidelines and the like lead to a gradual replacement of the start-up culture with the corporate culture of the large corporation. In order to avoid such worst-case scenario a corporate investor like Viessmann sees to it that the start-ups do not lose their independence. There is only one point of contact that establishes a connection between the large corporation and the start-up. This approach may even result in spatial separation: In the Viessmann-realm the Start-Ups are usually located at a completely different location (Munich, Berlin) than the parent company Viessmann itself.

Conclusion: Transformative M&A is an attractive option for acquiring digital product and market expertise (not least in view of the shortage of IT specialists). However, you need to carefully evaluate opportunities of new business models and markets. Not all technical visions and hypes can be transformed into long-term profitable business models.

Sebastian Zang
Author

The author is a manager in the software industry with international expertise: Authorized officer at one of the large consulting firms - Responsible for setting up an IT development center at the Bangalore offshore location - Director M&A at a software company in Berlin.