Michael's M&A Playbook: Investment Thesis and Value Capture in M&A
At its core, mergers & acquisitions is a tool to achieve a specific company goal. You can use it to grow faster in an existing market, expand into a new geographic area, develop your product & service portfolio, achieve cost savings based on synergies, or improve your competitive position (i.e., a market consolidation). You may get there organically, but M&A transactions certainly speed up the process. There are other motivations, but those are the most common reasons. The big question is whether you add value to your company with M&A, and here come the topics of value capture and the investment thesis in the game.
I'm not going into the (sometimes tricky) details between value creation vs. value capture. A simple explanation is that value creation is the potential gain (i.e., willingness to pay minus cost), and value capture is the actual gain (i.e., price charged minus cost). In essence, value capture is the capability of the company to achieve and improve its long-term profitability. In financial language and applied to M&A: Can we increase our net cash flows in the long run with this M&A transaction? We are not talking about short-term gains; this is a strategic question.
What is an investment thesis? At its core, an investment thesis in M&A represents a clear and concise statement of the strategic goals and expected outcomes of a transaction and how to get there. It is the basic idea of how you create value with the M&A transaction. In essence, the investment thesis is the same as the value capture because both focus on how a company actually achieves a financial gain with an M&A transaction.
When do we use the concepts of the investment thesis and value capture in M&A? There are three phases in a mergers and acquisition process where you address them.
Investment Thesis and Value-Capture Analysis in the Mergers & Acquisitions Process
During pipeline development: Add the investment thesis/value capture to your M&A scorecard - When you develop your M&A target pipeline, you rank them on an M&A scorecard consisting of quantitative (e.g., revenue and EBITDA) and qualitative elements (e.g., cultural and strategic fit). You also start developing ideas on how the specific transaction can add value to your company, i.e., increase the long-term net cash flows. This is the investment thesis/value capture. Ensure that you add a section with "value capture" in your target summary where you explain the strategic approach to create long-term value for your company. At this point, it is still an initial idea you need to verify in the subsequent two phases, but it should be a specific approach with estimated values.
During due diligence: Develop a detailed investment thesis/value capture strategy in your business case - In parallel to your due diligence, you develop your business case scenarios. In the business case, you include the target's base case plus the value you can create with the M&A transaction. For example, this can be cost savings based on synergies of the combined companies, higher cash flows with the expansion of your product and service portfolio, or cash flow growth in new geographic areas. Ensure you have different business case scenarios and include a risk percentage. The due diligence will provide you with more information; however, you still have limited access to key people of the target and data. During this phase, develop a quantitative value capture approach that you communicate clearly to your stakeholders. At the end of the due diligence phase, you need to decide whether you continue the M&A process and at what purchase price and TCs (terms and conditions). M&A is a stage-gate procedure with Go/No-Go decisions throughout the process.
After closing: Update your business case and start implementing improvements - After you complete the purchase, you will get the information you missed before and access to all key people. Now it is time to start reviewing all your main planning assumptions and update the business case and value capture strategy. There will be surprises after the closing, so be ready to be flexible and adjust your initial ideas where needed. Also, organize workshops and try to find new areas of performance improvement. You can read more about performance improvement projects in another article from me. This is the time when all the other M&A topics come together, and the right change management approach is crucial. Go through all areas of the company and think about performance improvement opportunities. Be creative with your ideas and strong in the implementation.
It's All About Adding Value
Mergers and acquisitions can play a significant role in your strategic value growth plans. One of the M&A rules I learned early is that you should never fall in love with the target company because you will overpay. Paying too much also means destroying value instead of improving value. The investment thesis and value capture strategy and calculation are essential to see whether you add value. Ensure that you start with initial value capture ideas and estimates and update your approach throughout the process when you get more information.
Feel free to contact me to discuss specific mergers and acquisitions examples.
