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Buy and Build, Integrate and Transform beyond Corona crisis

A&M INSIGHTS

Introduction

COVID-19 has changed the world we know and will continue to do so for a while. Right now, we experience unprecedented times that have already forced us to adapt to change (e.g. remote working) and we will have to stay flexible for further adjustments if we want to come out of this stronger and successful. Some of the changes that we have already undergone in this crisis will certainly have a lasting impact.

What do we know? After the initial shock, many of our clients are already planning the restart of their businesses and experiment with maintaining the newly learned ways of working, mindset and approach. Fortunately, the dynamics of such situations offer opportunities for those that are willing and able to explore their options. While we still do not know what our new normal will look like, nor when we will get there, we have already started embarking on the journey towards a world beyond coronavirus.

Transitioning from a world of the known through a period of unknown can be a leapfrog to transformation. An opportunity which is worth further investigation.

We want to give some rationale and guidance to those who do not want to miss out on potential opportunities – especially opportunities related to “transformation and growth through M&A”. We want to provide an outline on how to implement a successful process that delivers the full expected value of an M&A opportunity during COVID-19 times, even with associated capacity constraints.

Buy-and-Build, Integrate, Transform – The BaBIT Approach delivers value through three phases

With our BaBIT approach we match a company’s core competencies with current market dynamics and what it would take to grow successfully. Gaining a competitive advantage is desirable for businesses across all industries, especially in times of increasing disruption such as digitalization or competitors with a data-insights-driven strategy. But to decide whether a transformation is the best option requires a careful upfront assessment. In this context, we want to answer an important question: where and how to best spend one’s next dollar to maximize value creation.

In order to identify the optimal option – resulting in single or multiple actions – our BaBIT execution approach entails simultaneous modelling of all three transaction phases and their respective inter-dependencies.

We acknowledge that the impact of BaBIT to realize higher value is simple in theory and much harder to fulfil in the complexity of a business and within a corporate setting. It is even harder to imagine in these days of crisis where enterprises must focus on business economics and cash generation, continue to keep an eye on their customers and people and run their business – all at the same time.

Performance dips can be beneficial

COVID-19 is changing the dynamics of markets significantly – and probably irrevocably. Many businesses have already suffered a performance loss (see “You Now” on the graph). It is important for companies to ‘not waste a crisis’ and we believe this performance dip can be

By Alexander Bock, Philipp Ostermeier and Bob Rajan, June 2020

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beneficial. In certain cases, it might already be visible on a P&L or is expected to materialize in the next months (e.g. due to pre-crisis stocking-in effects), however, care should be taken that the effect is not one-time but recurring, value additive and cash generating.

The performance dip offers a strategic choice on how to emerge out of recovery mode. Consider the lower curve of the graph: Depending on the specific industry context, an improvement in performance that exceeds pre-crisis levels will most likely not be achievable by just restarting business the way it was before. Best case, this will take a very long time and given the global competitive economy, time is a luxury that cannot be counted on. Every second counts, and management must bring an even stronger sense of urgency to their business.

When looking at multiple M&A transactions over the years, our experience indicates that inorganic action has different value creation potential than organic action and in several cases, the recurring P&L effect is achieved sooner than simple organic actions.

With the former, we differentiate between three distinct post-merger conditions for acquired targets (i.e. expected impact on performance):

� (1) Standalone, add top-line growth primarily (i.e. do more),

� (2) Integrate, add scale, improve performance, realize synergies (i.e. do more of the same with less),

� (3) Transformation use an acquisition to create a ‘new’ business and gain a competitive edge (i.e. do much more and better).

However, acquisitions often fail to deliver the anticipated value generation, unless a proper integration plan can be prepared and implemented. In most cases, this

is due to approaches that, in their outset, are less interrelated than the BaBIT approach. Obviously, failures in execution, especially those occurring during integration and subsequently in any business transformation can exponentially destroy value.

Many M&A deals share similar patterns of sequential process execution, with a strong focus on the buy-and-build phase, followed by the integration phase, which if planned properly should deliver value and eliminate efficiencies.

However, there is rarely any focus on the transformation phase.

Why is this? One of the key factors for the lack of a successful transformation (even if the buy-and-build and integration are successful) is the lack of governance, without one central control tower. In fact, these phases are often led by different people or teams with different mindsets and incentives and this misalignment can lead to value destruction. With successful transformations the planning had already started before the M&A transaction was completed. In our experience, excluding external factors, if transformation is not dealt with starting Day 1, the likelihood of failure in the first year is more than 50% and it is very difficult to course-correct afterwards.

Our approach to transformation post coronavirus is to utilise BaBIT - a fully integrated approach of all three aforementioned phases. It connects the dots in a complex web of interdependencies, both forwards and backwards. The resulting BaBIT-based option for each phase might differ from an optimal, option-based model that evaluates each phase in isolation instead of the entire process. Additionally, BaBIT provides focus on performance, rigid execution and total oversight: It avoids changing responsibilities by putting one person or team in charge, accountable for all three phases, thereby ensuring a consistent, seamless and efficient execution.

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Phase I: Buy-and-Build

Identifying the opportunities for inorganic portfolio growth and performance is a given for M&A work. BaBIT goes above and beyond a classic target funnel approach. It is important to answer questions of ‘where to buy and what to build’. In addition, BaBIT combines an outside-in with an inside-out consideration to match current market dynamics (e.g. valuations and willingness to act) with creating opportunities (e.g. including partnerships or asset swaps) and exploiting synergies. Success here is determined by making sure that the buy-and-build narrative gets translated into consistent and concrete measurable actions that will ultimately shape growth and performance of the business and generate future shareholder value.

Whilst generated value is usually calculated at this stage from synergy assumptions (e.g. ROI, ROCE, TSR), it is rather theoretical, as the realization of such value tends to vary significantly when you factor in the reality of what is operationally achievable. In other words, just because something makes sense on paper doesn’t mean that it can be implemented successfully. Depending on the depth and breadth of an integration,

there are various and at times complex parameters to be considered. Execution of such a process requires skills and capabilities, that are not always at your disposal and likely fully bound during the management of COVID-19.

Phase II: Integrate

Even prior to finalizing a transaction, it is imperative to start preparing the integration plan and focusing on the key synergy leavers to unleash performance. It is critical to develop a detailed plan in relation to onboarding of people, communicating leadership, taking measures of control (e.g. portfolio decisions) and setting the foundation and implementation plan for the realization of synergies.

From our experience, improvement opportunities always exist and when looking at synergies, it is difficult to predict what the potential synergy savings are, as many factors need to be considered. However, as a basis from our experience, typical improvement opportunities resulting from such integrations are summarised in the following table1:

1 Source: A&M experience blended from various industries, not only synergies, but also including general improvement opportunities

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Nevertheless, the aforementioned figures are indicative, and each situation needs to be looked at individually. As we all know, the first three months will define how well an integration and how well the subsequent transformation will play out in the long run. Realising what is truly possible

en route to accomplishing these tasks is even more challenging during COVID-19.

Inefficiency or the inability to prioritize initiatives during this period make it almost impossible to catch-up and accordingly reduce the potential value creation and typically cause additional costs, thereby prolonging the integration phase. To be clear, one should not simply forgo the quality of a process in exchange for speed.

Phase III: Transform

Often, we experience a kind of a psychological hurdle towards transformation. Transformation typically involves a change in culture and the amount of work and energy required to implement a change management program accompanying a transformation should not be underestimated. Process improvements, when done correctly, should cut deep across an organization’s controls, and if successful will create a sustainable advantage and a competitive edge in the medium- to long-term. A successful transformation requires changing behaviours to have a lasting impact and that creates fear of the unknown.

With COVID-19, we observe that almost all corporates have had to overcome this hurdle already. They all have started on a path to transformation, be it in how they organize remote work or how they are managing uncertainty to shape a clearer view on how to steer operations. Some of those changes are likely to last way beyond the corona crisis.

Conclusion

Corporates should look at the corona crisis as a transformation stimulus to also change the threshold for opportunistic action. However, this requires additional focus and management attention while still fighting the crisis in parallel. If one adds diligent M&A activity into this equation, the managerial imbalance can further accentuate, thereby intuitively contradicting the pursuit of any such activity. While this challenge may deter activity, time is passing fast, and offers an unparalleled chance for those who take their chances. We anticipate fundamental

changes in customer and supply chain structures, as well as in many competitive landscapes. There will be companies facing insolvency, opening the doors for consolidation or even the emergence of new players entirely.

With that hindsight and knowledge, the important question that every business must ask itself, what does that mean for us? Phrased differently, it’s not only about restarting and ramping-up your business but also about being prepared to become a market maker vs. market taker. We are convinced that now is the right timing for exploring and seizing transformative M&A ‘leap frog’ opportunities. Execution eats strategy for breakfast, and so it is critical that management teams appoint a trusted advisor who with them can take responsibility to deliver results end-to-end.

With COVID-19 we are experiencing a time of crisis, that also creates opportunities in changing market dynamics. BaBIT is about choices, how fast and how strong a company wants to emerge.

It’s about excellence in execution to deliver a strong equity story and ultimately measurable results.

Contact the authors

Dr. Alexander Bock Senior Director, Alvarez & Marsal abock@alvarezandmarsal.com

Philipp Ostermeier Managing Director, Alvarez & Marsal postermeier@alvarezandmarsal.com

Bob Rajan Managing Director, Alvarez & Marsal brajan@alvarezandmarsal.com

ABOUT ALVAREZ & MARSAL

Companies, investors and government entities around the world turn to Alvarez & Marsal (A&M) for leadership, action and results. Privately held since its founding in 1983, A&M is a leading global professional services firm that provides advisory, business performance improvement and turnaround management services. When conventional approaches are not enough to create transformation and drive change, clients seek our deep expertise and ability to deliver practical solutions to their unique problems.

With over 4,500 people across four continents, we deliver tangible results for corporates, boards, private equity firms, law firms and government agencies facing complex challenges. Our senior leaders, and their teams, leverage A&M’s restructuring heritage to help companies act decisively, catapult growth and accelerate results. We are experienced operators, world-class consultants, former regulators and industry authorities with a shared commitment to telling clients what’s really needed for turning change into a strategic business asset, managing risk and unlocking value at every stage of growth.

To learn more, visit: AlvarezandMarsal.com.

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