November 1, 2022
November 1, 2022
With economic volatility continuing in 2022, some companies may be looking to grow through mergers and acquisitions (M&A) instead of entering or staying in the public markets, or in lieu of other paths to growth. To discuss pressing M&A topics, NACD, in partnership with Alvarez and Marsal, Deloitte, and Fried, Frank, Harris, Shriver & Jacobson, brought together panelists Wendy DiCicco, a board member and executive advisor at Board Advantage; Steven Epstein, partner and cohead of M&A at Fried Frank; Matthew Hency, managing director at Alvarez & Marsal, Corporate M&A; Judy Reinsdorf, a director at EnPro Industries, Nurix Therapeutics, and NACD New Jersey Chapter; and Mark Sirower, principal at Deloitte Consulting, Mergers & Acquisitions. Greg Griffith, NACD senior director of partnerships and corporate development, moderated the event. Below are key questions and answers from that conversation.
Companies are sitting on a lot of capital right now, but at the same time lenders are starting to tighten up. When is M&A a suitable alternative to raising capital?
DiCicco: Those are two very separate things in a normal world. A company can either raise capital… or an alternative might be to enter into a collaboration as a way to raise the capital necessary to pursue the company’s operating plan. Finally, a company can put itself up for sale.
Particularly in my industry and in biotech, a company with a single product trying to pursue a multi-hundred million dollar clinical trial might have had a plan to complete an IPO [initial public offering] this year; now companies are thinking about other ways to pursue that path.… Do we pursue a collaboration or put ourselves up for sale, maybe taking our single product and combining it with a company that also has a product or a manufacturing capability, or a clinical arm where we can put two very great teams and talents together, and two pools of cash, which may not be robust enough to pursue the next 12 to 18 months individually but could stretch to the next goal line… if the companies are together? And then that leads to a whole other set of challenges.…
In the life sciences industry, you should be sitting on 12 to 18 months of cash to pursue your operating plan. While many companies have a plethora of cash today, that’s not true in the biotech industry. This is what makes companies look at the operating plan and think about whether the capital raise is possible. If not, should we consider some sort of collaborative merger that helps us make it past what we think is a capital crunch and into the clearing, where we can then pursue two things together and target a fundraise beyond these challenging times.
Have current economic challenges such as inflation and the war in Ukraine affected the M&A market? How can they be offset?
Epstein: We’re in a very interesting time for M&A—in many ways, unprecedented—because on the one hand, you have powerful M&A drivers such as $2 trillion of ‘dry powder’ sitting with private equity and strong corporate balance sheets loaded with more cash than at any time since World War II. Borrowing costs, while up substantially, are still relatively modest when you take a broader view. On the other hand, there is no doubt we are running into significant headwinds like inflation, supply chain issues and geopolitical risks. As a result, this year M&A is a good news/bad news story. The bad news is M&A activity is down across the board. Deal volume is down sharply as is deal count. Last year, we achieved $6 trillion of worldwide deal volume. This year, we will fall shy of $5 trillion in all likelihood. On a brighter note, if you look at the average of, say, 2015 to 2019, just under $5 trillion is a pretty good result. But, due to the spike in activity during 2021, the perception of today’s downdraft has somewhat overtaken reality. M&A conversations are still quite active, although deal execution is taking longer. Ultimately, M&A comes down to confidence in the boardroom and in the C-suite. Confidence levels today have definitely fallen-off versus 12 months ago. On the other hand, some management teams will see valuation opportunities they have not seen for many years and, at least for some well-capitalized companies, this environment will present an incredible buying opportunity. This may be particularly true in the healthcare and technology sectors. All in all, when the calendar turns, I expect that M&A for 2022 is going to produce a strong showing. It’s not going to look especially impressive when you compare it on a year-over-year basis, but when you compare it to what we’ve experienced over the past decade, it’s going to look pretty solid.
What considerations should boards be thinking about at the intersection of M&A and the incredibly tight labor market?
Hency: M&A events are clearly a catalyst for employees reassessing their jobs, in particular at the targets. More and more employees are making decisions based on factors well beyond compensation. To help navigate the challenge that that’s presenting, we’re finding a few things are helpful. First, be intentional about having cultural assessments as a function of your deal. The companies that are doing this well aren’t beginning this at the time of announcement; they’re beginning to think about it in the later stages of diligence.
The next thing is the importance of leadership’s vision being communicated clearly and early on. This gets beyond the tactical things about what the vision is for the combined products, services, and operations of the company, but into things that employees are caring about beyond compensation. For example, what are the expectations around work location flexibility? What’s happening with respect to DE&I [diversity, equity, and inclusion] programs or ESG [environmental, social, and governance] programs, things that employees are looking for in the companies that they’re working with?
The last thing is that this is not just a 100-day activity any longer; this is a long game to play. We’re seeing that talent retention can be quietly lost over the six to 18-plus month period of a deal. Keeping that at the forefront of your mind well beyond the first 100 days is super important.
What is the role of the board versus management when evaluating a transformative deal?
Reinsdorf: It’s important to remember your respective roles. Management typically is the advocate for the deal. They bring the deal forward to the board, and usually by then they’ve conducted diligence and may even have strong views on the advantages of the deal. Management presents the financials and the value proposition for the transaction. The board’s role is to step back and to have what I call healthy skepticism about the proposal. Your role as a board member is to evaluate the transaction with the knowledge that the company has a limited pool of capital to allocate every year and, if you decide to do the transaction, it means that you can’t do other things. Basically, every deal requires you to restack your priorities. That deal must be a high priority from a strategic perspective; it has to fit into your strategic plan that the board has approved.
After you step back and ask the strategic fit question, ask whether management can deliver on the value proposition. Is it a team with a proven track record? How have they performed against their commitments to the board and shareholders? That degree of healthy skepticism as a board is really important because your investors are going to be critical; they’re going to react very quickly when they hear about the deal. Maybe they’ll be enthusiastic, but sometimes, we know investors can be vocal if they have doubts about the deal. Ideally, you have anticipated those concerns as a board.
What are some tools boards might use to investigate synergies in M&A transactions?
Sirower: The first question to ask is this: What percent of shareholder value are we putting at risk if no synergies materialize? That measure is based on the dollar premium that you’re offering to the other company divided by your own market cap—a measure of materiality of the deal. You’d be surprised sometimes at the amount of value you’re putting at risk. Ultimately, M&A is about managing the growth value that investors are willing to pay for your shares. Why would investors want to buy more of your shares instead of selling them when you announce a significant transaction?
Then you need to think about what is the high-level post-merger integration or PMI plan that will be required to deliver on the projected synergies. Management should be prepared to discuss the integration structure, the leaders, and certainly a basic roadmap with the size, timing, and cost-to-achieve for the major sources of cost or revenue synergies—that should have been developed during diligence to support the price. What areas are going to require the most attention and are most complex? Put yourself in the shoes of investors before you approve a deal. You’re dealing with this classic asymmetric information problem where, presumably, management knows more about the numbers than investors so investors can only go by what you tell them. How will they hear what you’re saying? Viewed that way, preparing for Announcement Day is the last stop in diligence.
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