How CFOs are grappling with increasing complexity in M&A market

The rapidly shifting economic landscape is driving changing approaches to valuations and deal activity.

Diligent finance leaders are finding new ways to reduce risks in merger and acquisition (M&A) deals and drive long-term value. They're scrutinising deals in much more detail and finding different valuation metrics, as markets become crowded with hard-to-price startups. This helps finance leaders weigh risks and benefits while moving quickly to avoid missing out in fast-moving markets.

A barrage of factors have increased complexity in M&A markets.

Rocketing prices for technology firms have threatened the validity of traditional valuation techniques as tech companies' values are often based more on intangible factors and future cash flow potential and less on fundamentals like current cash flow.

Economic and supply chain disruptions caused by the pandemic and the ongoing war in Ukraine have made it harder to identify and quantify risks in acquisition targets. Increasing regulation is adding risk and red tape. The shift to remote working slowed the deal-making process by depriving negotiators of the face-to-face meetings that are often critical to building mutual trust and closing deals.

CFOs say these complexities are testing their skills as they strive to ascertain fair prices for companies they are trying to acquire. Deriving long-term value from deals continues to be a challenge, with more than half of all mergers underperforming, according to PwC.

Addressing all these complexities is a critical issue, given that 62% of companies indicated their growth would come primarily from M&A in 2022, according to an outlook report by the US-based Citizens Bank.

Startups and complexity

Las Vegas-based Rodrigo Vicuna, CFO at the financial infrastructure provider Prime Trust, said soaring valuations of financial technology and related companies in 2020 and 2021 sparked impressive growth and spurred more startups to enter the market.

"But with interest rate increases and overall economic growth expected to slow in 2022, valuations are under pressure," he said. "Emerging and growth-stage companies will consolidate, and companies will turn to M&A to further growth."

As a result, finance executives will need to be nimble in this complex global market.

"CFOs will need to justify higher multiples," he said. "The fundamental complexities of valuing a company haven't necessarily changed, but finding or defining useful comparison has."

Vicuna added that companies that can stave off competition with unique intellectual property are more valued than those in the industry that can't offer solutions that are as dynamic. But it may not be fair to compare newer fintechs to older or less innovative companies.

Given that technological adaptation is now a consistent pressure across all industries, this is not just a tech sector issue. The increasing number of startups trying to disrupt many traditional industries can create a complicated picture of fair value, said India-based Anish Ailawadi, senior director at research firm Acuity Knowledge Partners.

"Complexity is higher in a startup ecosystem, where loss-making businesses are valued on future cash flow or uniqueness of business plans," he said. "As such, firms use those distinctive valuation metrics and KPIs in place of traditional metrics such as profitability or return on investment."

Adriana Carpenter, CPA, the CFO at the US-based expense management technology platform provider Emburse, encountered many of these issues in two acquisitions her company made last year.

"Valuations are high, with lots of competition for assets," she said. "'But there is also more uncertainty, which breeds more risk. For tech targets, we are getting savvier about digging into the type of tech and maturity of its infrastructure."

Carpenter said she now needs to understand fully the answers to questions such as, how are the company's operating platforms integrated and can they be transitioned? Do they use open source software? Where does their intellectual property sit, and are there issues with it?

Other factors include which international laws and taxes apply to the target and how they might mesh with local ones, Carpenter said. The proliferation of regulations in different regions — for example, around privacy and security in the EU's General Data Protection Regulation (GDPR) — also create valuation and integration challenges.

She suggested using a third-party firm familiar with tax laws and other regulations to fully understand any cash, tax, or integration challenges that could arise after a deal is finished.

Not 'room for forgiveness'

This proliferation of regulations may help explain why interest in international deals declined among both buyers and sellers, according to the Citizens Bank M&A Outlook 2022 survey. It showed middle-market companies' decreased interest in global M&A for sellers (from 33% in 2021 to 29% in 2022) and buyers (from 47% to 41%).

Citizens also highlighted that explosive growth means companies need to make more and faster returns to make deals work. But this is harder to predict, given the way the COVID-19 pandemic and other economic factors such as labour market challenges and higher commodity prices have hampered operations in many sectors.

As Carpenter put it: "There's not as much room for forgiveness, and the pandemic made that worse."

She highlighted that, with a workforce that is increasingly scattered around the globe, buyers must understand exactly where acquired employees are, how they can be integrated into the new company, whether there will be any headcount reduction or merging of teams, and how to communicate that.

"In a technology deal, you also need to know specifically who and where the software developers are, and whether they are outsourced or internal," she said.

Carpenter said using workers based in other countries is much more prevalent. So a key consideration is how likely it is that individuals in various locations will stay in the transition.

Buyers also have to balance all this detail about workers against the speed of the process and risk of losing out to competition, she said.

Effect of market uncertainty

Adding to these issues is a slew of economic uncertainties, including those linked to Russia's invasion of Ukraine and to rising inflation and interest rates.

Carpenter said: "We are watching the Ukraine situation closely. Any buyer needs to do a lot of due diligence into the target company's exposure, including any Russia-related revenue, operations, and potential effect from sanctions."

Vicuna said that with rising interest rates and organic growth forecast to slow, it is difficult to predict the trajectory of stock prices. In this situation, it is best to focus on fundamentals such as how fast and consistent the target company is growing, its debt level, and its competitive advantage.

"With capital tightening, companies that relied on short-term growth might have weaker positioning," Vicuna said. "Those with better fundamentals, such as strong balance sheets, will be better positioned in a changing market and benefit from acquisitions. Capital tightening means fintech companies will increasingly have to rely on investor capital, M&A, or organic growth, which could make it easier for acquirers."

Despite all these headwinds, PWC's 2022 outlook on global M&A industry trends predicts intense competition between corporates, private equity, and special-purpose acquisition companies for deals will continue. The strategic shift to digital, disruptive business models is not going away and should continue to drive M&A decisions. As these factors push up multiples and return expectations, it heightens the need to bring deeper operational expertise and puts sharper focus on value creation than ever before, PwC found.

How to weight ESG risks

Companies will also have to intensify their focus on environmental, social, and governance (ESG) factors, due to increased interest in sustainability issues amongst investors and consumers, according to PwC.

Buyers are increasingly accounting for ESG-related risks and opportunities in M&A decisions. For example, in PwC's 2021 survey on global private equity responsible investments, more than half of respondents either refused to enter an agreement with a partner or turned down a potential investment on ESG grounds.

Ailawadi said to expect more focus on sustainability as time goes on.

"We expect the increased focus on ESG metrics in deal-making and valuations to be more pronounced in 2022 and beyond," he said. "Valuations are expected to remain high for sustainable businesses."

Capability plays

PwC's report on doing the right deals shows 53% of acquirers underperformed their industry peers over the 24 months following completion of their last deal. This was based on analysis of 800 deals between 2010 and 2018.

The best way to avoid this is to base deals on capabilities, the report said. The analysis showed "capability access" deals — those that aim to capture value-creating strengths — were the only type that delivered above stated aims, across all sectors. Deals aiming to diversify strategy delivered as expected, while those looking to consolidate or increase product, category, or geographical adjacency all underdelivered.

PwC attributed the success of capability strategies to companies acquiring new strengths enabling them to thrive in a changing competitive landscape.

Carpenter explained how this kind of strategy has worked at Emburse.

"Take our acquisition of the Roadmap app last year," she said. "Many mobile apps will connect you to a travel platform, but our acquisition went way beyond that — integrating manual task automation with a suite of information that increases traveller happiness at their destination. It aligns with our strategic vision to humanise work."

She added that buying pre-revenue companies can be a drag on revenue growth. But it might be worth it if you can, for example, acquire synergistic technology. Start some integration before closing the deal or it could impair your ability to execute that vision.

You also can't miss a beat in making acquired employees feel welcomed and integrated, Carpenter said. As there is so much competition, the stakes are higher.

Despite the reduced interest in international deals, buying foreign companies is still a way to address complexity by widening your search into areas where there may be less competition or regulation, she said.

— Tim Cooper is a freelance writer based in the UK. To comment on this article or to suggest an idea for another article, email