Senior product management professionals (Directors, Vice Presidents, Chief Product Officers) are expected to have a lot of competencies and experience. Brent Tworetzky, SVP of Product at InVision does a good job of describing what skills are expected of product management professionals at each level of seniority. One topic that is missing from the list is competency in mergers, acquisitions, and divestitures. Senior product leaders make build / partner decisions all the time. The ‘buy’ component of “buy/build/partner” is often a missing component. Product Leaders should learn how to pitch M&A candidates.
As a company moves through the technology adoption life cycle, the ‘buy’ portion of ‘buy/build/partner’ decisions become more important. Consider the following chart:
In the early stages of the life cycle, senior product leaders’ competencies in domain knowledge, strategic thinking, collaboration, user science and empathy are critical. As a company moves into the Early and Late Majority stages of the life cycle, acquisitions become a more viable alternative to helping a company increase its market share and grow revenues/profitability. The time required to build and launch a new solution as well as the risk of achieving significant levels of revenue/profitability can be very high. The cost/benefit of acquiring an established company becomes more attractive option.
Most senior product leaders do not have experience in pitching potential acquisition candidates. Many may have participated on the periphery of an acquisition project at some time in their career. But, they don’t know how to pitch an acquisition idea in terms that their CEO and CFO can understand. Senior product leaders need to learn how to answer four basic questions:
- How does this acquisition fit our strategy?
- Can we afford it?
- Will the acquisition produce acceptable returns?
- Can we manage the risk?
It is important to put the role of product management in the M&A process into perspective. Corporate Development or Business Development teams are responsible for M&A activities. Product management will not supplant or replace these teams. Instead they will complement and support them. Senior product leaders do not need to develop the specialized skills corporate development teams do. Skills like detailed financial modeling, transaction structuring, financial and legal due diligence, are not required. Senior product leaders do need to learn how to structure and present their M&A ideas in a form that senior executives can understand and act on.
Product management brings a unique perspective to the M&A process. Product management sits at the intersection of understanding the market (prospects and competitors), customer requirements, product development, marketing, and sales. Senior product leaders can support these teams by identifying and profiling potential acquisition candidates. These ideas can move into the regular M&A process for consideration and action. For acquisition ideas to be taken seriously, they need to be framed in ways that senior executives can understand.
Senior product leaders need to be able to answer the four basic questions outlined above. Product leaders don’t have to answer these questions at the same level of detail as a corporate development professional. They should be able to address them at a macro level, in a similar manner to how a business model canvas can replace a 100 page detailed business plan.
This is the first question everyone asks about a potential acquisition. Senior product leaders should be in a very good position to answer it. A core part of product management is strategy alignment. Every day product managers answer the question ‘how does this initiative/project/product support implementing our strategy?’ Senior product leaders need to be well versed in their organization’s goals and objectives. Acquisitions are one of many tactics that the organization can use to implement their strategies to achieve the organization’s goals. Goals often include specific targets for market share, competitive positioning, revenue, profits, cash flow, or enterprise value. Senior executives are well versed in these topics, in fact their incentive compensation is often directly tied to them. Senior leaders should seek out and understand what these specific targets are and then tie how an acquisition candidate would help to achieve them.
Sometimes a simple graphic can help communicate this type of linkage very effectively in a way that senior executives can grasp. Gartner Group style Magic Quadrants are a good tool to do this.
You can align your organization’s goals into two major buckets – completeness of vision and ability to execute. You can then describe how the acquisition candidate will help to achieve these goals. The result will be a presentation and concept that your senior leadership team can readily appreciate.
Magic Quadrants are not the only tool you can use. Most organizations have some type of formalized annual business planning process. Senior management is familiar with the results of these processes. Examples include balanced scorecards, blue ocean strategy, OKRs, and scenario based planning. You investigate and understand what approaches your executives use.
Assuming that your acquisition idea passes the strategic sniff test, the next question will be can your organization afford to pay for the acquisition? To answer this question you will need to understand two things: acquisition currency and valuations.
Acquisition currency is the consideration paid to acquire a company. It can be cash or company stock, or a combination of the two. Cash can come from cash on hand, the sale of newly issued company stock, or new debt the acquirer takes on to finance the acquisition. Company stock can come from already authorizes, but not yet issued shares, or from new stock that the acquirer’s shareholders agree to issue.
If the acquirer is a public company you can find this information on the balance sheet that is reported every quarter. 10-Q quarterly reports are filed with the SEC. Financial statements are also filed as XBRL documents which can be downloaded into Excel. For example Smartsheet, a $200 million provider of collaboration and work management solutions, had $208 million of cash and cash equivalents and 467,801,369 shares of authorized, but unissued common stock on April 30, 2019. You can access the Excel sheets here and just the balance sheet here. While Smartsheet couldn’t afford to buy Google, they could spend $100 million in cash and stock for an acquisition.
Debt is a popular tool for financing tech acquisitions. Companies often combine debt with cash on hand to finance an acquisition. Most software debt financings are considered ‘junk bonds’. The infamous Michael Milken used junk bonds in 1985 to support Sterling Software’s acquisition of Informatics General. This was the first hostile takeover in the software industry. The amount of debt a company can borrow is limited by several factors. A common factor is the Debt to EBITDA ratio. Moody’s reports that the average ratio for CCC rated debt (junk bond level) is about 8.1x. A company could borrow eight times the incremental EBITDA in new debt. This is something you can blend into your thinking about acquisition currency for your company.
The second part of answering the question ‘Can We Afford It?’ is understanding what it will cost to acquire an acquisition target. Product leaders need to understand the valuation a target company expects to receive to agree to an acquisition. Valuation is the combination of what a buyer is willing to pay and a seller is willing to accept at a specific point in time. Relative valuations rise and fall as the business cycle changes. What is expensive today can become cheap tomorrow.
The core metric for valuations is enterprise value (EV or TEV). Enterprise Value is the value of a company’s equity, less cash and marketable securities, plus debt. It represents the total funds that would required to purchase a company at a particular point in time. Valuations are often described using enterprise value multiples, such as Enterprise Value/Revenue or Enterprise Value/EBITDA.
Calculating the Enterprise Value of public companies is easy. Most stock reporting sites calculate it automatically for you. I use the key statistics feature provided by Yahoo Finance. For example here are Google’s key statistics. While Google’s market cap is $754.21 billion, their enterprise value is $652.28 billion. As of March 30, 2019 Google had $113.49 billion in cash and $12.27 billion in debt.
Calculating the Enterprise Value of private companies is much harder. There is no central service that tracks private company enterprise values. You have to use techniques to estimate the company’s revenues and profitability, apply current industry valuation metrics like Enterprise Value/Revenue and Enterprise Value/EBITDA, and then apply a discount factor to accommodate for the fact that the target company’s stock is not liquid and financial results are not public, audited, or not compliant with regulations like Sarbanes-Oxley or Gramm-Leach-Bliley. Check out How to Calculate the Enterprise Value of a Private Company to learn more.
The hardest question to answer about a potential acquisition is will it produce acceptable returns. Forecasting future results is tough. To quote the Harvard Business Review
M&A is a mug’s game: Typically 70%–90% of acquisitions are abysmal failures.https://hbr.org/2016/06/ma-the-one-thing-you-need-to-get-right
While that makes a great headline, the reality is different. A recent example is Vista Equity’s acquisition of Marketo and subsequent sale to Adobe. Vista made $3 billion on their initial $1.8 billion investment in Marketo. Vista is a private equity firm. They did not make the improvements in Marketo’s valuation through creative financial engineering, but by making significant growth investments.
Product leaders can describe how an acquisition will improve their company’s technical capabilities, competitive differentiation, global sales distribution, etc. But these are ‘soft’ benefits that are subjective in nature. The CEO and CFO will want to know how an acquisition will produce dollar and cents benefits to the company. Investing in building a product versus spending the same capital in an acquisition often boils down to a cost/benefit/risk decision.
Product leaders need to take a stab at estimating what the financial benefits of an acquisition could be – increase in revenue, profits, and enterprise value. These estimates will never be as detailed or accurate as those produced by M&A professionals. The estimates will demonstrate the potential order of magnitude financial and valuation improvements a deal could bring to the company.
Product leaders need to dust off their financial modeling skills from MBA school and develop some high level pro-forma financial models. First they should develop an estimated P&L for the acquired business post acquisition. This does not have to be a detailed P&L, but it should reflect the changes to revenues and expenses post acquisition. For revenues, you should consider if there will be any revenue dis-synergies if your customer base overlaps with the acquisition candidate’s customer base and they decide to drop one or the other product. You should also consider if revenues will decline or grow post acquisition. In terms of expenses, you should consider raising the profitability of the acquired company to at least match the profitability of your company.
Next, they should develop a valuation model for the acquired company. Here is an example of what a summary valuation model would look like for a private company:
This level of financial modeling is not a core strength of most product management professionals. You may need to draft in some help from the Finance Department. It is important to stress that you should not expect to produce financial models as detailed as a M&A professional. What you are trying to do is show the potential financial aspects of an acquisition in a format that is familiar to non-product executives like the CEO and CFO.
Estimating returns is not an easy task to do. It is not something a senior product management professional can do. You would need access to not only the acquisition candidate’s financials, but your company as well. First, you would build a model that consolidates their financial statements. Next, you would build a forecast for what the next three or five years would look like. Finally, you would have to build a returns model. Corporate Development specialists can do this work. It is not something that is in the wheelhouse of a senior product leader.
Mergers and acquisitions are risky. There are a lot of moving parts and everything needs to come together at the right time to achieve the benefits. Unless you have done an acquisition at your company you never know what the risks are and how they can be mitigated. As product leaders pitching an acquisition candidate you will not be expected to know all of the potential risks and mitigations. You should be aware of what the potential risks are and spell out what you believe when you pitch the deal.
Three major areas of risk include:
- Distraction Risk
- Business integration
- Cultural integration
Distraction risk is the risk that during the merger integration planning and rollout the business becomes distracted from their core business and misses key objectives. For first time acquirers this is a major risk. Once your company has done a few acquisitions it becomes easier to manage.
Business Integration risk involves the challenge of integrating the acquired company into yours once the deal closes. Combining development, marketing, sales, and customer support organizations can be tough. So are activities like data center consolidation, business system migration, and employee benefit plans. Many organizations setup business integration project management offices to manage the detailed work of business integration.
Cultural integration is probably the biggest long term risk for any acquisition. Product leaders should make an effort to understand the basic culture of an acquisition candidate. They should form an opinion on whether it is compatible with your culture. The stories of failed merger cultural integrations are legendary. Examples include GM/EDS, HP/Compaq, and AOL/Time Warner. One of my favorites is a quote from Ross Perot about his opinion of GM’s culture after GM acquired EDS:
I come from an environment where, if you see a snake, you kill it. At GM, if you see a snake, the first thing you do is go hire a consultant on snakes. Then you get a committee on snakes, and then you discuss it for a couple of years. The most likely course of action is — nothing. You figure, the snake hasn’t bitten anybody yet, so you just let him crawl around on the factory floor. We need to build an environment where the first guy who sees the snake kills it.http://www.quoteswise.com/ross-perot-quotes-3.html
Once you have completed your research and analysis, how do you pitch your idea to the senior leadership team? I have analyzed 500+ companies as potential acquisition candidates and presented my results to CEOs, CFOs, Board of Directors, and Private Equity Investors. A typical acquisition candidate analysis document could be 100 to 300 pages long. That is too much for an initial presentation. I found a business canvas-like presentation to be the most effective way of presenting a concept. These presentations were generally less than 25 pages and could be delivered in less than 30 minutes. The goal of these pitches is to introduce the concept of a particular deal and get feedback to see if there is an interest in exploring it further. The table of contents for a typical pitch looks like this:
As companies move through the middle stages of the TALC M&A becomes a more important option. Product management leaders can play an important role. Product leaders have a unique perspective. They regularly collaborate across development, marketing, sales, support, and finance. This gives them a general management-like perspective of the opportunities and challenges the organization faces. Acquisitions are one strategy that can address these challenges. Senior product leaders need to be able to frame their recommendations in ways that executives can understand. This calls for learning some new skills and techniques. Senior product leaders do not have to become experts in the skills that M&A professionals have. They do need to be able to answer the four key questions that arise when looking at an acquisition. How does this acquisition fit our strategy? Can we afford it? What types of returns will it provide? Can we manage the risk?
Also published on Medium in The Startup
Also published on Medium.