This article originally appeared in Business Insider
June 24, 2013
Plans are only good intentions unless they immediately degenerate into hard work.
– Peter Drucker
The past several months have illustrated clearly the importance of tying well-defined assumptions to acquisitions.
In a period of increasing leverage, financial engineering was seen by private equity investors, rightly or wrongly, to be the driver of outsized investment returns. Post-recession, we are seeing a return to an earlier, simpler time, with the predominant driver of returns becoming operational improvements and a strategic approach to implementing them.
For strategic acquirers on a steep growth trajectory, purchases have too often been made quickly and with little thought to integration. A “land grab” mentality often prevails, and as a result much of what is most valuable in the acquired companies is lost or destroyed.
Financial Buyers Refocus on Operations
In retrospect the case of HD Supply seems obvious. The company made 30 acquisitions from 2005 – 2006, including the acquisition of Hughes Supply, which doubled the company’s sales. This blistering pace was a considerable increase from the more moderate pace set between 2000 and 2004, when the company made a total of 10 acquisitions.
As with many buyouts of a similar vintage (HD Supply was purchased in 2007), it could be argued that poor timing created headwinds that no management team could overcome. FY 2012 sales at $8.0 billion, were slightly below FY 2008 sales of $8.2 billion. However, 2012’s $683 million in Adjusted EBITDA (an 8.5% margin), showed significant improvement over 2008’s $476 million in Adjusted EBITDA (a 5.8% margin). An object lesson that increasing sales is not the only path to improved performance.
A Land Grab Without Benefit Of A Plan
After rising to prominence and an IPO on the back of its social gaming success, it is little surprise that Zynga (ZNGA) took some shortcuts. Shortcuts are one thing, value destroying folly (shares are down 55% in the last 52 weeks) is something else. Zynga shareholders have seen little benefit from the company’s raft of acquisitions other than a bloated cost structure (recently addressed in a drastic round of layoffs).
Somehow a company that managed to more than double sales between FY 2010 and FY 2012 ($597 million to $1.3 billion), and end 2012 with a strong liquidity position, has also failed to maintain a positive operating margin. This failure suggests that management was either too sanguine about the prospects for the company’s core product offerings, or was unrealistically enthusiastic regarding the prospects of the companies it was busy acquiring. Either way, the root of Zynga’s failings point to a failure to understand itself as a company.
In the absence of financial engineering, creating value has become harder. Those seeking to acquire companies must focus on developing a holistic understanding of both the acquisition target and the performance improvement initiatives to be implemented immediately upon close of a deal. The nexus of maximum value creation has shifted, and now resides at the intersection of strategic understanding and operational improvement.