Make or Buy? Organic growth or M&A?

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A tale of two value creation opportunities 

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On the 29th December 2016 and again the 7th February 2017 the Financial Times wrote about an M&A boom. “The M&A boom will carry on…Many companies face poor organic growth prospects, forcing them to consider buying rivals or expanding in new territories…” Deloitte reports that 75% of executives expect deals to increase in 2017 while according to Moody’s “A ‘major theme’ of recent activity was positioning for the future through the acquisition of technology.”

Does this strong appetite for acquisitions create economic value?

Depending on the industry and the profile of the acquisition target, bigger may well be better. But if both the acquirer and the acquired were struggling to grow before the acquisition, are we not simply moving the problem to the future?

Acquisitions instantly increase revenues and usually earnings per share. From this perspective, deals that expand a business’ geographic footprint and improve the competitive position can be an attractive approach, especially in mature markets. Focus on managing the integration of both companies, improving economic performance and cost efficiency and leveraging greater market share will certainly create some economic value. However, after a few years these effects taper off and executives will need to decide what’s next.

Furthermore, the current high share prices or, perhaps better said, the high market valuations put pressure on executives to quickly deliver synergies. This is usually shorthand for cutting costs. According to a Bain study from late 2014, 70% of companies announce synergies that are higher than the scale curve suggests. Unsurprisingly, most companies will be disappointed by the actual synergies created.

Against that background, organic growth can be an attractive alternative. Executives often underestimate the power of organic growth. Clearly, organic growth takes more effort and time for growth to manifest itself, but our research shows that organic growth typically generates up to one third more economic value.

This is hardly surprising as the upfront investment for organic growth is lower, while for acquisitions the acquisition price usually includes a takeover premium. Therefore, over time the ROIC and ROE is higher for organic growth compared to acquisitions.

This is a good reason to look hard at creating internal growth opportunities and leave the acquisitions to competitors that have run out of ideas.

Karel Leeflang and Roland Mosimann, StrategyPod powered by AlignAlytics

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