Qualitative Analysis
May 3, 2024
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This guide explains what strategic buyers are in mergers and acquisitions. It goes into further detail about the difference between financial and strategic buyers, and it explains the strategic rationale behind several different types of mergers and acquisitions. Here are some key takeaways about strategic buyers in M&A:
To understand M&A strategy, we need to understand the difference between two types of buyers—financial and strategic buyers. Beyond turning a profit, financial and strategic buyers have different objectives for making acquisitions.
Strategic buyers are other businesses looking to make acquisitions to grow their business, reduce costs, or eliminate competition. Financial buyers are professional investors (such as private equity firms) that are non-operators, looking to use financial leverage to make acquisitions and create value through equity rate of return.
A financial buyer is most interested in making an acquisition because of the return that can be made above and beyond the purchase price. Their primary focus is on the cash flow of the target business and on the potential exit strategy they can use to realize their return on investment.
Strategic buyers tend to be large companies that are well capitalized and able to look past immediate cash flow and instead focus on the possibilities for the growth of their core operations.
Strategic buyers are primarily concerned with achieving financial synergies and how the target business could help them achieve their strategic goals. The main idea with strategic mergers and acquisitions is that the company would improve its core business by making this deal. There are two types of financial synergies that strategic buyers look for—cost savings and revenue enhancements.
Cost savings are financial synergies that occur when two companies merge, and the effect is lowering the costs of doing business through increased operating efficiencies. Examples include layoffs for redundant staff, and a reduction to distribution costs.
Revenue enhancements are financial synergies that result in the business’ ability to generate more cash flows through more effective use of assets. Examples of revenue enhancements include access to new markets and the ability to cross sell new products to existing customers.
It’s easier to understand the motives of strategic buyers through a comparison of several types of strategic mergers and acquisitions. To better understand the different types of mergers and acquisitions, we recommend this guide. Here is a summary breaking down different types of mergers and acquisitions for comparison purposes:
Now that we’ve seen six different types of mergers and acquisitions, we’ll look at the underlying strategic rationale that helps strategic buyers decide which may make the most sense for their unique situation. Here are some major strategic considerations that will help a buyer narrow in on an effective acquisition strategy:
Improve Core Operations — When a business does an M&A deal, an obvious motive is to make a profit and to create value for shareholders. As we’ve seen so far, this often comes from cutting costs and from the ability to generate more sales as a result of the deal. M&A deals must create value to be deemed successful in the end. There are many opportunities to increase prices, to sell more units, or to enter new markets through M&A deals.
Reduce Redundant Expenses — M&A deals can be used to reduce costs and overhead by making them unnecessary. If two companies merge together (become one entity), then they don’t need two CEO’s anymore. Many jobs can be made redundant through M&A deals. In addition to layoffs, there are many other costs that can be made redundant as well. As an example, fewer buildings or vehicles may be necessary as a result of the deal.
Improve Production Output — Often M&A deals will give a business the ability to produce more. If a company buys a manufacturer, for example, they can focus entirely on their own business needs. It would be rare for a manufacturer to work with only one customer. They would likely have many customers they serve at any one time. Through an M&A deal, a business could acquire a manufacturer and focus their operations entirely on servicing their own business needs.
Achieve Economies of Scale — Often through merging with or acquiring another business greater cost savings are made possible through economies of scale. If both companies combined can purchase more volume, they can generally get a better discount. These savings can apply to a range of services as well as physical products.
Achieve Faster Growth — It may be faster to grow by acquiring another company—and through them, their customers—than it is to grow organically. A primary motive for M&A deals is the ability to grow faster than they otherwise could.
Reinvest Excess Cash — The ability for a business to generate excess cash, profitably, is important. However, accumulated cash comes at an opportunity cost. What could be done with that cash to earn a return. M&A deals offer businesses with large amounts of accumulated cash the opportunity to both reinvest it for a return, as well as to grow core operations through a strategic acquisition.
Acquire Patents or Technology — Another strategy for M&A is to do a deal in order to acquire patents, or gain access to new technologies that are otherwise out of reach. Some companies have larger focuses on R&D than others. M&A deals can be a cost-effective way to gain access to new technology or to improve existing products through the acquisition of patents.
Eliminate Competition — As is the case with horizontal integration, M&A deals can be done with the intention of eliminating a competitor. The motivation to do this can be to prevent an industry disruptor, or to raise prices. If competition is removed, there may be the opportunity to increase a price without a competitor offering a cheaper solution. Through M&A deals that eliminate competition, businesses can gain increased market share as well.
Improve Supply Chain Efficiency — M&A deals have always been a great way to improve supply chain efficiency. Supply chains may include the sourcing of raw materials, manufacturing, assembly, distribution, and the retail selling of the products to the end customers. Through an M&A deal, a business can reduce costs and improve profit margins by purchasing another business along their supply chain—a process called vertical integration.
Both financial and strategic buyers make acquisitions with the intention of making a profit, but as we've seen, have different intentions for M&A deals. Here, we'll look at some important deal elements that successful M&A transactions must have:
First, there needs to be a clearly defined timeframe for the deal. M&A deals can take years to complete and there needs to be both a sense of purpose and urgency that goes into advancing the M&A process. This isn't to say the deal should be "rushed," but to stress the point that progress in M&A deals takes effort and acquiring companies should try to set target deadlines for each part of the M&A process.
Second, there needs to be a long-term focus for the strategic rationale behind making the deal. Private equity companies operate on five- to ten-year timeframes for a reason. It takes time to realize a return on investment and both strategic and financial buyers should be making a deal that will benefit them years down the road.
Third, the deal should be focused on creating a win-win outcome. This is especially true for mergers. If one company stands to gain substantially more than the other, then the deal may end up failing. A large number of M&A deals fail to create long-term value and there is more to consider than just the financial picture. There have been numerous instances where two companies have looked like a perfect match on paper, only to see a culture clash lead to a failing deal. M&A deals work best when both parties see enormous upside to the transaction. What can be done to increase the likelihood that this deal will produce lasting value and keep everyone happy?
