Stripping M&A of Emotion and Intuition

With finite capital to invest, acquirers need a fact-based decision-making process. Here are the three lenses through which Thomson Reuters filters...
Tim CollierFebruary 24, 2012

How the United States can grow the economy and the workforce without overleveraging its future is the burning issue occupying political and economic pundits, affecting financial markets, and shaping a vigorous election debate. At the corporate level, chief financial officers are faced with a similar challenge: how can they preserve the cash and liquidity they need to remain operational without shortchanging the investment programs — and curtailing the necessary risk — that will fuel profitable business lines and long-term revenue growth?

Most executives agree that creating sustainable growth requires not a quick fix but a long-term strategy, thoughtfully deliberated and applied consistently over time.

For the CFO of a global corporation, a key element in that strategy is mergers and acquisitions. But what we find works is not the blockbuster, top-down acquisition strategy of decades past; rather, M&A is best looked at as an organizationwide initiative, aligned to a company’s global and regional goals, integrated into the mind set of its executives, and conducted with a clear understanding of the financial risk a company is willing to accept.

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Thomson Reuters’s integrated M&A approach requires the engagement of business line leaders, country managers, and financial executives worldwide. There is no better way to identify and initially vet promising companies for acquisition and partnership than through in-country contacts and local business experts: they know the competitive landscape in their regions. In addition, managers know the founders and owners of potential acquisitions. That provides deeper insight into a target company but also assures the owners that their teams and their culture — often very intertwined with the owners’ identity — will be respected.

We rarely buy a company that we don’t know really well from our in-country experience. But going back to our opening dilemma — how to keep a company capitalized and operational without sacrificing future growth — we also know that we have finite capital to spend. Therefore, we analyze the viability of an acquisition through three critical lenses: strategic alignment, growth and return, and value assessment.

Strategic Alignment
Our M&A strategy is to identify companies offering a distinctive and, to a degree, untapped value proposition. These companies would also benefit from not only our vision but also our technology and reach, and from the connections to other companies in our portfolio.

When we decide to invest in an industry or marketplace, it should give us the opportunity to deepen or broaden our expertise. Sometimes buying a company allows us to bolt-on an industry specialty or acquire a missing ingredient to supplement one of our existing products. For example, by purchasing a Brazilian legal business in Latin America, we were able to augment our legal offering and technical knowledge to rapidly expand the operation, take the business’s product online, and at the same time strengthen our roots in a region that continues to develop. Finally, an acquisition must also mesh with the other companies in our portfolio.

Using a Growth Grid
The structure of our decision-making process is based on the discipline of a growth and return model: growth is measured by organic revenue growth and return is based upon an operating income margin — we often use cash operating income — and displayed in a classic four-quadrant grid. The grid enables us to track a company’s accelerating, peaking, decelerating, and expiring growth and return stages, and it helps us maintain rigor in acquisition (and disposal) decisions. For example, a peaking company may have a terrific business, but it may be too late in its growth cycle to purchase it.

Our growth and return model also serves as the basis for what we call our fact-based decision-making process, which prizes objectivity and weeds out emotion. In today’s environment where intuition is highly valued and facts are in overabundance, this model helps us to step outside the consensus market perception of a company. It also challenges us to ask the right questions about a company’s future benefits as an investment and as a valuable element of our portfolio.

For example, if our view of a target’s growth potential diverges from that of the market, that company may be more valuable to another buyer. Or we might determine that a company requires a significant catalyst to achieve its potential — such as a change in management or business line — that renders it too high a risk.

Assessing Value and Risk
The third lens is a value and risk assessment, which becomes very important in the final analysis of a deal. Many target businesses get past the first two hurdles, but the next one is key, because it involves separating the business model from the purchase price. Although we are a large global company, we still have a finite amount of capital to spend. Therefore, part of our analysis is how investing in one company supersedes investing in another.

This analysis hones in on the difference between the company we’d like to own and the company we’d like to buy. There are many companies we look at that have strong growth rates and margins, but are valued too high. These are “nice companies to own, but horrible businesses to buy,” as it will be very difficult for us to deliver an acceptable return to our shareholders.

We have developed a seven-metric analysis to measure the risk of an acquisition. The analysis looks at a deal in terms of low, medium, and high risk. It is important to note that the seven metrics are not minimum levels of measurement a company needs to hit, but rather ways to frame the risk we are taking in acquiring them. Within each metric, we have hurdles that reflect what we consider to be high, medium, or low risk. These metrics are consistent across businesses and geographies. They are return on investment capital, integration time, net present value, internal rate of return, free-cash flow accretive, payback period, and terminal value/present value.

Some of these are relatively standard measurements. The payback period, for example, is how long (on a cash basis) it will take for the acquisition to repay its cost, and free-cash flow accretive is how quickly the acquisition will be free-cash flow accretive on an operating basis. A less common metric, however, is integration time. The longer it takes to fully integrate a company, the higher a risk it is.

As with all our assessments, these metrics are meant to guide decision making, and are considered alongside a target’s growth capability and how it stacks up against similar portfolio holdings. Just because a company falls into a high-risk category does not mean it will be rejected out of hand, but it will need to compensate by providing value or contributing to the portfolio in meaningful ways.

Tim Collier is chief financial officer of the financial and risk business unit at Thomson Reuters, one of the largest information providers to businesses and professionals. In his role, Collier is responsible for helping drive growth in the $7 billion Financial & Risk business, which sells in over 100 countries.