Analyzing major software companies’ 10-year performance and merger and acquisition activity, EY found enormous differentiation in both returns and degree of reliance on M&A. Some companies achieved differentiated returns while doing lots of deals, while others performed well with minimal M&A. Others suffered a decrease in shareholder value — whether they engaged in deal activity or not.
The study found that success in software is driven by strategic focus, augmented by strategic deals. In short, M&A is a powerful tool to enhance a good strategy, but it generally cannot save a bad one. A company’s degree of reliance on M&A alone is not, by itself, a predictive indicator for success.
The right focus for software companies over the past decade was clearly to be in the software-as-a-service (SaaS) or cloud space. Two of the best-performing companies in the study are SaaS-based, and those companies used different levels of deal intensity to attain their success. One executed only two deals, each of less than $15m in consideration for a total of less than 1% of its own market cap.
Another, conversely, was moderately deal intensive, with more than one dozen announced deals over the time period with a cumulative value of 16% of its market cap. The latter approach matches what has been shown to be a successful deal strategy: make a number of modest-sized deals that accelerate an existing strategy, rather than attempting one blockbuster deal that represents a strategy shift.
As further support of this M&A approach, several of the most successful companies in the study that were not as SaaS-focused were nonetheless companies that stuck to their knitting, undertaking a modest number of moderately sized deals that accelerated their strategy of dominating their niches.
The nuance that our research adds, however, is that even this well-regarded M&A approach of focusing dealmaking on a key strategy can produce less-than-stellar results if used in support of an off-point strategy.
In the 10-year period, one company executed a series of small, targeted acquisitions that supported its core strategy, as the research would recommend. Unfortunately, its core strategy of making on-premise IT shops more efficient was not as successful as one of pivoting to the cloud. As a result, its investors lost 27% of their initial investment, providing a good illustration of a famous Peter Drucker quote: “It’s more important to do the right thing than to do things right.”
Greater Complexity and Risk
Some of the largest companies in our analysis followed the same general approach of making numerous, strategically coherent deals, but they up-sized the deals to increase their impact relative to the buyers’ own size.
For example, among the dozens of deals one company completed, there were 11 that each weighed in at more than $1b in consideration. These deals were operationally complex, and the ability to integrate effectively was crucial. Foundational to the success of this approach were the significant investments the company made, over a long period, in developing effective integration processes and tools. Being able to manage the operational complexities of deals is a requirement for mega-cap companies that hope to enhance returns through M&A.
While the large deals by this mega-acquirer were complex, none represented a bet-the-farm event; even the largest was only 16% of the acquirer’s own market cap. This is critical, as research has shown consistently that an M&A approach of using a blockbuster deal to change strategy is risky, a finding that is corroborated in this study.
Some of the least successful companies in our study are those with a high deal intensity whose deals fit the profile of a strategy-changing blockbuster. In our sample, as in past studies, those kinds of deals haunted the buyer for years. A massive bet on an unproven concept, combined with the complexity of integration across two dissimilar business models, is not a winning combination.
Given these findings, how can a corporate development team best add value for a company?
- Refine the corporation’s strategic focus by learning from marketplace trends or assessing target companies.
- Develop tight screens on acquisitions to determine that target companies represent alignment with a proven strategy, not a pivot to a new one.
- Establish routine processes and deepen operational deal skills, building a foundation to effectively execute and integrate multiple deals concurrently with minimal disruption and loss.
Dean McCauley is principal and Joel John a senior manager at Ernst & Young LLP, transaction advisory services.