Salesforce.com announces it’s acquiring ExactTarget for $2.5 billion (a 53 percent premium!). The same day, IBM reveals plans to purchase competitive cloud company SoftLayer Technologies, which could be worth $2 billion. And both buyouts come on the heels of Yahoo’s high-profile acquisition of Tumblr for $1.1 billion.
The M&A upsurge last spring--and what it suggests about a growing corporate confidence in future growth--makes the Jim Cramer in all of us a little bit giddy.
But how can we know for certain whether a company’s acquisition strategy will produce long-term gains? Despite a glut of punditry, there is very little thoughtful analysis out there regarding the principles and strategies behind fruitful acquisitions.
Which is why we were so intrigued by the detailed checklist that Mike Volpi, former chief strategic officer of Cisco, contributed to Gigaom in 2011. Under Volpi’s management in the 1990s, Cisco was an M&A powerhouse (75 acquisitions in seven years) that few midmarket firms could hope to mimic in terms of scope and capital investment. But as Volpi says in his two-part post "Six Key Principles of a Successful Acquisition Strategy," Cisco’s methodologies for acquisition-as-growth "could be a template for a wide range of media and retail businesses that aspire to generate their next growth phase."
Rule 1: Choose a core objective.
Boost market share. Build economies of scale. Recruit top talent. These corporate objectives are all fine, but they can’t--and shouldn’t--collectively color your acquisition strategy. Choose one goal and tailor your acquisitions accordingly.
"At Cisco, we were pretty clear that we wanted to enter new markets," writes Volpi, who is now a partner at Index Ventures. "We fundamentally believed that we could better leverage [our] distribution channel with a product portfolio that was broader than what our development organization could produce within the necessary timeframes. As a result, we bought lots of young companies with promising technologies or products."
Rule 2: Develop a portfolio.
Technology acquisitions, Volpi argues, are not standalone events. They should build an interconnected investment portfolio. Some of those investments will pan out; others will not.
"No matter how good of an acquisition process you assemble, the odds are stacked against you that any given deal will succeed," Volpi writes. "It’s only when you assume a certain failure rate to be the norm and believe in the occasional massive success that the probability and expected value equation begin to work in your favor."
Rule 3: Understand that valuation is secondary to fit.
Roughly 20 percent of a company’s acquisitions will yield huge results. You're better off hunting down those two out of 10 "outsized returns"--and paying up to a 30 percent premium for them--than you are trying to finagle the best deal.
"Worry less about what you pay and worry more about what the market is saying about the products and the company’s fit with your organization," Volpi writes.
Rule 4: Build incentives for the long-term.
Volpi is not a fan of earn-outs. These incentives, often tied to revenue, earnings, market share, or other milestones for the acquired company, are too easily gamed. And they "create a schism right at the starting point of the two companies’ relationship," he notes.
"Simple acquisitions using stock rather than cash are much more effective," Volpi writes. "Of course, they help retain the acquired employees. But most importantly, this aligns the incentives of both parties: Everyone involved wants the acquirer’s stock price to increase in value."
Rule 5: Second-best is not good enough.
Corporate development teams are often faced with this decision: Buy an expensive market leader, a relatively cheaper No. 2, or one of many tier-two competitors. Though the first option appears the most expensive (and, therefore, not a "good deal"), Volpi implores leaders to think less about price and more about value.
"There were many YouTube wannabes in the market," he says. "Google could have acquired any one of them for 1/10 YouTube’s value. Instead, it paid $1.75 billion for the market leader, a seemingly enormous amount of value for a young company. But few today would suggest that it was not a good deal. Through that bold move, Google closed out that market."
Rule 6: Match your leverage points with their strengths.
Yeah, yeah, we get that synergies are important. But what does it really mean to align synergies? Volpi offers two examples: distribution and operations. The former places the acquired company’s best product into a large distribution channel of the acquiring company, and the latter uses the larger company’s economies of scale to procure of services (bandwidth, server, storage) or scale production for the smaller company.
He also warns against cost cutting. "When acquisitions are justified by cost-cutting in the acquired company, that should always raise a skeptical eyebrow."
This article originally appeared at The Build Network.