A.T. Kearney expects more mergers and acquisitions activity as companies prepare for an economic downturn in the economy by making strategic purchases to close existing gaps, such as supply chain issues, as well as look to rebalancing their portfolios by divesting non-core business operations.
The global strategy and management consulting firm completed a deep dive survey on the M/A front with more than 100 C-level executives from the consumer packaged goods and retail sectors. It found that these executives have shifted their focus from building economies of scale to addressing the change in consumer demands through new capabilities and technological tools that emphasize efficiency, agility and enhance the consumer experience. The firm summarized its key findings in a report titled “Fortifying Before the Storm.”
“This is one of the last good years of growth, and what companies have to deal with right now is how to fortify their business and fortify their portfolio before the slowdown,” said Bahige El-Rayes, partner in the consumer and retail practice at A.T. Kearney and co-author of the report.
Major economic factors, which seem to indicate a slowdown might be in the works for next year, according to El-Rayes.
As for investments in the supply chain, El-Rayes said many companies are looking at distribution right now, while native brands that grew online are now looking at retail assets, such as certain physical locations, so they can closer to their customer. The key issue on the supply chain side is how to be “as close as possible to the consumer,” he said.
Many companies are sitting on piles of cash they can use to buy firms to fill out what’s currently missing, whether a key business or other capability. But what might that be? While distribution and last mile delivery are top of mind concerns, El-Rayes pointed to digital capabilities and e-commerce as areas that can help one to “own the customer experience.” Other areas include fulfillment, robotics and data analytics for inventory management.
Strategic M/A deals will replace the megadeals in 2019, with the volume of deals under $30 billion expected to remain steady, according to the report. Small deals below $25 million have overtaken midsize ones in multiples, the study concluded, noting that strategic deals are “aimed at building legacy companies’ capabilities through the acquisition of smaller, disruptive companies.” These firms are integrated as “change agents-in the form of new brands, new customers, new concepts, new capabilities and new talent-at both lower cost and risk.”
One example is Macy’s Inc.‘s May 2018 acquisition of Rachel Shechtman’s concept store Story in Manhattan’s High Line neighborhood. Story approaches retailing through a storytelling experience, with a different curated experience each month.
“In an investment market where capabilities are the strongest valuation driver, and size and market share mean less and less, small companies are, on average, valued at higher multiples than midsize ones,” the report noted.
Helping to boost sustained M/A activity include falling asset prices, a large amount of cash ready for deployment, a trend toward divesting non-core assets, and growth through category expansion and investment in adjacencies. “Companies are taking more ownership of key capabilities such as digital and supply chain and investment in adjacencies to won the consumer experience,” the report said.
While investing before a downturn may be risky if one overpays for an asset as valuations soften, the opposing view is that no one knows when the downturn will occur and waiting too long to buy could hurt through a delay in either the integration of the asset or the benefit to the core business.
The report also noted divestitures for non-core assets, which EL-Rayes said will help with focusing on key business so it doesn’t have to worry about draining its resources.
“What I expect to see is a trade off between divestitures and investments of capital to fortify the portfolio where something can be acquired at a cheap multiple to acquire a capabilities that are missing,” he said.
As for whether divestitures of non-core, or non-performing, assets have enough value to attract a buyer, El-Rayes said, “Everything has a buyer at the right price. The vast majority [of executives surveyed] expect divestitures to increase…. That’s a key market for [some] private equity firms, [many of which operate with the mindset of] what can I grab at a discount that I can do a turnaround for.”
Private equity firms are believed to have about $858 billion at their disposal, and while they can pay a premium compared with a strategy buyer, competition has been heating up as both look for quality assets. That has some financial sponsors either looking at smaller deals or new concepts at an earlier stage of a company’s lifecycle.