Hostile Takeover 2.0
Between the 1960s and 1980s, the “hostile takeover” became a popular form of corporate activism.
It was fueled by a greed for immediate growth and used high PE multiple shares as currency or newly discovered junk bond money. Over time, the trend for doing a hostile deal — versus a friendly deal — declined, as the expenses and risk rose from companies defending themselves with ‘poison pills’, ‘golden parachutes’, and other pre-emptive corporate actions.
In the three decades since 1990, we have witnessed a new trend: the growth of private equity and hedge fund investors, including activist investors.
Mirroring the growth and power of the Internet itself, from the early 1990s, private equity funds and activist investors have grown from almost nothing to amassing trillions of dollars in acquisition-buying power.
They are beginning to recognize how far some corporates have fallen behind on technology
As the low-hanging fruit of bloated, lazy companies to acquire, leverage and recap has continued to dry up over the past decade or so, the smart money has become increasingly savvy in generating returns.
Smart activist and PE investors, who are now sitting on trillions of ‘dry powder’ cash, are moving into the next phase of capital sophistication. They are beginning to recognize how far some corporates have fallen behind on technology, and just how much ‘super-return’ can be realized over the coming years by supporting a portfolio company to transform itself into a customer-focused technology company.
We’re at the dawn of what I call ‘Hostile Takeover 2.0’.
Why the opportunity exists
Corporates have under-invested in technology for years. Generally speaking, they have relied on their market position or brands to remain competitive.
Their investment in startups has been minuscule. In Q1 2012, Corporate Venture Capital (CVC) activity across the globe was a mere $1.7 billion, according to figures from CB Insights.
While corporates have been playing catch up recently, and we saw CVC activity peak at $11.3 billion in Q3 2015, it has been declining since then.
But at the same time, many corporates continue to pay handsome dividends and sit tight on their cash. Cash holdings at US non-financial companies were $1.7 trillion in 2015. This means corporate venture capital investment is a literal drop in the ocean of available corporate cash.
There are many reasons for corporates to hold cash, but fundamentally, it means that corporates are making an active choice not to invest in innovation, R&D and technology.
Corporate leadership teams feel deep innovation is just a ‘nice to have’
These numbers are likely skewed by a few companies that hold a lot of cash. But, even then, all companies have benefited from ultra-low interest rates over the past eight years and few have used the opportunity to invest in technology.
This may be because corporate leadership teams feel deep innovation is just a ‘nice to have’. Or, worse yet, that deep tech investment is unnecessary. Many companies who have been performing well in terms of EPS and dividend growth over the past several years claim they have been investing enough in R&D and innovation. Many others falsely believe they can acquire their emerging competitors at a later date if the pressure becomes too much to bear.
But it is dangerous to look only at a company’s past track record, and the next year’s earnings estimates, when judging a company’s competitive capabilities. It’s the future that matters. And it is technology that represents the future.
One of the best measures of how a corporate values technology is to look at how its management engages with startup tech companies. On this measure, corporates are failing badly. Only one in 10 corporations say their senior executive team has any explicit responsibility for startup engagement at all, according to MassChallenge. Responsibility for innovation falls much further down the management chain, with R&D or even PR.
This is made worse by the fact that only 34 per cent of CIOs report directly to the CEO, according to a survey by Harvey Nash/KPMG. Discussion about innovation is often lost in layers of corporate bureaucracy, and for many corporates, it doesn’t even surface at the leadership or board level at all.
This has directly led to a loss of market value
The result is underperforming share prices against the indices, particularly against the technology company indices, for established companies. The market doesn’t see corporates taking the necessary steps to defend themselves against the coming disruption from technology.
My firm has recently created an index — the Aquaa Partners Wholesale Index — to track the share prices of some of the largest US public wholesale and distribution companies.
The results showed these wholesalers’ share prices have consistently lagged the S&P average by between 1 and 3 percentage points over the last few quarters, with some individual companies falling behind by as much as 20 points. I expect this gap to widen over time.
The market recognizes the wholesale industry is bad at investing in innovation. Their intermediary position also makes them especially vulnerable to disruption from Amazon, Alibaba and others.
But this trend is not unique to wholesale. It is affecting all corporates. The announcement of Amazon’s acquisition of Whole Foods sent not only grocers’ share prices plummeting, but also affected almost every company active in the food, distribution, or retail supply chain.
If we compare the prior day’s close with the intraday low on the day of the Amazon news, Mondelez was down $1.7 billion; fast-fashion retailer Inditex was down $1.8 billion; and high-street pharmacist Walgreens was down $3.7 billion. JD Sports, Next, and Foot Locker were also hit.
Customers are common to all businesses
These share price declines are only a temporary indicator, but they do point towards a long-term challenge for corporates. The real damage comes when corporates start to lose customers to disruptors at an accelerating pace.
All companies have customers, and technology has dramatically and fundamentally changed the customer experience over the past 10–15 years.
Companies that don’t invest in technology to enhance the customer experience are at risk of being outpaced by new competitors who can deliver things quicker, cheaper, and better.
Consumers now expect to be able to order almost anything, at anytime, anywhere, at a bargain price, and have it delivered to tomorrow, if not in a few hours, with a smile. And if we don’t like it or want it we can just send it back.
Most corporates are already well aware of the growing threat — or opportunity — presented by technology, but what are they actually doing about it?
Some have started to recognize their own vulnerability. Allianz, for example, has recently committed to invest more than $600 million annually in technology to enhance the Allianz customer experience, and to serve customers that “are used to dealing with the likes of Amazon.com,” according to the company’s Chief Digital Officer, Solmaz Altin.
Lost market value can be quickly captured by savvy investors
Lost market value is recoverable, but to recover value corporates need a turbo-charged injection of ambition.
Their boards need to recognize that they can outpace their disruptive competitors, and they can do it by making innovation of the customer experience a top priority. If they don’t drive such a transformation from within, then activist investors are now lining up to force them to act.
The best activist investors have the vision to transform a corporate, seize the potential of technology, and leverage it
Activist investors are well placed to drive change in corporates. On one hand, the best activist investors are disruptors themselves. They are determined to win at all costs in the same way that the best tech companies are. It’s in their DNA.
The best activist investors have the vision to transform a corporate, seize the potential of technology, leverage it and take the company from a victim of disruption to a market-leading disruptor.
They can take a stake in a corporate and — in addition to the usual breakup asset sales, cost cutting, and share repurchases — inject a dose of innovation through strategic technology acquisitions.
Several activists are dipping their toes in the water with this strategy. A very recent case in point is Dan Loeb and his Third Point fund taking a $3.5 billion stake in Nestle. Among the reasons is the emergence of digitally powered competition in the consumer goods and food and beverage space.
Once an activist or PE fund takes a stake in these companies, there is a well-trodden path for them to transform these companies into leaders of innovation.
Customer experience transformation — the new “Poison Pill 2.0”
Companies can best protect themselves from hostile forces by investing in transforming the customer experience. Customer experience gets a lot of lip service these days and most companies’ efforts to transform it are superficial and mediocre.
If a company is serious about transforming the customer experience, the most effective approach is a strategic acquisition of a technology company — the right technology company.
Companies can best protect themselves from hostile forces by investing in transforming the customer experience
Acquisitions of digital or technology companies help corporates transform their products or services, re-engineer their supply-chain as well as bring in fresh talent, while driving major enhancements in how a customer experiences a company’s product or service.
These acquisitions are at their very best when the innovative DNA of the startup leaks up through to the parent organization, transforming over time the parent’s very identity in the eyes of the public and the market.
The acquisition of Android transformed the perception of Google from a search engine to a mobile player
Perhaps one of recent history’s greatest acquisitions is Google’s purchase of mobile operating system Android. It is amazing to think now that Google quietly acquired Android for an undisclosed price, estimated to have been $50 million in 2005.
It is obvious why a Google executive recently called this the “best deal ever”. According to an Oracle lawyer, Android is estimated to have directly added $22 billion in combined profits to Google’s bottom line between 2005 and 2016.
But the acquisition of Android arguably played an even more important role in the history of Google: it transformed the perception of Google from a search engine, or at least a web-only player, to a smartphone player as well.
Google had the vision to see that one day, smartphones would supersede laptops as the Internet browsers’ tool of choice — and, most importantly the company executed on that vision. Google’s acquisition of Android transformed the company’s future, and without it, its market position, free cash flow and share price would all surely be significantly lower today.
The right acquisition target does exist for every company. The company just has to commit to executing a proper acquisition process and bring on the right expertise to make it happen.
What we can learn from PetSmart’s acquisition of Chewy.com
In my view, one of the very best recent examples of the right, transformational technology company acquisition has been PetSmart’s acquisition of Chewy.com.
PetSmart’s shareholders saw that new, online, deeply customer-focused retailers like Chewy.com were winning customers from its physical store network
While PetSmart is privately owned by PE firm BC Partners, and the public will not know Chewy’s impact on the company’s market value for some time, I have little doubt that this acquisition should deliver significant value for PetSmart and BC Partners in the long run.
While PetSmart operates more than 1,500 bricks-and-mortar pet stores, its management recognized both the risk and opportunity presented by market-leading e-commerce.
PetSmart’s shareholders saw that new, online, deeply customer-focused retailers like Chewy.com were winning customers from its physical store network. They also grasped the opportunity for PetSmart to become the leader in the digital space itself. It could steal a march on its own competitors and inject the rest of the company with a dose of innovation, new talent, and world-class customer service too.
The price for Chewy.com at a reported $3.35 billion was not perceived by the market as ‘cheap’. Given that PetSmart was itself valued by BC at the time of acquisition at a reported $8.7 billion at the start of 2015, it could be argued that shareholders were effectively gambling the company on the Chewy acquisition.
These smart investors are starting to recognize how far some corporates have fallen behind on technology
But I strongly believe that, if the execution of the acquisition and the company plans are managed successfully, then the private equity owners of PetSmart will benefit handsomely in the long run, regardless of the perceived rich price.
Through the acquisition, PetSmart has not only helped defend itself against potential ongoing future revenue decline from competitive pressure, but it has also immediately turbo-charged itself forward from what was arguably a legacy lower-margin high-street operator.
The transaction is an example of the opportunity that lies ahead for private equity and activist investors in the current market.
These smart investors are starting to recognize how far some corporates have fallen behind on technology. There is significant value to be created, and significant profit to be found.
This is the beginning of ‘Hostile Takeover 2.0’.
The smart corporates are the ones taking the new the poison pill to remain in the lead.
Paul Cuatrecasas is CEO of Aquaa Partners, an investment bank that provides established companies with advice on acquiring the right technology company.
For more information visit: http://aquaapartners.com