Acquiring innovation

Strategic deal-making to create

value through M&A

March 2014

At a glance
39 percent of US CEOs are
planning on an acquisition
in 2014 according to PwC’s
Global CEO Survey.

A PwC survey of tech

companies found that
76 percent of acquisitions
focused on buying
innovation met or
exceeded expectations.

With the right inorganic

growth strategy, buyers
in all industry sectors
can apply critical success
factors to their innovation-
focused pursuits.
 As part of an ongoing series, PwC conducted a roundtable with a
Deal-makers number of Silicon Valley corporate development executives to explore
the subject of innovation-focused acquisitions. We drew the specific
talk deal-making topics of the conversation from the results of a survey of technology
organizations conducted in the months prior to the roundtable. The
corporate development leads from several technology-focused Silicon
Valley companies participated in the roundtable. In this article,
we draw on some of the key themes aired during the roundtable
discussion and offer some perspectives on leading practice that
PwC has observed in the market.

The discussion reinforced our view that innovation is becoming an

increasingly important motive for M&A. As one roundtable participant
put it, “Acquiring innovation will continue to be a necessity for
technology companies.” Faced with a competitive environment that
demands ever-greater speed to market, they have increasingly looked
to M&A to complement internal research and development (R&D).

Deals, however, are not assured of success, and innovation-focused

M&A presents sizable and unique challenges that must be understood
and addressed to realize the full value of a deal. If not managed
appropriately, acquisitions can hurt, not help innovation efforts.
The participants in PwC’s M&A roundtable focused on some of the
key challenges they face when undertaking innovation-focused
acquisitions. Several key questions dominated the discussion,
including:

• How do we educate and engage key deal stakeholders?

• How do we identify the right acquisition targets?

• How do we value and assess targets?

• How do we execute post deal and measure performance?

The article accompanying this sidebar captures some of the most

thoughtful responses to these questions, as well as PwC’s own
perspective, shaped by our extensive experience in the field of
technology M&A.

2 Acquiring innovation: Strategic deal-making to create value through M&A

 Done right, M&A can help these

Strategic deal-making companies increase speed to market,

M&A is clearly a potent source
of growth if guided by sound
strategic direction. Tech companies,
for example, are under relentless
pressure to innovate. They look to
M&A to complement and enhance
innovation via internal research and
development (R&D).
outflank competitors, and relieve
pressure from threatening disruptive
market forces. (See Exhibit 1,
“Innovation as a driver of acquisition
activity over 36-month period.”)
As one participant in a 2013 PwC
roundtable on tech-company M&A put
it, “We will not be able to achieve our
strategic intent in a timely manner by
organic means alone.” (See the sidebar,
“Deal-makers Talk Deal-Making.”)

Because of its reliance on M&A to fill

its innovation pipeline, the technology
Exhibit 1: Innovation as a driver of acquisition activity over 36-month period industry can provide a model to other
% of Deals industry sectors for using M&A to
invigorate, diversify, and accelerate
Innovation their search for breakthrough
innovations. By studying how leading
57%
companies develop inorganic strategies
Channels and market access around growth themes, search and
21% screen for target acquisitions, perform
Consolidation/cost reduction/market share commercial due diligence, and
integrate their acquisitions, senior
6%
leaders across all industries can use
Geographic expansion
examples from tech sector M&A to
12% better meet their own organizations’
Vertical integration/supply chain need for innovation.
2%
Defensive
3%

0% 10% 20% 30% 40% 50% 60%

PwC 3
 Deal performance
According to the 2014 PwC Global
CEO Survey, 39 percent of US CEOs
plan to initiate a domestic acquisition
this year. To do so successfully, many
CEOs are focused on improving their
organization’s ability to pursue M&A,
joint ventures or strategic alliances.
Thirty-five percent of US CEOs are
considering M&A improvement
initiatives. Another 22 percent have
change programs underway.
The challenges of successful
M&A execution are no easier
when making innovation-focused
acquisitions. Creating value often
entails monetizing the intangible assets
of the target company, which may
operate at a considerable distance from
the acquirer’s core markets. Academic
research confirms that, if not managed
effectively, acquisitions can degrade
the innovation output of both target
and acquirer.1
Over the course of our work in
the technology M&A sphere,
PwC has observed that small,
“tuck-in” deals have a higher
probability of success than larger-
scale transactions. Management is
better able to manage and control
the post-merger integration process
with smaller deals than with larger
1 Journal of Marketing, January 2005
ones, which are more complex and
resource-intensive. (See Exhibit 2,
“PwC performance observations by
deal category.”) A large portion of
these tuck-in deals involve technology
or talent acquisition.
A PwC survey of tech-company
corporate development and IT
executives reveals that more than half
of innovation-focused acquisitions—
many of them tuck-ins—have at
least met expectations. (See Exhibit
3, “Innovation-Focused Acquisition
Results Over the Past 36 Months.”) But
that performance has not come easily.

Exhibit 2: PwC performance Exhibit 3: Innovation-focused acquisition results over 36-month period
observations by deal category
% of Deals

Far underperformed expectations

Innovative

2
11%
4 Underperformed expectations
13%
Met expectations
36%
Traditional

1 3 Exceeded expectations
35%
Far exceeded expectations
5%
Small Large
(“tuck ins”) (“transformational”)
0% 5% 10% 15% 20% 25% 30% 35% 40%
Note: Numbers represent observations of
deal performance with 1 indicating likelihood
of high performance and 4 indicating
likelihood of low performance

4 Acquiring innovation: Strategic deal-making to create value through M&A

Exhibit 4: Deal continuum

Strategy Deal execution Value capture

#1 Strategy #2 Options #3 Deal #4 Negotiation #5 Integration #6 Transformation

assessment evaluation evaluation and close

• Growth strategy • Financial/ • Core diligence • Financial packs • Functional • Portfolio analysis
• Market analysis accounting, (IT, financial, tax, and operational integration • Business
strategy, and tax HR, insurance, issues in the TSA support and performance
• Investment considerations operations) and SPA Integration
hypothesis analytics
• Deal structuring • Regulatory and • Preparation for Management (operations, IT,
• Alignment with (accounting compliance, capital raising Office (IMO) and financial)
corporate and tax) accounting/ planning, setup
development • Post-closing and governance • Target operating
financial purchase price model diagnostic
initiatives reporting, SPA structure
adjustments
• Assessment of • Target operating
potential • Employee model
acquisition agreements
• Customer,
targets • 100 day plans channel and
• Commercial • Target operating product
due diligence model strategies
• Synergy planning • Operating
improvements
and cost
reduction
• Financial
reporting
requirements

The deal team
In discussions with tech executives,
we learned that success depends on
a dedicated deal team that owns the
strategic development, acquisition
and integration process and that
is accountable for executing it on
time and to plan. The optimal deal
team brings a diverse range of skills,
functions, and expertise to bear
on a complex undertaking.
(See Exhibit 4, “Deal continuum:
PwC’s perspective on key evaluations
necessary in each phase of the deal—
strategy, execution, integration.)
There are seats at the table for the
following roles:
• Corporate development executive
to develop and communicate
the deal’s strategic rationale;
orchestrate the interactions between
buyer and seller; interface with the
seller’s investment bank; and set the
deal structure.
• Deal sponsor, typically an
executive from the business unit
that originally identified and
analyzed the target, who helps
make the business case for the deal.
• Deal approver, often the CFO
who scrutinizes the deal’s economic
impact on the company; this
individual may also help arrange
financing and will lead a robust
review of strategic alternatives to
an acquisition.
• M&A integration team, responsible
for rapidly aligning the target’s
people, operations, systems, and
processes with the acquirer’s
corporate structure.
• Deal engineer, typically the
chief technology officer or other
senior technology executive tasked
with integrating the acquisition
onto the acquirer’s technology
platform and resolving software
and hardware incompatibilities.
• External advisors, including
third-party advisors, investment
bankers and legal advisors,
to support deal execution and
documentation. This team
then draws on the skills of
specialists who can assist
with all aspects of commercial,
operational, and technical due
diligence and integration.

PwC 5

M&A is only a tactic to
execute strategy. It is not
the strategy itself.
While the above roles are adequate
for smaller, quicker “tuck-in” deals
that pose lower amounts of risk and
complexity, larger transformative
deals—where officers are “betting
the farm”—require more up front
planning and scrutiny to succeed.
Well before any targets are identified,
companies need an inorganic
strategy that properly analyzes the
macro and microeconomic markets,
factoring trends and disruptive
market forces. M&A is only a tactic to
execute strategy. It is not the strategy
itself. Companies need to have a
clear, well-defined strategy for their
specific business vertical. And that
strategy should be distinct from but
complementary to the organic growth
strategy. The inorganic strategy should
identify areas of potential new growth
to evaluate for market entry, product
portfolio expansion, etc.
6 Acquiring innovation: Strategic deal-making to create value through M&A
Target identification Target identification does more than
just uncover possible acquisition
Successful acquisitions begin with
candidates. The very process of
the right target, and executives
exploring multiple channels and
explore numerous channels in their
search for companies with superior
touch points acts as a powerful
market-sensing tool that enables
innovation potential. Most tech sector
potential acquirers to collect valuable
executives place the most weight on
intelligence on competitor, market,
internal channels, primarily corporate
and product trends. “We speak with
development teams and R&D and
a number of players,” one roundtable
engineering teams. They are willing
participant said, “and it is a hugely
to explore unconventional channels,
valuable process whether or not we
such as venture capital funds, to
consummate something with them.”
identify targets and increase deal
flow. They also use existing alliances
and relationships with other
organizations to perform informal
due diligence on potential targets.
(See Exhibit 5, “Survey results—
identifying and screening potential
innovation-focused acquisitions.”)
As one roundtable participant said,
“You may want to do a licensing deal
to get warmed up and see if they are
the target we think they are and get
to know management better.”
Exhibit 5: Survey results—Identifying and screening potential
innovation-focused acquisitions
• Proactive pipeline development within corporate
Commonly used development team
• R&D/engineering team
• Venture capitalists/private equity funds
Sometimes used • Investment bankers
• Customers
• Board members/executive team
Rarely used • Consultants/3rd party experts
• Sales team

Valuation
Valuation is a particularly thorny
problem for innovation-focused
tech acquisitions. It is nearly
impossible to apply traditional
valuation techniques to companies
in their early stages of development,
when operating histories are brief
and there’s little or no historical
or predictable future cash flow.
Acquirers therefore must resort
to other measurements to build
the case for a particular investment.
(See Exhibit 6, “Valuation
techniques ranked by relevance
and effectiveness.”) Their executives
typically consult internal R&D and
Exhibit 6: Valuation techniques ranked by relevance and effectiveness for evaluating innovation focused acquisitions
NPV analysis
Selling party expectations
Market comparables (public companies)
Market comparables (similar transactions)
Cost to build analysis
EBITDA and earnings multiples
Most recent financing round valuation
Revenue multiples
Option value analysis
Very often, the acquirer has the necessary capability,
but the lead time to build the product or service is
prohibitive, and an acquisition can significantly
improve speed to market.
product teams to determine the
cost—in terms of both time and
money—of building a product or
service internally. Very often, the
acquirer has the necessary capability,
but the lead time to build the product
or service is prohibitive, and an
acquisition can significantly improve
speed to market. “I am confident that
in most instances our engineering
team could build the solution,” one
roundtable participant said, “but it is
the time component that is critical
and makes M&A attractive.”
Less important More important
PwC 7
Post-deal execution Measuring the outcome of an
innovation-focused acquisition
Integration of any sort of acquisition
requires the development of a
places significant demands on the
scorecard that captures and quantifies
acquirer’s capabilities and resources.
the deal’s value-creation rationale
But innovation-focused acquisitions
and enables executives to monitor
are a unique challenge. “With
the target’s post-acquisition
innovative acquisitions, the real
performance. Because many targets
challenge comes post-completion,”
have little or no revenue history
one participant in our roundtable
and may take several years to earn
said. “It takes a significant level
out, the scorecard’s metrics must
of commitment, patience, and
include both financial yardsticks and
ongoing investment to make these
a broader set of strategic milestones,
deals work.” Indeed, such deals
such as product-development
require commitment and focus from
targets, talent retention, degree
stakeholders that extend well past
of collaboration, and the level of
the first 100 days following closing.
technological uptake. “You can steer
the deal off course if you place too
much emphasis on revenue,” one
roundtable participant said. “You
may artificially drive the business
to produce short-term revenue that
is inconsistent with the long-term
strategic intent of the transaction.”
Because innovation-focused
acquisitions tend to have longer
time horizons and highly uncertain
outcomes, successful acquirers build
a great deal of flexibility and agility
into their post-deal plans. Some go so
far as to develop a range of post-deal
scenarios to prepare for deal outcomes
that diverge from the original plan.
Other companies focus on critical
areas to improve the odds of
post-deal success. Our survey
of innovation-focused acquirers
reveals several of those areas.
(See Exhibit 7, “Survey results:
Most effective strategies for
capturing deal value in innovation-
focused acquisitions.”)
For a more extensive focus on M&A
integration as it impacts the research
and development (R&D) function,
see the PwC white paper, “R&D
Integration: Unlocking product
development opportunities in M&A.”

Exhibit 7: Survey results—Most effective strategies for capturing deal value in innovation-focused acquisitions

Clear Strategic Ownership by

roadmap integration sponsorship

• Clarity of objectives and • Team retention, integration, • High degree of involvement

articulation of roadmap and alignment with BU by acquisition product team
• Defined yet flexible product plan • Alignment of long-term strategic
• Defined go-to-market strategy vision between acquired team
from the beginning and acquisition sponsor

8 Acquiring innovation: Strategic deal-making to create value through M&A

Conclusion
M&A is an important weapon in
the arsenal of tech sector companies
whose success depends on producing
a steady stream of innovations—
whether those innovations occur
in products, processes, or business
models. As a result, the ability to
identify and execute deals efficiently
and effectively is a critical competency
well worth studying by executives
in other industries that depend
The ability to
on innovation for advantage, such
identify and execute as healthcare, financial services,
deals efficiently and and retailing.
effectively is a critical
The value of innovation-focused
competency well worth
technology acquisitions is often
studying by executives predicated on the ability to
in other industries that monetize intangible assets. Moreover,
depend on innovation innovation-focused transactions
for advantage. often entail a long return horizon
and a high risk profile. These deal
characteristics create a number of
challenges that M&A leaders must
manage. The responsibility for
addressing these challenges extends
beyond the corporate development
team, requiring continuing
engagement by R&D, the product
development team, the strategy
function, and senior management
long after the deal has closed.
The M&A process need not end in
a transaction to be successful. It’s
also valuable as a tool for gathering
competitive and market intelligence
that can be exploited strategically.
Capturing and sharing the intelligence
collected along the deal continuum can
be of significant value to organizations
seeking to innovate and grow, and
represents an opportunity that
many organizations have not yet
explored in full.
PwC 9
www.pwc.com/us/strategy

To have a deeper conversation

about how this subject
may affect your business,
please contact:

Roger Wery
Principal, Strategy
(415) 498 6401
roger.wery@us.pwc.com

Patrick Gordon
Principal, Strategy
(646) 471 7978
patrick.g.gordon@us.pwc.com

Chris Lederer
Principal, Deals Strategy
(646) 471 9878
chris.lederer@us.pwc.com

Martyn Curragh
Partner, US Deals Leader
(646) 471 2622
martyn.curragh@us.pwc.com

Rob Fisher
Partner, US Technology Industry
& Silicon Valley Practice Leader, Deals
(408) 817 4493
rob.fisher@us.pwc.com

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