Tales from the Trenches: Double Trouble Revisited

Last year we published our first “Tales from the Trenches” blog post, where we examine real-world acquisition blunders.  In one of these examples, “Double Trouble”, we described an acquisition where the buyer made 3 key errors.  In this post we look back and evaluate what the company’s performance looks like in the years since the deal.  But first a refresher:
​

Company A had historically enjoyed high profitability on their subscription-based market offer; however, other companies had developed or acquired similar products, and were providing free subscriptions to these substitutes as part of their overall go-to-market strategy.  With viable free substitutes flooding the market, Company A's revenue was declining, and the future of the business in doubt.

Company A decided that the solution was to purchase another product line that sold subscription services to a similar customer base, bundle the products into a new offer, and thus compete effectively with the freeware by offering a combined value proposition.  Given the difference in the offer attributes, Company A knew it was unlikely that any significant administrative cost synergies could be realized; however, they were convinced that the revenue synergies from the new combined market offer would be sufficient to turn this into a fantastic investment.  After all the target- Company B- had similar customer demographics, so fantastic cross-selling opportunities seemed likely, correct?

 Company A paid a significant EBITDA premium to acquire Company B, and post-deal integration consultants were hired to evaluate Company B in preparation for integration planning.  These consultants soon discovered that Company B's biggest challenge had been…wait for it… adjacent companies had developed similar products and were giving away subscriptions as gifts to their customers! To make matters worse, Company B had gathered most of the addressable market share by promising customers a lifetime subscription with no increase in price.  And for the icing on the cake, more than 80% of Company B customers were existing customers of Company A.  This meant that the only way to increase revenue would be to raise the price of the combined offer to be higher than the price existing customers were paying to buy each separately, with the added wrinkle that the price of Company B’s products could not legally be increased for existing subscribers, and of course the original problem of readily available free substitutes for both.  

So, what were the 3 key mis-steps that Company A made in the deal above? 
​
1). Neglecting Strategy Fundamentals
​If Company A had taken the time to use the strategic frameworks some significant red flags should have been obvious.  Porter’s Five Forces would have highlighted the availability of substitutes for both Companies A and B as a significant strategic hurdle, along with high customer bargaining power, and a competitive business environment.  SWOT analysis would have shown similar concerns, while an elasticity study would have pointed out the inability to raise prices.  Finally, a proper TAM and share study might have uncovered the pre-existing customer overlap, indicating that cross-selling would not be a profitable effort in an environment of price inelasticity.  To be blunt, when you have negative margins it is a really bad idea to try to make that up with volume!

2). Forgetting the Deal Rationale in Due Diligence
​Company A did a good job of combing through Company B’s audited financial statements, double-checking the previously audited numbers and carefully evaluating revenue recognition.  They evaluated the exposure to major customer groups, sales channels, and the like.  They reviewed the valuation against sales trends.  What they never did was ask the 2 key questions demanded by the deal rationale, questions that strategic analysis would have highlighted:

• ​How much customer overlap already exists in the combined TAM (total addressable market)?
• Can we raise prices (price elasticity)? Asking either of these questions would have clearly shown that this was NOT the proper acquisition to address the challenge of readily available free substitutes. 

3). Overlooking Deal Alternatives 
I state frequently (at the risk of putting myself out of work) that deals are a very costly way to achieve strategic objectives.  Acquisitions can absolutely make sense; however, alternatives should always be considered.  In the case of Companies A and B, their markets were stable-to-declining.  The structure of their back offices made achieving administrative cost synergies unlikely.  The companies were in no wise competitors.  Finally, the stated goal was a combined market offer to a joint customer base.   These facts cry out for some type of joint marketing arrangement, not an acquisition!

In conclusion, we can observe the following 2 years post-acquisition:

• While the S&P 500 is up 16% over the same horizon, Company A's share price has fallen 14.5% since the acquisition closed.
• After an initial small acretive bump, revenue has remained mostly static, but gross margins have declined a little over 1%.   Based on this data, it doesn't appear that the cross-selling and price increase asperations were realized.
• Company A is struggling with the debt from the transaction, and is actively seeking a buyer to help them avoid a bankruptcy.  Several key personnel have already moved on.

Strategy matters.  It should be the driver of the deals you seek, and each deal should have a valid rationale that supports at least one strategic objective.  Once that deal rationale is determined, it is absolutely critical to keep it top of mind throughout the process.