Acquisitions happen for a variety of reasons. Bell (BCE) entered into an agreement to acquire MTS in Manitoba. This is a typical “big buys small competitor to gain access to an under-served market and geographical gap in revenue” deal. So, how can business owners draw parallels between a deal like that and their business?

An Example: Bell and MTS

The following background information is required to set the scene:

  • BCE is a massive $22 billion in revenue player in the Canadian media, the Internet and telephone market.
  • MTS is a regional $1 billion in revenue player in Manitoba.
  • Both companies sell similar products to the same people and businesses. Each has their proprietary offering, but essentially are selling a commodity with a few twists to gain an edge over one another.
  • The market for their products is growing in most of their product categories.
  • The markets of businesses and people to sell to are increasing.

Reasons Why Acquisitions Happen

If we ignore the size of the players and focus on business reasons why acquisitions happen, there are a number of factors that need to be considered.

Growth

Acquisitions happen because any business that has the plan to grow will eventually need to get out of its yard and enter new markets or create new products, raise prices, etc. Suppose you cannot raise prices enough to sustain growth or create new products fast enough. You need to enter new markets. Entering markets is not easy, particularly when the local competitors do a good job of keeping you out. Sure, you can enter and offer deep discounts, but the local competitor will only match prices and clients will continue buying from the "local guy" because switching costs are high and supporting local is important.

Buying Local Matters

Supporting local has value and, well, it's just easier to stick to status quo. So, a grand plan to enter the market fails. This situation is a common occurrence. Therefore, you need to acquire the local company to gain access to that particular market. It's expensive, but often cheaper than fighting it out for five years trying to enter a market only to realize you've lost. Bell was not winning in Manitoba, and it needed to compete in a bigger way: The only way to do it was to buy MTS.

Status Quo Is a No

Growth is an animal that needs to eat all the time. I am not familiar with one business owner that is satisfied with a “flat year,” no matter what the environment. Growth helps pad the bank account, provides employees better opportunities, helps recruit better staff and adds wealth. You must grow to achieve these things. Shareholders are equally unsatisfied with “flat” growth. The only way their investment increases is for the company to grow or expand and improve. Business value is heavily dependent upon growth rate.

A quick primer in net present value (NPV) of future cash flows will prove that a simple change in growth from 0% to 2% will improve the value of a company significantly. Simply put, in private business and public markets, status quo is unacceptable.

A Word on Valuation

Moving on from acquisition reasons, it is important to talk about valuationbriefly. Bell, valued at 9.24x EBITDA (at the time of this writing) acquired MTS for 10.1x EBITDA. Effectively, they valued MTS higher than their company. However, Bell forecasts that after all adjustments have been made, the acquisition price will look like 8.2x EBITDA and, thus, their investors will be satisfied.

Back to Bell and MTS

Growth Rate

Adjusted EBITDA at Bell in 2015 grew by 3% over the prior year. That may seem small, but research indicates this is reasonable. Have you ever heard the saying, "You're only as good as your last game?” Well, 2016 and 2017 need to be better than a 3% growth rate, and buying MTS helped to do that.

Here lies an interesting thought: Assuming MTS can earn similarly to Bell, adding MTS’ revenue of $1 billion per year and considering their EBITDA margin is similar to Bell's, Bell's EBITDA should grow 4.5% based on MTS alone. That would certainly keep owners happy for another year.

Infrastructure

Leveraging infrastructure to increase margin is all about capacity! If you have an apartment building, fantastic. If it isn't full of renters, you are not maximizing your infrastructure or being as profitable as you could be. Running a business is similar.

If you've built a fantastic website, use amazing technology, have an incredible set of policies, procedures and processes in place, all you need to do is get more paying clients. The cost to serve and wow” those clients is a variable cost, and if you can acquire and keep clients happy, you'll add plenty to your bottom line. This all sounds relatively straight forward, but it’s not easy to do.

Bell has a strong infrastructure, but adding one customer at a time is costly, risky and less profitable than adding several hundred thousand in one fell swoop. Boom! Load customers onto their existing platform (with some tweaks) and money should drop to their bottom line.

It Can Be Expensive Taking Over the Competition

Increasing revenue to reduce costs sounds simple, but is complicated in practice. Raising prices is difficult for many owners to wrap their head around. It includes fear of the client switching from them to another, fear of how many complaints they'll get, or simply that it just takes more work to do. In reality, raising prices is necessary and finding better, less expensive ways to deliver service is critical. However, competitors can make it tough for you. They can match prices and find more efficient ways to deliver.

An example of this is when Bell tried offering discounts to Manitobans, providing and promoting superior services, bundling products and services together, but MTS made it tough for them. Then Bell thought, "Why keep fighting when we can and should just buy them?" So, they did. And after the deal closes, they should introduce superior services at market prices and make money without worrying about how MTS could thwart their growth plan.

Sometimes when you plan to take out a competitor, also expect to pay handsomely to do so. Good deals that meet your objectives don't come cheap, so expect to play fair and pay fair for your world domination.