M&A Explained Part 1: Economies of Scale & Reacting to Competition

Bij PVC geloven we dat de uitdagingen van de toekomst om actie en een ander perspektief vragen. Daarom bekijkt onze community of solvers complexe vraagstukken van alle kanten. Zo zetten we ambitie om in actie. En maken we samen een wereld van verschil voor organisaties, hun stakeholders en een omgeving. Duurzame vooruitgang noemen we dat. Lezer alles over op pwc.nl. Hallo en welkom bij de deelroom, waar we alle wedstrijden we specifically voor alle dingen verkoordelen. De grootste m&a en p-deels zijn een strategie dat een business decision maakt. We moeten we in de klasroom verkoordelen met real-worlde exemplen en hopelijk hebben we hetzelfde tijd met het fund. Dus laten we gaan. Welkom terug bij de deelroom en op het begin steden we een slechte script met mij. We gaan een fantastische openen geven, maar dan was het discussie dat we ons gaan discussen. Steden, wij gaan het beter doen dan de script. Waar gaan we deze miniseries doen? Explaining m&a, about case studies, how that could be useful for applications that are ongoing. We had just said it to me literally two minutes ago off there. That was so perfect as to the rationale behind a new kind of using the deelroom for a miniseries. So what was that rationale? Over the next four episodes we're going to spend a bunch of time going through why companies acquire other companies. It's a standard, if you were to read the m&a textbook in your undergraduate course, you would probably get your six or seven reasons why one company might want to acquire another company. Maybe a couple of reasons why a company might want to be sold. But we're going to put this into a miniseries partly because as you get interviews and as you prepare for assessment centers, it's fantastic to be armed with this information and to be armed with it in a couple of relatively short podcast episodes. Secondly, because we spend all of our time teaching this, discussing it in the deal of the week, putting it in the podcast, so just add a bit of structure to what we already do in order to help you become slightly better with regards to your application process and your interview process and your assessment sense process. It makes sense and hopefully it's going to be a really, really fun type of episodes. So look to give you a bit of insight as to what we're going to cover in this first episode of the four part series, we're going to look at economies of scale and reacting to competition. We're going to use she is acquisition of misguided and also going to look at Google's two billion dollar investment in the AI company and thropic. So we'll also take a look at some other things we've had this recent wave of mega deals in the oil and gas sector. So we'll talk a little bit about how the weight of cold hard cash acts as a reason to go out and find some acquisitions and finally in this episode. We're going to be using Intel and Blackberry. Blackberry is still knocking about. It exists to discuss the logic of spin-offs and the rationale behind selling the family silver. So perhaps we could kick it off then. Being the fashionista that you are Steven with the story about she and misguided. Yeah, I have to confess I've never bought anything from she and I don't really know what today is, but I have been doing some research. So I'm better informed than I used to be. So yeah, so in these podcasts, we're going to give three ration at deal rationals and then what one reason for selling. So the first one we're going to talk about is economies of scale and I like this one because it is straight out of an economics textbook whenever I ask audiences, students. Why does one company buy another company someone always says economies of scale and to an extent it is true. Economies of scale, the textbook definition is the decreasing of unit costs as you grow as a company, which means that your gross margins, your revenue minus cost of goods sold is increased. You are becoming more efficient, you are being able to drive down prices from your suppliers, you are benefiting from the scale that you are generating as an organization. Now, this is a really good textbook example when looking at she and misguided. So we put this on our deal at the weight because I think it's a really, really interesting deal. So she and doing a little bit of digging my gosh, it's a bear mouth, it's valued at nearly $100 billion. It's looking at an IPO probably at some point next year, depending on the market, it's got 150 million users and it's revenue growth rates over 100% year on you. So it is an amazing fast fashion on demand network of manufacturers that provide clothing to users, pretty fascinating company. And they have been going out and buying basically failing brands and failing fashion companies forever 21 was something that was a joint venture that they participated in last year. And a couple of days ago, it was announced that they had just bought misguided the UK again fast fashion but female focused fast fashion online retailer. Basically, the, the rationale behind this acquisition was, hey, look, wish Ian, we've got the most extensive customer directory, over 150 million people that use us. We have unbelievable data on these customers. So you've got amazing customer targeting. This is what, what we would call marketing economy to scale from a textbook definition, but also we are going to insert you misguided into our supply and network and our manufacturing network. Because what she does is they say, look, we're almost an intermediary between the buyer and the manufacturer. And we are offering, you know, $50 million contract, $100 million contracts to the manufacturing base, often in China, to go and develop these clothes at a very, very low unit cost. So misguided just gets to insert themselves into both the marketing economy to scale and also what we call the supplier economy to scale, which should drive down unit costs for the misguided label whilst also giving them access to a far wider audience of potential customers. So it's a pretty neat again, textbook rationale for a particular deal. And it explains to me in that way would have made a lot more sense, would have been a lot faster for sure. Yeah, yeah, absolutely. And it makes a lot more sense when there's when there's a real deal on the table, you know, so often I was thinking about how, how you would teach it without a deal on the table. And the textbook would say, look, imagine a manufacturing facility, imagine a small manufacturer, they can't produce things as cheaply as a large manufacturer because you've got the automation in the warehouse. But it probably given Tesla as the example, right, their initial roadster was $150,000 because they couldn't get the cost of production down, but now you can pick up a model Y for $50,000. That's that is kind of textbook on the scale, but there are other times, especially when it comes to these types of acquisitions and and I and I think it makes sense for she and again, another reason they probably picked it up on the cheap. It's another deal rationale, because it was insolvent just a year ago. So there's all money is that, you know, as we've always said, a deal is either good or bad value, depending on how much you pay. But yeah, there's a couple of reasons there. Well, look, before we move on to the next part, about I can ask you and the listeners, a quick quiz question, which brand do you think has the longest average duration of a user being on their website. So when it comes to fashion retail, to a user landing on a website, and you know what, I don't know what the average for any global website, but we're talking what seconds normally isn't it for before you get a bounce off. So what do you think is the most sticky website where people come on and stay the longest. I guess it's interesting because you've got you've got you probably it's probably something that leverages that kind of addictive scroll ability. So I immediately think invented as something that you can scroll through for hours, just looking and trying to get a cheap, you know, a decent deal. I think it is vintage, you know, it could be she in because you because you suggested this quiz in this in this part of the podcast, but I don't know, I'm going to give she why not. Well, you've obviously done your research then you obviously looking at the she in holes on TikTok. That's a lot of landed in the right place. So yeah, Nike is actually number two, and I think the I think it. I can't remember the exact second, but it's something like three and a half minutes. The average session was she and by far and away as the highest, it's more like seven minutes, which is insane. But yeah, and there was H&M's, they all comprise of the other sort of top five, but yeah, but there you go. So, okay, economy to scale, tick, got that down. Nice. So, reacting to competition. Yeah, I think this is a really interesting one. The context of remembering, I always say this, remembering that what we talk about, when we talk about deals and we talk about M&A and we talk about careers in finance, it's all a human-based industry, and we're all humans, and we all look at our next door neighbors from a company perspective, and we're constantly thinking, what are they doing? Should we be doing that? Or should we be doing something totally different? So, reacting to competition is such an important driver of doing deal, and we've got a couple of examples here, actually kind of hit the inverse of each other. The first one, again, is she in, so again, she in acquisition and misguided. Some people say that this bringing in of brands, forever 21, misguided, is a slight reaction to the growth of its Chinese competitor, Temu, which is an off-shoe of the Chinese company Bing-Du-Du, and Temu, who act as a marketplace, rather than a, you know, owned brand retailer, they act as a marketplace, and they have grown much quicker than she and in the US, and they have been number one in the IOS app downloads every single week for the last six months in the US. So they are growing incredibly quickly, they are, you know, it becomes a bit of a lowest common denominator when it comes to these fast-fashing companies. If she and can sell a dress for $10, can we find a supplier that will sell one for $8? And that's what it's looking like going. So she and instead of going, can we compete on unit costs and on sales, well no, maybe we can look at our competition and differentiate. So reacting to competition, I'm going to go out and buy established brands, I'm going to go out and buy forever 21, I'm going to get them onto the sheen ecosystem, I'm going to go out and buy misguided, get them onto the sheen ecosystem and start to become a little bit different from this upstart rival in order to protect the valuation, which is, as we said, upwards of $100 billion, in order to further create that story when it comes to the IPO. So again, reacting to competition by differentiating is a really, really important one. The flip side is the fear of missing out and we've spoken both on this podcast and on the Friday podcast a lot about this AI hype cycle or generative AI hype cycle and I'm not sure whether you covered it on Friday, did you cover the Google earnings on Friday? Yeah, we were talking about Microsoft and Google, so we did talk AI, yes. It's so, it's fantastic. So obviously Alphabet had a big earnings, well, it's going to say I had a big earnings miss. It didn't really have an earnings miss, you know, let's be honest about it. How was such a successful ported, you know, reacted with a 10 cent drop in share price? Well, yeah, I mean, the summary of that is when you are in the collective of the magnificent seven, anything short of magnificent, it's just not good enough as far as Wall Street is concerned these days. It's absolutely insane. So I've about had a cloud computing earnings miss on the 25th of October, Microsoft had a massive win revenue 30% up as you spoke about on Friday. And the share price of Google went down almost 10% in reaction. So what happened a couple of days ago, well, Google announced or Alphabet announced that it had invested a further $2 billion in AI generative AI startup and philanthropic off the back of Amazon investing $4 billion in the same company and obviously Microsoft with open AI as well. So this is a jumping on the bandwagon. This is reacting to competition by doing what they're doing, right? So this is everyone in this magnificent seven, everyone trying to jump on this bandwagon because they have seen the massive, massive share price increase related to this boom and generative AI. So sometimes you look at your competition and you go, I want to be different. Sometimes you look at your competition and you say, I want to buy a company so that I can be the same or I can be more like my rival that seems to be getting a little bit of a head start over me. So reacting to competitions are very interesting to you, rationale. Yeah. And looking at the anthropic founding members, they were the founding members of open AI. So it literally doesn't get more inter-bred in terms of the sharing of knowledge in that space. So yeah, super interesting actually. Yeah. And who knows what will happen, you know, just taking a step back. You know, who knows whether the kind of valuation wheels will come off once we, once we realize that the use cases may well be limited. However, I don't know if you've been, I mean, open AI's growth rate in terms of revenue is quite staggering. From a standing start of almost nothing, it's quite remarkable. So maybe we've got a few, a few months and years left to run on that. Cool. All right. Let's discuss a little bit on using capital. Now we've discussed quite a bit on recent podcast episodes about the actual deal mechanics themselves, but maybe how it plays into the context of this conversation with Exxon and Chevron. Yeah. So using capital isn't necessarily the most textbook, deaf, and most textbook explanation as to why someone would go out and do a deal. But it stands to reason that if I've got a load of cash on my balance sheet, and that cash is growing and growing and growing, I am going to be under pressure from my shareholders to do something with that cash. Now, as you can do three things with that cash, you can reinvest it in the business. It's what we call organic growth, quite slow, quite steady, often quite hard to find things to spend that money on within the business, especially if you're an established business. The second is to return it to shareholders, which obviously shareholders love in the form of dividends or share buybacks. And the third is to go out hunting, go out and buy another company. And often when there is a lot of cash on the balance sheet, shareholders will start asking the question, what are you going to do with that money? Because remember, if I'm investing in a company, I don't want them to just hoard cash because I can hoard cash. I want them to go out and do something with it that's going to make my investments increase, right? So, Exxon acquiring Pioneer, Chevron, with its latest acquisition that we covered and deal of the week, these are two representations of companies that have had bumper years, bumper recent years, due to the spike in oil prices, hoarding cash and then spending some of it. Now, especially in the case of Exxon acquiring Pioneer, Exxon has 30 billion dollars of cash on its balance sheet. It needs to use some of it, otherwise it will start getting feeling the pressure. Actually, Chevron was slightly different because it was a more share transaction. So, Chevron's recent $59 billion acquisition was a more share transaction. And that's partly because the share price from March 2020, Chevron share price rose from $59 to $165 a share, which means that your shares go further. You're a more valuable company. So when you're looking at an all share transaction, which means that the targets shares get converted into a number of the new owners shares, means that I have more leverage because I'm a more valuable company. So using capital and leveraging valuation, leveraging increases in share price is a very common deal rationale. And obviously, when you're riding the upswing of a cyclical surge as Exxon and Chevron has been doing, it's, again, it stands to reason that they should be going out and hunting and entering in this new era of oil and gas consolidation that we've spoken quite a lot about. So I always say, you know, if you want to, if you want to find out who might be doing the next wave of acquisitions, just go to the balance sheet and go to the, go to the increase in share price because you know that those two factors will contribute to an urgency of finding a suitable acquisition. Yeah, and it seems like at the moment, a bit of a return to reality for some of these oil majors because we've had all the earnings started to come out and BP this morning. So they made a Q3 net Q3 net income. This figure is, which makes it even more like huge came in a 3.29 billion for the quarter net income. Now, that sounds like a giant figure, but actually it was short and less were looking for 4 billion and remember a year ago, a year earlier Q3. they were clocking in at 8.15 billion net income. So yeah, they were kind of building up the war chest, so to speak. And that money is still coming in evidently at this point, but has dropped off quite dramatically. And look, these big oil majors, they have a very, very consistent dividend policy, which is the fundamental reason why a lot of people own shares, in these companies, but 8 billion in a quarter, there's going to be some room for maneuver. And there have been calls actually recently for BP to get active in the market. Again, is there this kind of fear of missing out? Well, your competitors are doing deals. What are you doing? Are you just going to sit tight? So we'll wait and see whether BP and Shell start making some moves as well? Maybe a deal between each other, perhaps. Could that even be possible? You often get every now and again, don't you? A little bit of murmuring around the super majors coming together. Yeah, I mean, so Exxon and Mobile was a pretty big transaction right? A pretty big merger, and I mean, Shell and BP are so large and so competitive with each other as the European, or two of the European super majors, anything's possible, but that would be quite remarkable. Well, now's the time for Shell. BP is a bit of a, without a captain, so to speak, the interim CEO right now. So we've covered a couple of things, economies of scale, react into competition. We just discussed there using capital. Now spin-offs, something which you often hear a lot of. So how does that fit into the picture? Yeah, so I like to do one reason why a company would sell, or why an organization would consider receiving offers for its company. So there were obviously two sides to every transaction and working in M&A, you will have a bank that acts on behalf of the buyer and a bank that acts on behalf of the seller and it's got to be a deal that works for both parties. So I talked very quickly about spin-offs. Now spin-offs are where a larger company decides to sell or spin-off a division of its particular company in order potentially to unlock value that is not being realized because that particular unit is being weighed down by the rest of the company or doesn't make strategic sense. And I'm just going to link this to a very, a little bit of theory. So as an analyst, as an M&A analyst, you are likely to do, to conduct quite a few some of the parts valuations. So how do we value a particular company? Let's think about alphabet. How do I value alphabet? Well, I can do my traditional cash flow or I can do my creating and transaction comps analysis. But I can also do, I can also value the individual parts of the business to see whether the sum of the parts is more valuable than the whole. And in Google's case, well, maybe it is because you've got one of the most valuable social media companies or social media content companies in YouTube, you've got the cloud, you've got the search, pretty remarkable set of businesses. But if they are unleashed, if they are spun off, maybe we'll create even more bad. Just going back to our economies of scale argument, the reason why you might acquire a company, this is more of a dis-economies of scale argument, right? Maybe you've got, you've got a little bit big for your boots as a company and you've gone out and acquired a bunch of other companies, and you suddenly become a bit of a mess. You become a bit of a strategic mess with all sorts of different units doing different things. The share price gets weighed down because you tend to get valued closer to your least productive business unit relative to your most productive business business unit. So what you do, you consider spinning off a chunk or spinning off a business unit, and that is what Intel has recently announced that they are going to do with their programmable chip division and Blackberry with its internet of things division as well. So let me give you, let me give you, I was going to add a question, I was frantically typing away because something came to mind as you were describing spin-offs. So just given the spirit of talking a little bit on this episode about alphabet or Google, and obviously YouTube revenues, there was a US analyst that back in 2019, this is a few years old, mind, that forecasted how much YouTube would be valued if it was spun off in its individual entity. What do you reckon would be as a valuation standalone YouTube? Well, back in 2019. Yeah. It's a really good question. I think it's an incredible, incredible company and probably should be valued at more than meta is valued at the moment. I'm trying to think back to 2019. 800 billion. That's brilliant. How are we doing? 300 billion. So it's still a very big number, but in fact that would at the time, so context 2019, if YouTube was valued at 300 billion, that would put it as the 15th biggest company or one of the biggest 15 in the S&P 500. So yeah. That doesn't mean it. Again, it just doesn't surprise me. It's such an amazing company. And I just wonder whether, again, I don't think that there's any discussion going on about, you know, splitting up Google apart from if you're in the FTC part of the antitrust discussions. But yeah, an independent YouTube as an attractive investment is an attractive, it probably would be one of the top 10 in the S&P. For sure. A question from a strategy point of view then. If I was Zuckerberg, is there any way I could use some sort of spin-off or shareholding way of managing the virtual reality labs, which is just like leaking money, but does hold a future key source of technology that could be redistributed across the business? Is there any way I can kind of off like put that away somewhere on the balance sheet to have it away? Or is it just more just the CFO doing good job engineering on conference calls? Yeah, it's really interesting. It's kind of what it's why Facebook's now called Meta and it's now called Alphabet, right? And Alphabet is a collection of different companies. The most important is their search is Google. But within that they've got DeepMind, which is their AI research company, let's call it. And they've got previously they had their kind of moonshot labs where there was a huge budget for doing moonshot type businesses. The could fail, but could also become the next trillion dollar business. They're kind of incubator. Now that's a really exciting thing to think about and that's probably what Meta's done with its Metaverse and you know put it in that separate section. When the economic going gets tough, this start this division, the moonshot division or the Metaverse division, that starts to become strategically a little less palatable because you're like, "Ah, where's the money here?" Like, you know, the search business is amazing for Google. The marketing and advertising business for Facebook is amazing. Just focus on that. We just want to see your EPS grow. We don't really care that much about moonshots now. During the next kind of hype cycle, maybe we can get back into it. So strategically, that's kind of what Meta's doing at the moment. But I might want, yeah, I'm just going to end at one point about these spin-offs and we don't need to go into too much detail about Intel and Black Reads, it's worth just looking them up yourself. But the the stock market reaction, the investor reaction to both of these spin-off announcements, Intel spinning off their programmable solutions group, which is what they're going to be calling it, and hopefully IPO-ing it next year. Black Reads spinning off its IoT Internet of Things division, and maybe IPO-ing it next year. These share prices of both Intel and Black Reads went up. Now Intel went up through in half percent. Black Reads went up five percent. Think about that in the context of many of the episodes that we've spoken about in the last few months. Usually, on the announcement of an acquisition, the acquirer share price goes down. Because investors would rather see that money return to them in the form of dividends or buy backs or whatever and tend to think the big acquisitions may well be dilutive, as opposed to accretive to their to their earnings per share. Whereas in a spin-off, a typical stock market reaction is that share prices go up of the company that's spinning off. Because suddenly, they're like, all right, well, maybe there could be a liquidity event, a kind of a cash event that could get returned to us. Maybe this company's going from being quite flabby to be quite focused. We quite like that. So it's quite interesting just to see the typical stock market investor reactions to these different strategic moves, whether it's an acquisition or a spin-off. Well, look, Stephen, this is part of a four-part series. So I'm going to plug for people to make sure, if you're not already, that you subscribe to the channel because you don't want to miss those other episodes. But what can people expect from the rest of the series? Well, look, I've got a very, very long list of rationale for Geals, and I'm going to try and patent, well, I'm going to try and match that list with things that have been going on in the news over the, over the, over the preceding week. So I can't tell you what's going to come up next week because I'm going to try and make it relatively flexible and live. But by the end of this little series, you're going to have a pretty strong compendium of strategies and rationales for why companies do Geals. Cool. And just the final shout out as well. I understand you've got another M&A finance accelerator session happening this week. Is that right? Yeah, we're going, we are going this Thursday 4 p.m. UK time till 6 p.m. These things usually sell out, quote unquote. They get booked up. It doesn't cost any money. They get booked up really, really quickly. So follow the, follow the socials, follow LinkedIn for the next, for the next session. But the next one is coming up this coming Thursday at 4 p.m. Cool. The link you will be able to find in the show notes. So just go there. There's probably a few spaces left because we'll drop this episode. And then there'll be a day or so until the event. But yeah, hopefully you can get in on that action. But yeah, thanks Stephen. Thanks everyone for listening and see you on the next episode. Thank you. You know how much money you've got when you stop working? More than half of the people can come up with serious money. Or to their own base or business. Look at brand new day.nl. And give yourself an extra pension pot you can do. Armee is part of Balecht for later. And the best thing is that you can also get a lot of a lot of money for the next episode. And that's it for today. See you next week.