Why More Transformational M&As Are On The Horizon For 2018

When Amazon bought Whole Foods for $14B last year, imaginations ran wild over what the merger between the e-commerce giant and the national supermarket chain would mean for retail.

Product integration has been one of the subtler outcomes of the merger. At the Amazon Go Store in Seattle, which opened to the public in January as a cashierless convenience store, brands normally exclusive to Whole Foods appeared on the shelves. 

The Amazon/Whole Foods partnership highlights the growing appeal of transformational mergers and acquisitions. More than the absorption of a company, these M&As have the potential to reshape industry landscapes, disrupt conventional business practices and open up access to new markets previously inaccessible to a company. 

As the economy continues to diversify thanks to the influence of technology, more companies are looking to expand their reach, Baker Tilly partner Ken Fleming said. Increased spending in areas like defense and infrastructure will lead to more M&A activity in the public sector.

Fleming is a partner in Baker Tilly’s financial advisory services practice, where he leads buyer and seller due diligence, business valuations and post-transaction financial integration assistance. Transformational M&As present an opportunity for companies to enter new markets where the time and investment required are too high a barrier, causing companies to buy access. This provides an opportunity for businesses to hit growth and value trajectories that would otherwise be unobtainable.

“This is differentiated from conventional transactions like absorptions or a tuck-in, which tend to lead to near-term gains followed by a return to the prior trajectory,” Fleming said. 

Transformational M&As have become more commonplace in the retail industry, as e-commerce gains traction and brick-and-mortar stores look to redefine themselves. It has also become a strategy for retail REITs to consolidate assets, as stores continue to shutter nationwide. 

Divestiture can be part of the process. Walmart announced earlier this month that it plans to close down 63 of its Sam’s Club stores and convert 10 stores into e-commerce distribution centers. The consolidation will better position the retail giant to compete with Amazon by providing a faster and cheaper online shopping experience. 

While retail consolidations have drawn the attention of industry professionals, M&As are also growing in popularity in the construction industry. President Donald Trump’s administration released a plan in February saying it would stimulate at least $1.5 trillion in new infrastructure investment, shorten project permitting time to two years, improve training to get more qualified workers and boost investment in rural projects. 

“Roads, bridges, airports and more continue to be topics of future federal spending,” Fleming said. “I expect to see consolidations and vertical integrations in order to service the demand while angling for scale, increased margins and market permission to bid on large contracts. We’ve seen large, billion-dollar infrastructure funds raised by the likes of Blackstone and others in anticipation of growth.”

Baker Tilly has helped construction and development companies in the past to acquire businesses that allow for cost-effective access to construction materials, leading to higher profitability and improved vertical integration. 

Congress also plans to raise the 2019 defense spending budget to $719B in 2019, a 2.4% increase compared to $700B in 2018. Readiness, on both the cybersecurity and more traditional defense fronts, has become a popular topic. As countries like Russia have made strides in cyberweaponry and have maintained the ability to deploy tens of thousands of troops, jets, warships and tanks, the U.S. has looked to upgrade outdated military equipment. 

Defense contractor General Dynamics recently announced its $9.6B acquisition of CSRA, which will make the combined company one of the largest federal IT providers to the Department of Defense, intelligence community and federal civilian agencies. Robust defense spending could translate to a positive spike in office absorption in Washington, D.C., where government contractors lease or own an outsize share of office space.

There are caveats to transformational M&As. A buyer entering a new industry, market or customer base is operating in a new environment. Post-acquisition integration and operations are critical to success, Fleming said. Both parties should take the time to conduct proper due diligence prior to the deal and have detailed plans on what is critical to integration and, oftentimes, what will be left alone.

Issues like culture fit could also stand in the way of an M&A reaching its full potential. 

“We would just caution that management and boards of directors make objective M&A decisions that have a sound investment thesis, have been appropriately vetted through due diligence and include a solid and realistic integration plan,” Fleming said. 

To learn more about this Bisnow content partner, click here.