Three trends shaping portfolio moves in a red-hot M&A market

Three M&A trends shaping portfolios

Below are three trends that are driving companies to pursue M&A and divestments, and how companies are seeing success.

1. Technology disruption

Digital everything — cloud capabilities, artificial intelligence (AI), cybersecurity, and more — is driving change, particularly in the industrial, manufacturing, automotive, health and life sciences sectors. Companies are buying capabilities that take too long to build in-house while using divestments to jettison businesses that don’t fit their digital footprint or can generate proceeds to accelerate technology investments.

Action items for buyers:

• Consider how to incorporate new selling and distribution or delivery models, new customers who engage with products in a different way, and more data to be analyzed.
• Understand synergies and risks that differ from the core business and can be difficult to measure directly, such as customer lifetime value or customer acquisition costs.
• Assess governance structure and retention policies, especially when planning to allow the acquired company to retain autonomy.

Action items for sellers:

• Determine if you are better selling a non-core or slower-growth business, as such businesses may struggle to secure internal growth capital. 
• Consider alternative deal structures, such as joint ventures with a technology company, to bring needed capabilities and scale innovation rapidly while also allowing current owners to reap valuation upside in a subsequent sale.

2. Changing customer behavior

Companies are adapting their operating models to pandemic-induced customer behavior changes. For example, health care is often delivered digitally; and business-to-business (B2B) customers have become more accepting of remote sales visits, lessening business travel. On the consumer side, the EY Future Consumer Index finds that 46% of consumers will shop more online for products that they previously bought in stores.

Action items for buyers:

• Identify growth platforms, which could include both selling the current product lines to new customers and expanding offerings to existing customers.
• Assess a potential target customer base: What is the growth potential? What does the target sell that you don’t offer? Consider opportunities for cross-selling and bundling offerings.
• Clearly articulate the sales strategy based on new products and services to align your go-to-market team with marketing messaging.
• Reward employee behaviors that align with the new go-to-market strategy.

Action items for sellers:

• Assess whether all businesses in your portfolio are meeting changing customer demands, if the capital required to support them is reasonable and available, and whether there may be a better owner for some assets.
• Define what the customer experience needs to be during the divestment transition process. Minimize disruption to avoid customer attrition.
• Plan for go-to-market changes and cost changes at the remaining organization.

3. ESG

Focusing on profits alone is no longer enough. CEOs need to consider broader stakeholder considerations around financial value, customer value, people value, and societal value.

All companies’ KPIs should capture the value created for all stakeholders – including traditional measures like revenue and costs, but also brand value, diversity and inclusion, community impact, sustainability and other measures.

From oil and gas companies reassessing alternative-energy investments to auto companies embracing electric vehicles, investors and other stakeholders are influencing company’s ESG-related transaction decisions. At the same time, a rise of ESG-focused activist funds is driving scrutiny of corporate portfolios and ESG narratives, calling out “greenwashing” when they see it.

In 2020, the renewable-energy sector dollar volume in the equity capital markets reached a four-year high of $14.8 billion globally, while the sector hit a record 74 transactions, according to Dealogic.

Action items for buyers:

• Understand the valuation impact of possible future ESG risks, especially considering upcoming government standards.
• Buyers of ESG-friendly businesses like clean energy need to assess the asset’s financial potential and competitive advantages.

Action items for sellers:

• Weigh whether divesting assets can elevate the company’s ESG profile, thereby reducing stakeholder scrutiny. In fact, 46% of sellers in the 2021 EY Global Corporate Divestment Study say ESG issues directly influence divestment plans.
• Consider how a potential buyer might handle the environmental and stakeholder concerns surrounding a divested business.

Plan your next move

Realizing CEOs’ long-term growth ambitions requires both M&A and divestments, each informing the other at every step, as companies actively manage their portfolio of businesses to increase long-term value.

This EY-Parthenon article is part of a sponsored content series as seen on hbr.org.