After deciding that M&A is the way forward in terms of achieving the company’s long-term strategic goal, the next step is to decide which market or country to look for potential targets to invest in. As part of a three-stage process, we will first explore how to evaluate the macroeconomic environment that a potential target firm is in. There are two key criteria to consider before a target is deemed suitable from a macro-level standpoint.
1. Commercially desirable market or industry
The first layer of evaluation comes from the study of the economic conditions that the target company operates in. Economic data such as GDP growth, population size and inflation rate should be extracted and studied in detail. These are key to evaluate the robustness of the economy and if it indicates a favourable environment for growth. Furthermore, certain key characteristics of the country, such as education level and condition of infrastructure should also be examined. This is to better make judgement of the long term economic prospects of the nation based on its level of development.
After establishing the state of the macroeconomic climate, the next crucial step is to zoom in on the industry and sub-sector that the target company operates in. Understanding the factors that drive the growth of the industry is key in identifying future opportunities. A common tool to think about the industry is to use Michael Porter’s “Five Forces” analysis. We should examine the level of competitiveness among existing firms, bargaining power of the customers and suppliers, threat of potential entrants as well as number of substitutes available. Industry benchmarking of key financials such as profit margins and returns on capital should also be reviewed. All these are to judge if the industry still has meaningful opportunities for growth and profitability.
2. Favourable regulatory conditions
There are many potential government and regulatory risks that need to be considered when evaluating an investment opportunity in a target company. Careful examination should be done for the relevant government policy directives and key regulations such as M&A laws and the Company’s Act to evaluate the business environment. It might even be worthwhile to consult professional legal advice for countries with a less developed legal system.
Some of the key risks to take note of are the possibility of an unstable government, poor industry regulation, difficulty in access to capital and an unfriendly legal framework. Although in principle, the acquirer should avoid investments with these risks, there are several factors to mitigate such factors. An effective way to test the market is to look for long-term partners in that country and leverage on their local knowledge before making a full acquisition. Having directors with connection to the local government can also be useful in establishing diplomatic relationships and trust.
In the next article, we will then explore the second stage of the process and that is to delve into a detailed company analysis of the target investment. This will require deep understanding of the business to evaluate the future performance of the target and how attractive it is as an investment.
