M&A Selection Criteria & Evaluation Process: Macro Economic Factors

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.

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