Financial analysis is obviously central in assessing a target’s real value. However, it is not sufficient. It must be backed by an equal (if not superior) amount of strategic analysis. These two fields of expertise are complementary, not substitutes !
I personally believe that private equity (and most M&A) belongs to the realm of strategy as much as it does to the realm of finance. And in this regard, true transactional insight comes from rigorously intersecting them.
Let’s take the fictitious case of an investment professional who’s part of the corporate M&A team at a generic industrial company. The aim of his work should not be to close deals for the sake of closing deals. His task is first and foremost to gain a deep understanding of his employer’s strategic plan and use that understanding as a compass for deal screening. Indeed, in a corporate context, M&A is not an end itself but rather a means to achieve an organization’s strategic plan. In this context, M&A will be sometimes be used
- to acquire technical competencies missing in the company
- to accelerate product development
- to acquire a customer base in a different geography and expand footprint
- to consolidate the market and reduce number of competitors
While the above might seem obvious, it aims to illustrate that corporate M&A does not live in a vacuum. Its purpose is to accelerate or enhance strategic corporate development. It is a tool to deploy corporate strategy, just like in-house product development or corporate alliances.
Now let’s take the case of a pure-play private equity investment fund looking at each opportunity as a standalone opportunity. The fund’s goal is to deploy capital to achieve targeted returns. In this case, the need to quickly develop a strong and insightful strategic understanding of the target is even more crucial, as the fund generally does not benefit from massive in-house strategic expertise/insight about the target’s specific sector. Sure there are lessons that can be applied from adjacent sectors that the fund is familiar with, but that will only go so far. The challenge is this case is for the investor to rapidly develop a strategic understanding of the industry’s attractiveness and of the target’s competitive positioning. Not a “high-level” understanding. A subtle understanding that gets as close as possible to that generally possessed by the seller. This is easier said than done. This is the challenge that strategic due diligence aims to meet. It aims to reduce, as much and as fast as possible, the massive information asymmetry existing between a buyer and a seller. It aims to close the knowledge gap. Its aims to help you see what the seller is not saying. And sometimes, it even helps you see what the seller is not seeing.