When the merger’s complete, will 1+1=1?

By

Neil Desai

Ernst & Young LLP US Operational Transaction Services Executive Director

Transaction professional with a focus on unlocking value through operational strategy and execution. Advisor to clients on their M&A journey across the deal lifecycle.

5 minute read 2 Oct 2019

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Five key focus areas for Aerospace & Defense M&A integrations to help manage risk and achieve deal objectives. 

Acquirers continue to focus on deals that can address the need for new capabilities, strategic stakes to offset threats, market share, talent and more. If done right, they can create value and provide new competitive advantages. However, if not properly planned and executed, deals can destroy value and cause unplanned disruptions, both within the newly merged entity and in the market.

The hurdles for aerospace and defense (A&D) can be even higher than for other sectors, as it’s a capital-intensive business with long development cycles. Furthermore, the ripple effects through associated services and solutions can be severe given the highly entangled nature of products, customers and suppliers. A&D companies can also have global value chains and long-term commitments with both suppliers and customers. Global footprints are exceedingly exposed to geopolitical risks and other sources of disruption, including sector consolidation.

As such, A&D companies need a non-templated approach to M&A. Each deal is unique and requires careful planning, from diligence to post-merger integration, so that value is created and realized for the acquirer. Acquiring A&D companies should consider the following five key focus areas of the deal life cycle.

1. Understand the value drivers

Throughout the complex A&D value chain, all value creation opportunities should not only be expressly defined in the deal thesis but planned for realization. This is a critical component of a complete acquisition integration strategy.

Value drivers can vary by type of acquisitions; in cases where established aerospace companies buy new technology companies, the value drivers may be both talent and intellectual property. Alternatively, in a traditional vertical integration, the value driver may be reducing component costs for a program. Understanding the value drivers of the transaction is critical to keeping the integration teams focused on the core objectives throughout the deal life cycle.

As boards increasingly look for a clear integration plan before signing a deal, defining and quantifying detailed value creation hypotheses should be accelerated. Whether it’s determining how specific capabilities will increase market share or evaluating opportunities to take out costs, conducting a thorough analysis earlier in the deal life cycle can more effectively inform the deal thesis and provide alternative negotiation levers.

In addition to identifying value drivers, diligence should also incorporate deal-specific risks that could jeopardize the deal value, such as exposure to geopolitical risks, cybersecurity and supply-side constraints.  

2. Determine the right governance structure

Due to the high degree of cultural, geographical and operational differences that can occur among A&D companies, striking the balance between the degree of program structure and speed of integration can help minimize value dilution.

In our experience, many companies continue to take the traditional approach of organizing functional teams to execute the integration. While that can effectively achieve transaction compliance objectives, the ability to create value can be limiting.  

An alternative emerging approach is centered on defining value creation groups as a core pillar of a program structure.

Ideally, companies may consider a cross-functional approach, as multiple functions need to work together on broader initiatives such as customer experience transition, go-to-market realignment, and network and footprint rationalization. Rather than centering your efforts around functions, you can focus on solutions and how multiple functions need to work together to achieve them.

Governance models are key to delivering on deal value, managing interdependencies and addressing risks in a timely manner. Hence, it is essential to identify and socialize a robust governance structure early.

3. Create a “clean room” for diligence

During the pre-close transaction phase, availability and access to data — such as supplier contracts, asset quality and customer information — can be stumbling blocks. You could begin to delve into the specifics after deal close, or, in the time between when you sign a deal and when you close on it, you can leverage a “clean room” to accelerate your integration planning activities.

In a clean room, you can rely on a third party or specific individuals without conflicts to share data between the acquiring company and the acquiree. Clean rooms can help provide strategic insights on the impact of key integration areas such as understanding the product and customer overlap, identifying cost synergies in procurement contracts, and exploring cross-selling opportunities.

For example, there may be significant impact on current and future opportunities that are being negotiated and proposed to government agencies. Failure to manage or disclose these impacts can result in significant financial and business risks, including inaccurate pricing, disqualification from considerations and allegations of defective pricing.

Assessing the future state synergies and cost savings — and quantifying the potential exposure to both the buyer and the acquired entity — can inform how anticipated gross synergies assumed in the business case will need to be addressed and presented to the government customers. Additionally, the analysis in aggregate can be leveraged to identify how the operating model of the combined business will need to change relative to the evaluation of contract terms and recoverability of costs.

Companies can analyze data from both parties while maintaining procurement integrity and protecting otherwise sensitive and proprietary information. This allows proactive and responsive management of the public sector portfolio while mitigating the risk of business loss and future liabilities related to alleged noncompliance.

A clean-room analysis can help you develop an accelerated integration plan and identify and deliver on quick wins. It can also support the collection of inputs for developing an integrated future state blueprint of the combined entity.

4. Develop detailed operating models for the complete value chain

It’s crucial to understand each company’s current state on people, processes, systems and assets. This information forms a foundation for understanding and assessing respective capabilities — a blueprint for analyzing how to operate as a combined entity.

Future state operating models depend on the type of the deal; for example, for a small “tuck-in” transaction, where the objective is perhaps to increase production capacity, you may not want to make sweeping changes to your operating model.

However, in the case of a large transformative deal, you may leverage this as an opportunity to reshape the business completely. Hence, identifying the main value drivers is important to developing the future state operating model for the combined business.

Operating model questions can range from the highest level — such as “What should be our go-forward distribution footprint?” — to even more granular decisions, such as “How will the combined companies place purchase orders for parts?” It’s critical to conduct a careful current state assessment of the entire value chain and a thorough future state design by involving both parties and keeping in mind the value drivers that were identified during the deal’s initial stages.

5. Perform culture assessments to achieve value

While operating models and synergies are crucial components of an acquisition integration strategy, designing for the right culture can be just as important to achieve the value inherent in the deal thesis.

Whether it relates to how decisions are made or how people collaborate, culture plays a crucial role in enabling a business to deliver value to internal and external stakeholders. This is especially important as A&D companies evaluate targets across borders or consider new capabilities outside of the core business.

To obtain a better understanding of how cultural differences between the acquirer and target may impact the integration strategy, companies may want to perform a cultural assessment as part of the diligence phase, if key personnel and policies are available for access.

The baseline assessment, for example, of how each company makes a business decision or engages customers can be used to inform integration planning activities related to what needs to stay intact vs. what needs to change.

Trends on workforce reactions to prior transformative changes should also be evaluated: Was there significant attrition or loss of morale related to a past deal? What function was impacted the most? What were some of the drivers of such behavior, and how did they affect decision-making?

Additionally, the assessment should focus on identifying the specific initiatives required to sustain or improve the values of a combined company. The values, in turn, will drive the specific behaviors required of employees to support new business objectives.

By addressing cultural differences as part of the overall integration strategy, potential mismatches that could dilute the value of the target can be proactively identified and addressed.

Keeping these five steps in mind can give you an actionable path forward to begin reaping the rewards of your transaction quickly — rather than trying to work it out as you go along.

Summary

Today’s A&D company is tasked with evaluating how to stay relevant and competitive in an ever-changing landscape. Whether due to a rapidly changing geopolitical environment, industry consolidation or variance in demand patterns, your M&A transaction integration strategy must also evolve. You will need to leverage an integrated strategy that can mitigate execution risk and achieve business objectives. Components of such a strategy include focusing on value creation drivers, creating a robust governance structure, using a “clean room” for accelerated integration planning, developing end-to-end target operating models, and, most importantly, preserving and enhancing people and culture for the combined organization.

About this article

By

Neil Desai

Ernst & Young LLP US Operational Transaction Services Executive Director

Transaction professional with a focus on unlocking value through operational strategy and execution. Advisor to clients on their M&A journey across the deal lifecycle.