The concept itself is not new. It was successfully developed in the US and has crossed the Atlantic with the many US PE firms who plan to replicate their successful buy & build strategies on the European continent. These US firms, such as Clayton Dubilier, Hicks Muse, KKR et. al, have been lured by the prospects of a unifying European market stimulated by the introduction of the euro. However the European market, if there is such a thing, is a long way from becoming as homogeneous as the US market is today. And that is what the success of the buy & build strategies of the US PE firms has relied mainly upon. Homogeneity in terms of legal, commercial, cultural, financial and cultural infrastructures has been an important factor in realising the synergies needed to make a buy-and-build strategy work.
Although a similar homogeneity is lacking in Europe today, many companies are attempting to consolidate across their national borders. But the diversity of the European market throws up many challenges. This article discusses these challenges from the perspective of a typical German private equity firm that wants to pursue a cross-border buy & build strategy,
referring to both the difficulties and opportunities it may bring.
Attractions of buy & build
At first sight, a buy & build strategy seems imperative at a time when European industries need to become more efficient and competitive in the face of globalisation. In addition, it
has also become much more relevant as a way to create value when stagnant or falling stock market valuations make the old-fashioned buy-and hold strategy ineffective. Buy & build also offers some attractive side effects. It gives a PE firm the opportunity to outbid its competitors in auctions by being able to pay a strategic premium. It allows the development of a proprietary deal flow through industry contacts and expertise and the outsourcing of some of the M&A work to the management team.
Besides these generic advantages, there are some specific opportunities for a German company that wants to pursue a European cross-border buy & build strategy:
* There are some important benefits to be gained from building a multinational company out of a German platform in a region where national economies are not yet integrated. When economic cycles are not aligned, they can provide a means for a multinational to generate more stable revenues and thereby improve its debt capacity.
For example, Germany is the home of many industries that can be labelled as cyclical’ (construction, automotive, engineering). During the last three years, while Germany’s economy has been sluggish, France’s has been amongst the strongest in Europe. There have been several buyouts of German companies with significant French subsidiaries, which would have been more difficult to structure had it not been for the smoothing effect
on consolidated earnings and cash flows contributed by their strong French subsidiaries.
*German companies could also have a scale advantage relative to their other European counterparts in attempting a cross-border buy & build strategy. Thanks to a relatively large home market, German companies have the opportunity to acquire a critical mass by consolidating in their home market before embarking on cross-border acquisitions. This could make them better prepared in terms of financial firepower and managerial depth for a cross-border buy & build strategy.
Challenges and pitfalls
Wash your own dirty linen first
Germany is considered an attractive market for buyouts because of the restructuring potential of its industrial base. This feature is not an ideal precondition for a successful buy & build strategy. It is more difficult to make a buy & build strategy work when the acquirer hasn’t put his own house in order first. Restructuring acquired companies to realise synergies becomes more challenging when management and personnel of the acquired company believe the problems lie with the parent, not with them.
Many German companies suffer from high overheads and rigid operating structures, made more difficult to remedy by unyielding unions. This makes it trickier to have painful changes accepted by the employees of a foreign subsidiary, especially if they believe they have to suffer because their German colleagues are protected by strong unions. On the other hand, exposing the German management and employees to more efficiently run foreign subsidiaries can also, if well managed, be a catalyst for change at home.
Language and culture
Language, culture and national
pride can also be obstacles that should not be underestimated. These obstacles may have been overcome by the larger German multinationals, but less so by the Mittelstand or corporate spin-offs that are the typical source for buyouts. Although many German managers of Mittelstand companies speak English, they often lack international experience and therefore are not tuned into the message’ their foreign partners may be trying to convey.
The task of communicating becomes even more difficult when acquiring medium sized companies in, for example, Southern Europe or even France, where many managers do
not speak English at all.
The Not Made Here’ syndrome can also raise problems. In spite of changing attitudes, many Europeans still think in stereotypes when it comes to their neighbours in other countries. Germans often believe that in the field of engineering they make the most reliable products and that the label Made in Germany’ always justifies a premium price, a perception that is not always shared by foreign customers. Moreover, these higher prices are often necessary to subsidise a relatively high cost base found on German production floors. When such a German company makes a foreign acquisition, it may have difficulties integrating or closing the acquired production sites because they are specially geared to manufacturing cheaper’ models, which their domestic customers prefer over the more expensive German models.
Banking structureFor a leveraged buyout to successfully implement a cross-border buy & build strategy, it also needs a banking partner that has the experience and the network to structure cross-border deals. There are yet not many German banks that have the experience or the multinational presence to help finance these
foreign acquisitions. Seeking help from London-based banks can be a solution, however management in Mittelstand companies often lacks the experience working with non-German banks (and vice-versa).
Market structureCross-border synergies are often harder to find because of differences in market structures. Customer concentration, distribution channels, competition, etc. can vary between countries. These downstream structures usually leave their imprint
on the production floor and can make benchmarking between production sites in different countries more difficult. In business-to-business industries, a way to alleviate this particular problem is to venture cross-border in order to follow an established domestic customer when he moves abroad to consolidate.
This way, the potential problems of a foreign market can be tackled alongside the customer.
Regulatory barriersRegulatory barriers to realising synergies also still widely persist, in spite of attempts by Brussels to harmonize them. National champions in many countries still lobby their governments to maintain overt or covert regulatory barriers such as e.g. national safety standards. This often means that products need to be made to local specifications, denying companies buying a foreign company the opportunity to increase the size of their production runs and realise economies of scale.
None of the problems of cross-border acquisitions described above are new. German buyout firms will encounter many of the same challenges as their larger corporate brethren who have been expanding cross-border for many years. But while making any merger
or acquisition work is known to be hard, adding a cross-border dimension only makes it more difficult. Add the parameters of a leveraged buyout, and its management team has relatively little room left to manoeuver.
While synergy problems at the operating level can only be solved by management, an internationally oriented and structured private equity firm could make a difference in helping its portfolio companies bridge the cultural and language problems described. In order to play such a role, it needs to have a multinational but well integrated team, with an affinity for cultural differences but with enough experience to be able to bridge them. This is a challenge facing many private equity firms today, which have stumbled in the past as they tried to create a unified team out of their domestic and foreign offices. But their experiences could be of great value in smoothing the path to a successful European buy & build strategy.
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