How strategic deals can accelerate growth ambitions

Businesses must critically review their portfolio and boldly seize M&A opportunities with board support.

In brief

• A continual portfolio review will allow companies to identify growth and underperformance areas to help maintain long-term profitability.
• Divesting underperforming or distressed assets can allow capital to be deployed in higher-impact investments.
• The board should steer the management to act boldly and take advantage of M&A opportunities to drive transformation for success beyond the crisis.

The COVID-19 pandemic has fueled a strategic reset for businesses, with bold investment intentions now focusing on thriving rather than just surviving. As companies emerge from the COVID-19 crisis, more than half of the business executives surveyed in the latest EY Global Capital Confidence Barometer  expect a recovery in profitability to pre-pandemic levels by 2022. The survey covered more than 2,400 C-suite executives globally, including 185 respondents across Southeast Asia: Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam.

The majority of executives are satisfied with their pandemic-response performance relative to competitors. More than half of Southeast Asian respondents believe that their organizations have outperformed competitors during the pandemic in several areas, such as operational stability, digital transformation and engagement with local communities.1 But while respondents may feel that good progress has been made, the reality is disruption will continue in a world changing at a faster pace than before. Products and services are coming on the market faster, with start-ups challenging business models across all industries and rewriting the rules of the game. Companies must, therefore, continually review their strategy and future business fundamentals and, to that end, critically review their portfolio to see if it will remain relevant and profitable in the long term.

Divest to reinvest?

According to the survey, the vast majority of Southeast Asian executives conducted a comprehensive strategy and portfolio review in 2020. Their main strategic considerations include identifying and investing in talent, divesting underperforming assets or businesses, and making strategic acquisitions.

An always-on strategic and portfolio review process will allow companies to identify areas of growth at the earliest opportunity and surface areas of underperformance sooner. This will also prepare them for divestment and reinvestment should the need arise. Companies should also identify assets at risk of disruption or facing future growth challenges and consider their divestiture. However, the top-down assessment by the management and board can sometimes conflict with a bottom-up review process, especially with regard to assessing synergies and the value of business units as stand-alone entities or potential divestitures. Business unit management bias, which, while understandable, can obscure the holistic view of the business that the review process should yield.

Divesting underperforming or distressed assets is a typical trend during a crisis and recovery that we should also expect beyond the COVID-19 pandemic. Even a strong-performing business that does not fit with the organization’s strategy might be tying down capital that can be better deployed in higher-impact investments.

Transformative or bolt-on deals?

The survey also revealed that more than half (56%) of Southeast Asian respondents are looking to actively pursue M&A in the next 12 months: the highest of such sentiment since 2012 and beating the 11-year average of 44%. Issues relating to regulations; tariffs and trade flows; the strengthening of technology, talent and new capabilities; and growth into adjacent business sectors or activities are some of the drivers of greater M&A appetite.

Most deals in the next 12 months that respondents worldwide intend to pursue are targeted at bolt-ons and the acquisition of specific capabilities. Whether such smaller acquisitions will be sufficient for companies looking to position for growth in an environment that may look very different in the wake of the pandemic remains to be seen. Most corporate M&A deals in Southeast Asia tend to have bolt-on characteristics as they are easier to execute. Some companies have also attempted roll ups — where a fragmented sector is consolidated by aggregating a number of sub-scale players — but these transactions are far more difficult to execute and carry much greater risk.

However, the board should also assess together with the management whether there is a need for transformative deals that will completely change the scale and focus of operations. Current market conditions present an opportunity where bold moves, while risky, will also provide outsized returns. Transformative deals are far more difficult to get right as the management needs to support them with very strong execution under the right circumstances.

The success of the M&A approach is dependent on several factors, such as the acquisition being part of the business strategy, having a well-structured and deep analysis of the market and target, as well as correct financing of the acquisition.  Other factors include adequate consideration and mitigation of transaction risks as well as a detailed value-creation thesis with proper ownership and implementation actions. The extent of articulation, ownership and implementation of the value-creation thesis makes a difference between success and failure.

Bold actions needed

While the pandemic may have turbocharged transformation plans for some companies, the route ahead is not without challenges. Southeast Asian respondents acknowledged that effective execution of the company’s strategy was hampered by a lack of leading technology, cost and capital constraints, and a lack of external advice.

The board needs to challenge the management on how the core competence of the company can be enhanced by utilizing the technology ecosystem: what to acquire, build or collaborate on. Given the rapid pace of change, companies are increasingly exploring alliances to access the best technologies available, whether at the front-, middle- or back-end. A good example of such an alliance is digital banking, where new market entrants have been formed through collaborations between entities that own the customer and those that own products and technologies. Having a consulting partner to help navigate these decisions is very useful.

The private and public capital markets are flush with cash, and a wide variety of capital providers that can provide customized solutions are looking to actively deploy capital. Therefore, companies have the choice of picking the right capital source and structure to match the requirements of the project or acquisition. Before looking outward, boards should look inward to what their own balance sheet can provide through divestment of noncore and nonoperating businesses and assets, working capital efficiency, and an efficient capital structure.

Sustainability at the core of actions

While companies acquire and grow, the board and management also need to be strong stewards of the community. Environmental, social, and governance (ESG) considerations must be an important component of the corporate acquisition playbook. ESG and acquisition frameworks need to be updated to reflect various topics. Examples include environmental compliance, sustainable practices, operating with integrity and good corporate citizenship from the perspective of all stakeholders, such as employees, suppliers, customers, the government and the broader community in which the company operates.

We know companies that transformed and transacted in past crises emerged stronger than competitors. Companies in Southeast Asia must therefore act boldly and embrace transformation — accelerated by the right acquisitions — as a winning formula now and beyond the pandemic.

Boards should consider the following questions:

• In an era of rapid disruption, does the business strategy help maintain market leadership and growth? How does build versus buy versus collaborate combine to achieve these strategic goals?
• Is the current portfolio strategy sound or does it need to be reshaped through divestments and investments?
• What KPIs and analyses should the management use when looking at business units in their portfolios?
• Is the capital structure right, and are returns commensurate with the capital allocation to each business unit?
• Does the management fully understand the return on investment for strategic acquisitions, especially with digital and technology?
• Is the company actively looking for opportunities to build out its ecosystems beyond the usual suspects, or considering cooperation with competitors?
• Does the management have an acquisition and integration playbook that is updated and consistently implemented in each transaction?