When our firm is talking to prospective clients about merger / acquisition activity or raising capital, we tell them that anyone considering a financial arrangement with their company will want to know the answer to three high level questions.

1. Is this the right industry to be in to make money?
2. Is this the right company in that industry to maximize the opportunity?
3. Is this the right management team to make it happen?

Parsed out, each of those three questions lead to many additional questions, and the need for meaningful, documented substantiation. The questions’ elegant simplicity belies a lot of underlying complexity. For instance, a select few of the many more detailed questions under number one could be:

• How big is your market?
• What Political, Economic, Social and Technological factors (PEST Analysis) have, are, and/or will influence this market?
• Why is the market ready now? What is changing that makes the timing good for your company?
• Within what segment of the market have you already created a meaningful presence, or what segment do you believe that you can capture in a growth scenario?

This is just a tiny sample of the more detailed questions underlying those three high level ones. Of course, more extensive question lists are widely available. Additional strategic tools to derive meaningful answers to the questions often include a Strengths, Weaknesses, Opportunities and Threats (SWOT) Analysis, Value Chain Analysis and a Five Forces Analysis.

There is nothing magic or elusive about these three simple questions, but fairly commonly, company executives are unprepared to offer a response to all three that would indicate that they have thought much about them. That’s a problem.  At best, it puts the company in a weak negotiating position; at worst, it terminates the discussion within the first few minutes.

What if the answers seem unfavorable?

 In a mergers & acquisitions context, there may still be significant economic opportunity even if the answers appear unfavorable. We are contacted routinely by investors seeking to buy outright or buy a portion of companies in which opportunity exists to correct deficiencies. Even if a company is competing in a shrinking or otherwise competitively difficult industry, there may still be ample opportunity to make money by changing the strategy of how the company competes or merging with another industry participant. Importantly, the first question focuses on the opportunity to make money in the industry, not necessarily whether the industry is inherently attractive.

Here are two examples of companies that responded to unfavorable conditions, but in entirely different ways.

Changing the Nature of How They Competed – Apple Computer

As successful as Apple is today, it’s almost easy to forget their near-death experience prior to Steve Jobs returning to his former role as its CEO in 1997, and who then brought it from near bankruptcy back to profitability by 1998. At the time, Apple had been trying unsuccessfully to compete against IBM and other PC manufacturers. Though the PC market was growing rapidly, Apple had a very small market share, due to a number of strategic decisions made in the past. Apple shares traded around $22 (about $5-6, adjusted for splits) when Jobs took over in 1997. Under Jobs’s leadership, Apple introduced new products such as the iPod, then later the iPhone and iPad, to change how it approached the computer market. Today, Macintosh desktop and laptop computers account for only about 13% of Apple’s revenues, and their share price is around $500. 

Key lesson: sometimes the best way to make money in a market is to redefine it.

 Merging With Another Industry Participant – Applied Materials Merger with Tokyo Electron

The semiconductor manufacturing industry is by all measures a tough industry in which to operate. The market for chips and the equipment to make them is characterized by boom and bust cycles, and the now-mature industry peaked in the late 1990’s. As smart phones and tablets have continued to rise in sales, PC sales have fallen steadily, while there is a growing need for research and development spending to support the growth of smart phones and tablets. A sales base shift to new technology, along with increased costs, spells declining profitability and the need for cost-cutting to improve efficiencies.

There’s no such thing as standing still in any industry, but this industry is one of the quickest to punish laggards.  One must adapt, migrate or die.

The largest equipment buyers, Intel, Samsung and Taiwan Semiconductor Manufacturing Co. (TSMC), exert significant pricing power, squeezing profits from the equipment manufacturers and simultaneously pressuring them to spend money on research and development.  Sales of chip making equipment fell 16% last year, as chip makers’ inability to hold firm prices has reduced their demand for the equipment.

Last September, the largest company in the semiconductor equipment manufacturing industry announced the intent to merge with the third largest, Tokyo Electron (it’s still awaiting regulatory approval).  If approved, it’s expected that the combined company will have greater pricing power to protect their profit margin, will be able to reduce their combined costs, and will be able to take advantage of each other’s strengths in order to pursue new markets. They expect it to be accretive to shareholders by the beginning of the 2nd fiscal year.

Key Lesson: sometimes the best way to play unfavorable industry dynamics is in combination with another company facing the same problem.

 Conclusion

Early stage and mature company owners and executives alike should think about these three questions regularly, as they profoundly influence their personal fortunes. Just as industries are continually evolving, companies’ are as well – even if they think that they are not.  When an industry evolves, but the company remains static, that company is still “evolving” relative to its competitors, and may be on the fast track to obsolescence.


McGavock Dickinson (Dick) Bransford is a Managing Director in San Francisco with Mid-Market Securities, LLC, an investment bank headquartered at 11 East 44th Street, 19th Floor, New York, New York 10017. Member FINRA/SIPC.
He can be contacted at (415) 294-0002 or mdb @ mid-marketsecurities.com.

Disclaimer: This article provides general information, and is not intended to constitute, and should not be construed as, legal, tax, accounting or business advice, nor does it constitute an offer to sell or to purchase securities. Rather, it is summary compilation of timely issues confronting your industry and as such does not purport to be a full recitation of the matters presented. Prior to acting upon any information set forth in this article or related to this article, you should consult independent counsel and/or more detail contained in the Source Information. The article reflects the opinion of the writer, and does not necessarily reflect the opinions of Mid-Market Securities, LLC, or its affiliates. IRS Circular 230 Disclosure: In order to comply with requirements imposed by the Internal Revenue Service, we inform you that any U.S. tax discussion contained in this communication is not intended to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.