The art of digital M&A: How to enable value-add from digital assets

The past year brutally exposed companies that are still struggling with their digitalization activities and again highlighted the urgency to build up digital capabilities rapidly. According to recent market insights and experience from client projects, companies that already started transforming their businessmodel and business operations as well as underlying technologies and tools were able to react more quickly to the radically changed environment, and therefore managed to ensure business continuity. Digital leaders with mature digital service offerings and operations were even able to leverage this competitive advantage to outperform their industry competitors.

However, most companies still do not have a sufficient level of digital maturity, which consequently increases their vulnerability and puts significant pressure on traditional businesses. Continuing the waiting game will often lead to costly and time consuming reactive measures, and will only worsen their handicap while the “digital gap” is further widening.

Internally driven transformations can sometimes be challenging, due to a lack of resources and know-how. We often see a silo mentality across units, as well as the missing digital mindset and ability to innovate effectively. Venture building is another approach to leverage a company’s capabilities to drive digitalization and innovation outside of core business–most often in a green field approach and decoupled from the parent company.

As an alternative, a dedicated adjusted M&A approach can be an effective way to address a company’s lack of digital readiness. External investments are great substitutes or add-ons to accelerate the digitalization journey. Recent market data confirms this trend, as we can see a considerable growth in digital deals. Currently numerous transactions in the market are solely aimed at accelerating the companies’ digitalization activities, which can range from e.g. strengthening AI-based automation efforts up to building new digital business models. A strong understanding of one’s own transformation needs is required to select, filter and funnel potential opportunities.

But when considering external investments in digital capabilities, traditional valuation methods – such as the asset, market or in come approach – often fail since valuations based on balance sheet data or established financial and performance KPIs don’t show the full picture.

Attractive digital assets focusing on innovative business models, emerging technologies and/or other digital capabilities usually operate in early growth markets and they are hard to evaluate due to their novelty, in tangible nature and low comparability. Therefore, new "forward-looking" approaches must be applied, which differ from traditional valuation and due diligence methods – and rather follow an evaluation based on the statement:

The rationale of acquiring a digital asset can be manifold and includes e.g. new digital products or services, business enabling software and tools or digital talent. These can enable the company to stay ahead of the curve, create new revenue sources and/or help to optimize costs. Depending on the type of asset, the real value-add needs to be analyzed based on its potential impact on the business and its value chain. Digital assets need to be valuated with a “forward-looking” approach focusing on growth, synergies and operational KPIs.

Essentially, the two following methods can help to evaluate the asset:

• Value contribution through top-line growth: Determine additional impact on the company’s top-line based on expected incremental sales and margin growth, e.g. through an extended product and service portfolio, new sales channels and customer access with a significant cross-selling potential.
• Value contribution through synergies and operational value-add: Evaluate top-line and bottom-line improvements for both the acquiring company and the digital asset, e.g. through shortened time to market processes, increased cost efficiencies or best practices in digitalized sales, such as improved conversion rates and marketing tools.

Given the nature of the targets, not only the valuation method but also the integration approach for digital assets differs from traditional frameworks and concepts. We see five crucial elements to be considered:

Instead of fully integrating and therefore dismantling the digital asset per default, the tailored PMI approach requires a thorough review of synergy potentials (e.g. top-line measures, process optimization) and a well-targeted execution. By doing so, companies ensure sustained digital value creation over time, and avoid any increase of organizational and operational complexity (e.g. parallel processes, legacy systems and tools).