For companies or investors looking to make acquisitions or investments โฆ how should you diligence and value companies amid fears of a market downturn?
Here are three mental models weโve applied in recent client projects:
๐ญ) ๐ฆ๐๐๐ฑ๐ ๐๐ต๐ ๐๐ต๐ฒ ๐ง๐ฎ๐ฟ๐ด๐ฒ๐โ๐ ๐ฐ๐๐๐๐ผ๐บ๐ฒ๐ฟ๐ ๐ฏ๐ฒ๐ฐ๐ฎ๐บ๐ฒ ๐ฐ๐๐๐๐ผ๐บ๐ฒ๐ฟ๐ ๐ถ๐ป ๐๐ต๐ฒ ๐ณ๐ถ๐ฟ๐๐ ๐ฝ๐น๐ฎ๐ฐ๐ฒ. ๐ง๐ต๐ฒ๐ป ๐ฒ๐ ๐๐ฟ๐ฎ๐ฝ๐ผ๐น๐ฎ๐๐ฒ ๐ถ๐ณ ๐๐ต๐ฒ ๐๐ฎ๐บ๐ฒ ๐ฑ๐ฟ๐ถ๐๐ฒ๐ฟ๐ ๐๐ถ๐น๐น ๐ฐ๐ผ๐ป๐๐ถ๐ป๐๐ฒ ๐๐ผ ๐ต๐ผ๐น๐ฑ ๐ถ๐ณ ๐ฐ๐๐๐๐ผ๐บ๐ฒ๐ฟ๐โ ๐๐ฝ๐ฒ๐ป๐ฑ๐ถ๐ป๐ด ๐ฏ๐ฒ๐ฐ๐ผ๐บ๐ฒ๐ ๐ฐ๐ผ๐ป๐๐๐ฟ๐ฎ๐ถ๐ป๐ฒ๐ฑ
Buying patterns driven by regulation and non-discretionary spend (e.g. rent, food staples, insurance, healthcare) are stickier.
For example, one Target that we evaluated in the real estate industry has a wall of patents around their technology, and nearly all the revenue was driven by town safety mandates .. and we modeled the demand drivers to continue.
Spending patterns driven by discretionary or non-essential spend could get squeezed (e.g. restaurant eating, leisure products or services including travel, expensive technology)
๐ฎ) ๐๐ผ๐ฟ ๐๐ฎ๐ ๐ฐ๐ผ๐บ๐ฝ๐ฎ๐ป๐ถ๐ฒ๐, ๐๐ฟ๐ ๐๐ผ ๐ฎ๐ฝ๐ฝ๐น๐ ๐๐ต๐ฒ ๐ฎ๐ฏ๐ผ๐๐ฒ ๐ฐ๐ผ๐ป๐ฐ๐ฒ๐ฝ๐ ๐ผ๐ป๐ฒ ๐ผ๐ฟ ๐๐๐ผ ๐น๐ฒ๐๐ฒ๐น๐ ๐ฑ๐ฒ๐ฒ๐ฝ๐ฒ๐ฟ
For example, we recently valued a Target (โCompany Aโ) that provides video technology to monitor the public areas of high end hotels (โCompany Bโ).
Reduced high-end travel spending negatively impacts Company B, which in turn negatively impacts the revenues of the Target, Company A
๐ฏ) ๐๐๐ฎ๐น๐๐ฎ๐๐ฒ ๐ถ๐ณ ๐๐ต๐ฒ ๐ง๐ฎ๐ฟ๐ด๐ฒ๐ ๐ฐ๐ฎ๐ป ๐๐ฎ๐ธ๐ฒ ๐บ๐ฎ๐ฟ๐ธ๐ฒ๐ ๐๐ต๐ฎ๐ฟ๐ฒ ๐ณ๐ฟ๐ผ๐บ ๐ฐ๐ผ๐บ๐ฝ๐ฒ๐๐ถ๐๐ถ๐ผ๐ป ๐ผ๐ฟ ๐ด๐ฎ๐ถ๐ป ๐ป๐ฒ๐ ๐ฐ๐๐๐๐ผ๐บ๐ฒ๐ฟ๐ ๐ฑ๐๐ฒ ๐๐ผ ๐ฐ๐ต๐ฎ๐ป๐ด๐ถ๐ป๐ด ๐ฏ๐ฒ๐ต๐ฎ๐๐ถ๐ผ๐ฟ๐
Reduced customer spending is not always bad, it depends on the specific investment.
A Target that has already demonstrated strong product-market fit can thrive in an environment where its competition is less mature or where the Acquirer / Investor can fund operations enough to give the Target some buffer
A recent client was evaluating a technology acquisition in the education industry (and the Target in this case passed both the tests #1 and #2 above).
Further, the Acquirer was prepared to fund the Targetโs sales and operations for ~2 years, even if the Target generated minimal cash flows, to focus on capturing key new accounts. This a war chest that the Targetโs competition does not have.
Only time will tell us how accurate our assumptions were, but our business case, while still conservative, reflected this as a growth driver.