The number of user touchpoints has increased exponentially due to digitalization, disrupting traditional business models and paving the way for new forms of high-value enterprises that provide innovative products and services. The change in how customers interact has left virtually no business sector untouched. It’s a brave new digital world that is also rapidly transforming the landscape for mergers and acquisitions, says a panel of Roschier M&A experts.
For Björn Winström, Partner with Roschier’s Private M&A practice in Stockholm, the nexus of digitalization and the customer interface is more than the key to company value in the digital economy, it also trumps in the battle for competitiveness.
“It will be a fight among all business areas to determine who will own the customer interface. It will be the same discussion on the B2B-level, although perhaps not as visible as on the B-2-C-side,” he declares.
“What is important today are data and the number of users. Many of the big companies such as Facebook and Google, a great part of their value is based on how many users they have, the user growth and user engagement,” notes Björn Johansson Heigis, Partner-elect with Roschier's Intellectual Property practice in Stockholm.
According to Partner Malin Leffler, Head of Roschier’s Private M&A practice in Sweden, a company's competitive edge turns on the potential it can do in its user interface.
“The fact that the number of people globally with access to a smart device continues to grow of course contributes to a boom in companies' monetary value and development potential,” she points out.
Staying abreast in the digital era to drive M&As
The Roschier experts note that major corporates typically do not have large R&D teams working on digitalization issues. Moreover, companies that appreciate the need to harness the potential of the digital economy will turn to transactions to better compete.
“They’ve understood the transformation happening but also realize that if they start researching, in 5 years they still may not have got it right. They will deal with this by looking at the startups, following them and when they are a few steps from maturity they will go in and buy and stay current in that way,” says Winström.
Helsinki-based Partner and the Head of Roschier’s Private M&A practice in Finland Jouni Salmi notes that in some cases large incumbent firms may develop in-house capacity to identify investment opportunities in key disruptive areas because they recognize that standing still in the current environment could prove fatal.
“Some industrials have venture capital arms specifically for this purpose. They are making minority investments in a lot of companies and they know from experience that maybe 2 out of 10 will succeed. But then later on they may see an acquisition or transaction opportunity if there is a winning application they want to purchase,” Salmi adds.
Dispute-triggered acquisitions may also become more common as large corporates jockey for pole position in the innovation and technology league tables.
“We all know that licenses and royalties trigger acquisitions on the back of lost disputes, for example Ericsson-Qualcomm,” Winström says, referring to a landmark telecoms sector transaction in which the Swedish mobile phone giant Ericsson bought out the wireless infrastructure business of US wireless phone maker Qualcomm as part of a deal to bury a long-running patent infringement dispute.
“There will be disputes again and the loser – the big corporation – will need to buy the winner and this will bring a wave of M&As,” Winström predicts.
M&A valuations to rise in digital economy?
In contrast to the IT bubble of the early 2000s, modern up-and-coming digital superstars are accumulating wealth at a rapid rate. The sheer moneymaking potential of today’s digital unicorns will also create a major incentive for large corporates to boost their future earning power by snapping up young, trendy startups.
“That might be something that could trigger M&As, as potential buyers see startups already making money in the early stage, in contrast to how it was in the beginning of 2000,” Stockholm’s Heigis adds.
Salmi points out that modern startups’ superior profitability is likely to impact on M&A valuations in the future. That’s because the typical portrait of digital innovators paints a picture of a small firm with a low number of highly skilled employees.
“But you won’t have a massive production engine in which you’ve been investing millions, so your operating profitability is relatively high as a starting point.”
“If parties doing the M&A use the same formula to valuate transactions, which is a multiple of that profitability then that automatically puts the transaction prices rather high compared to traditional industries, where profitability is affected by high depreciation, personnel and investment costs,” Salmi adds.
Roschier experts counsel that the vast difference in the structure and operations of these digital powerhouses might warrant a review of valuation models, particularly because of the volatility of some segments of the digital economy.
Volatility and other risks to the digital economy
A talent for churning out big money in relatively short periods while running what could be considered a skeleton operation may go hand-in-hand with high levels of volatility.
Jon Unnérus, Helsinki-based Partner and Head of the Private Equity practice in Finland concurs that M&A transactions will be high value when companies find the route to capitalize on digitalization. However, he points to the game sector as an example of a segment where volatility is also likely to increase in proportion to value.
“If you have a blockbuster game, that might increase the value of your company overnight to extremely high levels. But it’s also possible that overnight the next blockbuster will be out there and everybody will move in herds to the next game. And unless you’re able to renew very quickly, the value of your company will disappear overnight again.”
Salmi observes that the networked nature of the digital economy in itself poses threats to companies. There is a risk that cyber criminals are able to infiltrate connected systems used by key organizations such as banks, energy companies and utilities. Data and system protection is a critical risk factor in an economy dominated by the trade in users and data.
“If your products and services are digital and you are victim to cybercrime and your production services or customer interfaces no longer work, you are crippled. You may not necessarily have alternative options.”
Legislative development in the digitalization era
In much the same way that legal practice converged with economics to give teeth to competition law 20 years ago, IT and law are now intersecting to throw up new legislation and regulations governing areas such as data privacy.
New EU data protection regulation is due to come into force in two years, significantly increasing the penalties for data protection violations.
“In 2 years sanctions can amount to 4% of a company’s global turnover or 20 million euros, whichever is higher, for a breach. So it becomes more important to be aware of these issues,” Winström observes.
The EU’s Single Digital Market initiative is also spawning other actions. Heigis notes that apart from rules on data protection, practitioners can also expect to see new EU-initiatives relating to e.g. copyright matters. New cyber security rules will also be part of the EU’s regulatory toolkit.
“All member states have to ensure that all essential services like banks and energy companies are careful about security and vulnerability to cyberattacks.”
Digital economy to impact on M&A practitioners’ capabilities
The Roschier expert panel agrees that in the digital economy’s shifting and disruptive landscape, M&A advisors will need to move swiftly to acquire the necessary skills to stay ahead of the curve.
"It will become increasingly critical for large firms like Roschier to identify a strategy for the sector and to anticipate the possible arrival of new and nimble players in the market," says Unnérus.
Building up such a strategy will increasingly involve keeping an ear to the ground and a finger on the pulse of the vibrant digital scene, particularly its startups. Unnérus says that Slush – one of the leading annual startup events in the world (organized in Helsinki in November and attended by entrepreneurs, startups, venture capital investors and big corp representatives from over 100 countries) – is a good example of one of many places to start accumulating the required intelligence.
“It’s important to be in these fora to understand where disruption will happen and what will be the next big thing. This will be an important part of identifying ecosystems and finding your role there,” Unnérus declares.
Lawyers will also need to be fully proficient in the legislation and regulations governing key aspects of digital trade.
“Lawyers need to be able to structure agreements and also use the law proactively to go against competitors or enterprises with damages claims – as we do in competition law,” Unnérus points out.
Clients grappling with the rapidly changing business models in the digital economy will also be looking for proven expertise to shepherd them through unfamiliar territory as they use M&A transactions to build up competitiveness.
“Clients will be looking at those seen to be gurus in areas such as ensuring that a transaction between a big corporate and a startup happens all the way. Therefore demonstrating our experience and expertise in this area is key, as this shift might happen very fast,” Unnérus adds.
Salmi acknowledges that while the landscape for M&As will undoubtedly change in the decades to come, the role of legal practitioners will remain largely intact.
“You still need to understand what the client wants to achieve, you still need to know the law and still need to give advice – that won’t change, at least not for the foreseeable future.”