How to Buy a US Outsourcing Firm, Part 2: Deal Management by Investment Banks

U.S. companies that have not globalized their production or service operations are prime acquisition candidates for Western and overseas investors. Following an acquisition, the new owners can gradually shift some or all of an acquired firm’s work offshore to competitive locations, making the entire business more profitable and competitive.

The success of acquisitions often hinges on the role played by investment banks in managing each deal process. It is the role of investment banks that serves as the subject matter of this article, taken within the context of implementing an acquisition-plus-globalization business model.

Minimizing Excessive Costs

The acquisition-plus-globalization business model can be implemented at firms whose offshoring or outsourcing activities have stalled or are hamstrung by excessive costs. Acquisitions can be made by investors with pre-existing access to facilities offshore or by those who plan on obtaining such access once they have made an acquisition and can define their offshore capacity needs with a high degree of confidence.

The advantages of the acquisition-plus-globalization business model are described in the first article in this series from the perspective of non-U.S. entrepreneurs. These advantages are also compelling for North American entrepreneurs who can make a domestic acquisition and them pair it with an offshoring arrangement outside the U.S.

There are three key factors in this business model:

1. Identifying suitable acquisition candidates
2. Successfully conducting the deal process
3. Managing the transition so as to retain the client base and therefore the value of the acquired firm

The third factor above, preserving the value of the acquired firm, is particularly risky for acquirers from outside the U.S. This is a critical variable for promoters of Indian call centers and business process outsourcing (BPO) facilities who lack a demonstrated track record running domestic U.S. operations or are not attuned to U.S. labor market conditions and personnel management practices. Without proper preparation and support, such acquirers may unintentionally diminish the value of their newly acquired assets.

Maintaining Continuity

The value of an acquired U.S. firm can be preserved in part by retaining and re-energizing incumbent American managers who can maintain client confidence after the acquisition. In some acquisitions, the most creative and productive U.S. staff may be the first to leave or be pushed out. Retention efforts can include those non-management staff.

The first two factors for successfully implementing an acquisition-plus-globalization business model can be addressed with help from a U.S. investment bank that specializes in buy-side acquisition work. Whereas investment banks receive considerable attention for assisting private firms with raising capital, it is their role in arranging for mergers and acquisitions (M&A) that will be examined here.

In investment banking parlance, the term “mergers” is eschewed because it describes a specific type of legal procedure that often does not occur. Instead, the broader term “acquisitions” more accurately describes the transfer of ownership that can take place under a variety of deal structures.

The importance of M&A activities for investment banks has increased as their income from brokering financial products has decreased. Profit margins from stock and bond trading have been driven down by the rise of low-cost online trading services. The best-positioned firms to make money on such low-margin activities are those with huge economies of scale.

Investment banks are not involved in all M&A activities in the U.S. Large companies that make frequent acquisitions can establish an in-house staff of acquisition specialists. However, occasional or first-time acquirers find that it is less risky and ultimately far cheaper to use investment banks to manage the deal process from start to finish.

The highest value-for-money contributions that investment banks can make in M&A work are typically seen in managing the acquisitions of mid-market firms. Mid-market firms generally cost between US$5 million to $40 million to acquire. In obtaining assistance for mid-market acquisitions, buyers can choose between two types of investment banks.

Niche vs. Generalist Investment Banks

The first type of investment bank consists of niche players with substantial expertise in narrow industry sectors. Niche firms are small, often with between five and twenty partners, most of whom have long-standing contacts with leading industry figures. Niche firms can be highly effective in industries where personal connections are paramount, such as outsourcing firms that specialize in government outsourcing contracts. Niche players can use their contacts to quickly identify a small number of companies that are ready to entertain buyout offers.

The second type of investment bank consists of generalist firms that operate across multiple industries. By not concentrating on just one or two industry sectors, generalist firms can more energetically identify and pursue targets that best fulfill buyers’ criteria and interests. Generalist firms are usually bigger than niche players, both in terms of the number of professionals and research staff that support them.

Bankers in generalist firms often have expertise in discrete industry sectors. Some became investment bankers after serving in management positions in industry sectors that are the focus of their M&A activities.

Generalist firms can be more ruthless in pursuing buyers’ interests because their revenues are not dependent on gaining repeat business (especially seller-representation business) from the same population targeted on behalf of a buyer. Generalists have a wider scope to identify and spearhead acquisitions that are most suitable for buyers, rather than follow the niche firm model that emphasizes outreach to firms with whom they have previously established contacts.

A buyer who initially intends to enter one industry sector may not be well suited to do so. Generalist investment banks are more likely than niche players to help buyers reformulate their strategies towards industry sectors that represent the best fit for buyers. Strategic advisement and positioning are critical for buyers from outside the U.S. who may not have a thorough working knowledge of the U.S. economy.

Transparency can distinguish niche investment banks from research-driven generalist ones. Transparency varies in terms of the manner and frequency of reporting provided to buy-side clients. More significantly, it can be reflected in the size of the nets that research-driven generalist firms cast in searching for acquisition targets, as described in the following article in this series, which details the deal steps commonly employed in acquiring mid-market firms.