While most people know what a horizontal acquisition is (commonly referred to as a “merger), diagonal acquisitions are lesser known, but equally as important. The best way to explain the concept of diagonal acquisitions is to think of multi-national conglomerates like General Electric. A diagonal acquisition occurs when a company acquires another business that operates in a completely different industry. For example, General Electric is known for making industrial machinery like airplane jet engines or engines for train locomotives, but at one point, they acquired NBC Universal. NBC is a film and media company that is completely unrelated to manufacturing jet engines for airplanes. But since any industry will have his limitations (i.e. there are only XX number of airplane manufacturers in the world that buy new jet engines every day), General Electric thought it would a more effective use of capital to pursue a diagonal acquisition by acquiring a company outside of the manufacturing industry. While the concept of pursuing a diagonal acquisition might seem like an effective use of available capital that is not being used to support the acquirer’s primary business, there is definitely a point where too many acquisitions make a company too big. Larger operations are more vulnerable to inefficiencies when a company is too big to pay attention to the small details. Coming back to the General Electric example, General Electric eventually sold NBC Universal to Comcast approximately 10 years after they first acquired NBC. The motivation for the sale was championed by General Electric shareholders that believed General Electric should consolidate its focus, which should result in increased shareholder value.
When it comes to diagonal acquisitions for middle market companies, the benefits aren’t always the same as horizontal acquisitions or vertical acquisitions, but there are usually different types of benefits that can often be more beneficial to a company. For example, when a larger apartment building is constructed, there are many different types of construction companies that contribute towards the construction of the building. For example, you would need to hire a steel erector company for the frame of the building, an electrician for the electrical wiring work, a concrete company to facilitate the concrete pouring process, etc. Savvy operators within the construction industry recognize that it takes many different companies to facilitate the completion of a new apartment building. As a result, there are many instances of companies that started out as offering one service and then acquired other businesses through diagonal acquisitions that serve different parts of the construction industry. For example, a construction company that has excess capital available to invest might acquire a steel erection company or an electrician company since these acquisition candidate companies play a role in completing the construction projects that the concrete company is often hired for. Next time the construction company (parent company) gets awarded for a new construction project, there are now opportunities to cross-sell services from their newly acquired steel erection company. For the company that is building the apartment building, they understand that they will need to hire multiple companies within different segments of the construction industry to complete the project and it makes sense if they can hire multiple companies that are owned and operated by a larger single parent company. This reduces the risk on both sides of the construction project and simultaneously allows the new parent company to take on larger projects as a result of their increased service offerings. To further clarify, the reason the construction parent company example wouldn’t be considered as a vertical acquisition is because the construction company isn’t the entity that’s actually ordering the construction of the apartment building. Now if the entity that actually ordered the construction of a new apartment building acquired a concrete company, an electrician company, a steel erector company, a crane company, etc. those would all be considered vertical acquisitions. The entity ordering the construction of the new apartment building would be acquiring all of the companies it would normally need to hire to build the apartment building. To provide another example for clarity, if the concrete company acquired the manufacturing facility that actually produces the raw concrete, that would be the definition of a vertical acquisition.
In summary, diagonal acquisitions can be a very effective use of capital that is not otherwise earning a return. At Smith Holland Advisors, our experienced M&A advisors have the expertise and transactional insights needed to identity the most ideal acquisition candidates for business owners and adjust our value story approach accordingly depending on if the acquisition candidate would be looking at the deal as a horizontal acquisition, a vertical acquisition or a diagonal acquisition. Selling a business is a complex process, but we understand better than most that the key to maximizing shareholder value is finding the right acquisition candidates that can realize synergistic revenue opportunities that others can’t. This all starts with crafting the right value story and targeting the right buyers with the right message.
If you’ve made the decision to sell your business, it’s important you choose the right team to help you navigate the complex process for structing an M&A deal. At Smith Holland Advisors, we have experience advising on all types of exit strategies across many different industries and our results-driven process always puts our client’s best interests above everything else. Selling a business is challenging, but our M&A advisors will work with you to make the process as seamless as possible. With offices in Chicago, London, Houston and Vancouver, Smith Holland Advisors has the cross-border expertise needed to advise on even the most complex middle market M&A transactions and our M&A deal team can be there for you whenever you need us, anywhere in the world. Lean more about Smith Holland M&A advisory services by scheduling your free exit consultation to discuss the options for selling your business. We will walk you through the different exit strategies available and then custom tailor a unique exit strategy based on your financial goals and expectations.
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