AABA Altaba Inc

By Tatyana Shumsky 

Companies increasingly are looking outside their comfort zone for acquisition targets as they seek to propel growth and stave off digital disruption, according to a report by Bain & Co.

Companies struck global strategic deals worth $3.4 trillion in 2018, the consulting firm said. Of those, 51% were classed as "scope deals" that gave the company something new, such as new capabilities or access to new markets.

It was the first time in at least four years that such deals outpaced what Bain refers to as "scale deals," which merely boost the buyer's share of an existing market. The report analyzed the largest 250 deals each year since the start of 2015.

Companies are seeking to add capabilities as they contend with disruption to their business models, particularly from new technologies. They also are finding it harder to maintain or increase their pace of growth. The median annual revenue growth rate for some of the world's largest public companies has declined to 5.9% in 2018 from 9.7% in 2005, according to Bain, which analyzed companies in the S&P 500 and four other international stock indexes.

"Rather than trying to build that [new capabilities] internally, which has a mixed record of success, they are instead looking to buy it from outside," said Peter Horsley, a partner at Bain and one of the report's authors. "In many cases it can be quicker and it can guarantee that you've got access to the best-in-class capabilities."

Amazon.com Inc.'s purchase of online pharmacy PillPack Inc. and Coca-Cola Co.'s acquisition of British coffee-shop chain Costa are among the high profile scope deals struck in 2018, according to the Bain report.

Companies have long turned to mergers and acquisitions to stave off slowing revenue growth. But transactions that only aim to boost market share and cut operating costs do little to protect a business from disruption, Mr. Horsley said.

Companies looking to fireproof operations are turning to deals that add product lines, geographies or capabilities. Deals focused on adding a capability accounted for 15% of all strategic deals valued at more than $1 billion in 2018, up from 2% in 2015, the report said.

Executives rank competition with companies that were "born digital" and the rapid speed of disruptive innovations among the top risks for 2019, according to research conducted by North Carolina State University's Enterprise Risk Management Initiative and management consulting firm Protiviti Inc.

Scope deals require a different approach to everything from due diligence to integration when compared with scale deals. Executives assessing an acquisition that will add a new capability must focus on how the combined company will jointly create value over time, rather than seeking potential cost savings from operational scale, Mr. Horsley said.

The risks of such transactions can hinge on talent retention. A buyer must assess the compatibility of the target company's culture and whether employees are likely to stay.

Managers also must decide whether to bring the newcomer into the fold or keep the target as a separate company. "There are real dangers to over-integrating: You stifle its people, you slow its decision-making velocity and you lose the value of the company you acquire," Mr. Horsley said.

"You can buy a company that's very different to yourself and keep it separate, but then you face a hard question about what is the parenting advantage, what do you bring to that combination," he said.

Unfamiliarity is another reason why scope deals can fail. Executives from one industry can find it challenging to assess how much value they are likely to realize by purchasing a business from another sector, Mr. Horsley said.

Take Yahoo Inc.'s $1.1 billion acquisition of blogging site Tumblr in 2013, which was growing rapidly but unprofitable. In 2015, Yahoo's decision to integrate Tumblr's advertising sales team sparked a talent exodus from Tumblr, Mr. Horsley said, adding that Yahoo ultimately wrote off roughly $700 million in connection with the deal.

A spokesman from Verizon Communications Inc., which purchased Yahoo in 2017, declined to comment.

Write to Tatyana Shumsky at tatyana.shumsky@wsj.com

(END) Dow Jones Newswires

January 23, 2019 12:14 ET (17:14 GMT)

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