Analysis - IPO vs. Acquisition: The costs and benefits of each route

Posted by Mo Rassolli on Feb 04, 2020 07:07: AM
Mo Rassolli

cost and benefit

Instagram and Snap Inc. were born within months of each other, the former in 2010 and the latter in 2011. Both operated in photo and video-sharing social networking service space and focused primarily on millennial, social media-savvy users. However, this is all they have in common as one was acquired by the social media and social networking service giant Facebook, and the other chose to take the IPO (initial public offering) path - and this made all the difference in their fortune.

Going public via an IPO or being acquired are two mechanisms by way of which successful start-ups seek liquidity to continue to grow at a steady pace. Snap decided to opt for an IPO and therefore spent approximately six years growing its business to generate interest among investors before finally going public in March of 2017.

 

What is an IPO?

Initial Public Offering (IPO) refers to the process of offering shares in a private corporation to the public for the first time. Start-ups that require capital for growth and expansion offer an IPO. Well-established companies may choose to offer an IPO to help owners cash in on their investment.

 

Advantages of an IPO

Public enthusiasm for the shares drives up the demand and subsequently the equity’s valuation. In this way, the company can raise more capital from the public market than from the private market. Higher valuation of equity also means less dilution for existing shareholders.

Stocks of publicly-traded companies are liquid, which can help them with acquisitions.

Public visibility lends credibility to a company and augments its chances of raising additional growth capital in the later stages.

Public shares are highly liquid. Founders, investors and employees can realize their investment by selling them in the public market as and when they desire.

 

Disadvantages of going public

Going public involves significant legal & disclosure obligations. The company must make extensive disclosures to shareholders and regulatory bodies. The company’s officers and directors are also heavily scrutinized.

The process is both expensive and time-consuming as complying with the FCA (Financial Conduct Authority) rules and regulations involves going through stringent procedures.

Market pressure often compels the management to give precedence to short-term results rather than long-term growth.

 

Why Snap Inc. took the IPO route?

Snap wanted to be the master of its own destiny by retaining its independence. Its founders and employees wanted to retain control of the company and work in a start-up environment rather than as a division of a larger behemoth.

 

What went wrong?

The desire to remain independent and control, though admirable, comes at a price. As mentioned above, market pressure for short-term growth often compels the management to behave questionably. Long-term strategic growth is often sacrificed at the altar of quick stock appreciation. Public market is pretty much unforgiving about bad news and stock market listing rules are much more rigorous.

The weight of such high market expectations seemed to bear down on Snap right from the inception of its IPO. Its attempts to launch new products such as Spectacles failed to elicit the desired response. A series of negative news headlines such as ‘Snap is having a bad day’, ‘Snapchat lays off two dozen employees’, etc. further plummeted its revenue and growth.

 

Acquisition of Instagram by Facebook

Meanwhile, Instagram was acquired by Facebook in 2012 with approximately US$1 billion (£791.97 million or £0.79 billion) in cash and stock. Its acquisition by the social media giant may have compelled it to compromise on its independence and control, but Instagram benefited tremendously from being taken over.

The acquisition by Facebook gave Instagram access to Facebook’s huge resources and one of the largest user bases in the world. Shielded from negative news and criticism, Instagram continued to thrive in an environment of growth and support provided by Facebook. A thorough expertise, sound awareness of tools and the market reach of Facebook allowed Instagram to launch and grow new products quickly, including the launch of Instagram Stories, which surpassed Snapchat's daily active users within a year of launch. And since Instagram is a part of Facebook, it is generally shielded from public scrutiny as any negative events that occur are absorbed within the organization.

 

So is Acquisition always better?

This example does not imply that acquisition is any day preferable to IPO.

Timing of an IPO depends on several factors such as industry, current market condition and the sentiment and progress of the company in the form of sustainable profitability, revenue growth, etc", says Ilayda Taze, CEO of London-based TrendScout. “The Snap IPO came towards the end of the era of blockbuster unicorn IPOs, which may have contributed to its limp performance”.

Mergers and Acquisitions have their own distinct sets of benefits and advantages. However, they do not always hit the bull’s eye. If a merger or acquisition goes well, the company gets immediate liquidity. Also, an all-cash deal means the seller is shielded from stock volatility. A successful merger or acquisition leads to value appreciation as investors anticipate synergies to be actualized, leading to more cost savings and higher revenues for the new entity.

However, impediments such as cultural clashes, management disagreement, turf wars, dilution of a company’s brand and overestimation of synergies among others can lead to busted deals. Here we present a few examples of famous mergers and acquisitions, some highly successful, others gone horribly awry.

 

Vodafone and Mannesmann

This merger, which took place in 2000, was worth over $180 billion (£142.71 billion). The U.K.-based Vodafone acquired German company Mannesmann in the largest merger and acquisition deal in history to become the largest mobile operator in the world. Unfortunately, the deal did not work the way Vodafone had hoped, leading to billions of pounds in losses.

 

America Online and Time Warner

The consolidation of America Online (AOL) and Time Warner perhaps occupies the pole position when we mention all-time biggest merger blunders. Warner Communications merged with Time, Inc. in 1990. In 2001, Time Warner was acquired by AOL for $165 billion (£130.82 billion). The top management in both organizations thought the merged entity would greatly benefit from the convergence of mass media and the internet. This proved to be an impossible idea to materialise as the dot-com bubble burst shortly after the merger, thus slicing through the valuation of AOL like a hot knife through butter. In 2002, the company reported a staggering loss of $99 billion, the largest annual net loss ever reported.

During the same time, revenue generation from internet-based search was taking off. AOL failed to capitalise on it as well as other opportunities, such as the emergence of higher-bandwidth connections, owing to the bath it took in the wake of the dot-com bubble burst. Moreover, AOL realized that its expertise in the internet sector did not automatically equip it with capabilities to efficiently run a media conglomerate with 90,000 employees and politicized and turf-protecting culture. The trouble-ridden deal was finally scrapped amid external embarrassment and internal animosity in 2003, when Time Warner severed its association with AOL.

 

Sainsbury’s and Asda

And as recently as April, the merger between Sainsbury’s and Asda was torpedoed by Britain’s competition watchdog, which ruled the £7 billion deal. The merger threatened to push up prices and reduce the choice and quality of products on sale in stores.

 

Sprint and Nextel Communications

In August 2005, Sprint acquired a majority stake in Nextel Communications in a $35 billion (£27.76 billion) stock purchase, a move that made the new entity the world’s third-largest telecommunications provider, behind AT&T (T) and Verizon (VZ). Spring’s expertise lay in catering to the traditional consumer market, providing long-distance and local phone connections and wireless offerings. Nextel had a loyal base among businesses and the transportation and logistics markets. Both hoped to benefit from each other’s customer base.

Soon after the merger, the differences in work culture of both the companies rapidly started coming to the fore. Nextel was more entrepreneurial and customer-centric. Spring was more bureaucratic and had an awful reputation in customer service. Cultural differences, technological asymmetry, changing macroeconomic scenario, decline of cash from operations, high capital-expenditure requirements and increasing pressure from competitors forced Sprint to cut costs and lay off employees. In 2008, it reported an astronomical loss of $30 billion (£23.79 billion) and its stocks were awarded the junk status.

 

Pfizer and Warner-Lambert

Also in 2000, pharmaceutical company Pfizer acquired Warner-Lambert for $90 billion (£71.37 billion). Considered to be “one of the most hostile in history”, the deal created the second largest drug company in the world. Pfizer acquired Warner-Lambert because it wanted to get hold of its blockbuster cholesterol medication Lipitor.

 

Exxon and Mobil

This merger in 1999 (dubbed by Yahoo Finance as “one of the most successful in M&A history”) created a “superpower” in the energy industry. The US government approved the deal after assurances that the two merging companies would sell over 2,400 gas stations across the country.

 

Conclusion

The IPO market is losing some of its steam and start-ups are finding it increasingly tough to compete with the deep resources and market power of big technology companies, which include Google, Amazon, Facebook, Microsoft and Apple. Unicorn darling Uber recently sought a valuation of $82.4billion (£65.32 billion), against the $100billion (£79.28 billion) it was hoping for. The San Francisco-based ride-hailing app is asking investors to pay $45 (£35.67) per share. But it had hoped for a higher valuation. Appetite for the stock is thought to have been stifled by the damp performance of shares in rival Lyft, which was floated in March and has since lost 27% of its IPO strike price. The share prices of recent start-ups such as Snap and Blue Apron are on a downward spiral while at the same time, share prices of Apple, Google and Amazon continue to surge at an unprecedented pace.

Many Unicorns, wary of lackluster reception in the public market, are opting for private equity placements to fund their expansion and growth.

Some unicorns in the near future may start considering the feasibility of acquisition as an exit option more seriously”, signs off Taze.

Mo Rassolli is a senior consultant at London-based TrendScout. With 15 years of experience in the financial industry, Mo closely follows young tech start-ups and the equity markets. He can be reached at mo@trendscoutuk.com

Topics: IPO, merger, acquisition