Vertical mergers have been stealing some of the thunder from horizontal deals of late. As horizontal targets become harder to come by, some acquirers are focusing on companies up or down the supply chain from them—presenting both new opportunities for expansion and a new set of challenges.
To explore the drivers of recent vertical transactions as well as their potential pitfalls, Mergermarket on behalf of Toppan Vintage spoke with four dealmakers for their insights.
Toppan Vintage question: Several high-profile vertical integration deals have been done recently in sectors such as healthcare and media. What have been the main drivers of this trend, and do you expect it to continue? Leading industry experts weigh in...
Mark McCareins, Professor of Business Law, Kellogg School of Management says: As for main drivers, there are many industries and sectors that are clogged from a consolidation standpoint. Whether it's grocery chains, consumer packaged goods companies, airlines, banks, or others, they have all seen a significant amount of consolidation over the last twenty years or so. As a result, the ability to achieve regulatory clearance in horizontal deal has become increasingly difficult in concentrated markets. Put another way, when there is a four-firm market, and the deal would decrease the four players to three, the government will be hard-pressed to give a quick clearance.
In response, firms have started looking outside the box, and vertical integrations have been one opportunity they are now considering in greater numbers. In the last 18 to 24 months, there has been a significant upswing in interest for many American businesses in exploring vertical alliances. One example is Boeing's recent acquisition of a major parts supplier—a deal likely prompted as much by the company needing to grow but having no one to acquire as the need to compete on the global stage. After all, there are a lot of efficiencies to be gained by becoming more vertically integrated, as well as the chance to control one’s destiny by integrating major suppliers into production chains. To the best of my knowledge, the government has not challenged that Boeing acquisition, which is just one example of many deals of a vertical nature that are either in the hopper or will be announced.
Jeff Swearingen, Managing Director, Edgemont Capital adds: In healthcare, we have seen a tremendous amount of horizontal consolidation across the payer-provider continuum, and several of the vertical transactions involving payers happened after they tried a horizontal transaction. If you will recall, there are five big payers: UnitedHealthcare, Cigna, Aetna, Anthem and Humana. Similar to what Mark said, four of the five tried to merge, which would have resulted in just three players, but the Justice Department stepped in, blocking the deals on antitrust grounds. That's what drove Aetna, Humana and others to look for a different strategy.
From the payer’s perspective, the underlying premise of these vertical transactions is the belief that they must either get bigger or become directly involved in the provision of care in order to effect change in the healthcare industry. Healthcare is clearly on everyone's mind, as the percentage of GDP consumed by it continues to grow. Moreover, people who look at the data say we're just not getting the return on investment in healthcare expenditures in terms of life expectancy.
A lot of the vertical deals in healthcare have been headline-grabbing, not only because of their size, but due to how many of them look to change the typical healthcare delivery and reimbursement model. Of the attention grabbing transactions announced over the last 12 to 18 months, the buyers have been a very small group of extremely large, well-capitalized providers and players in the retail space. In the case of a CVS or Wal-Mart, those companies were looking to leverage their retail footprint and presence, while Optum/UnitedHealthcare and Humana were already very large and well-capitalized companies in the healthcare space. There just aren't many firms of that size and scale out there with the capabilities to pursue large vertical transactions, although when they do happen, they are by definition transformative and headline-grabbing.
Cathy Leonhardt, Managing Director, PJ Solomon weighs in: My focus is the retailing industry, which has seen vertical integration only in very specific instances. I’ll point out some examples from recent years. The first area that has seen activity is in luxury branded goods, in which companies use acquisitions to shore up portions of their supply chain. This is driven by a scarcity of raw materials and a high importance placed on quality. In the handbag market, brands such as Hermes and LVMH have purchased foreign firms dealing in alligator and crocodile leather, for instance. While not multi-billion-dollar transactions (and typically less than $100 million), these are very specific to the companies’ supply chains.
The second example involves major Western brands that expanded internationally to China, Japan, or other mega markets outside their home market. In a lot of instances, they did so through joint venture or distribution agreements with local partners. Over the past 10 years, many of these brands have bought back their partnership arrangements to control activities, particularly in major markets and key product categories. This unifies the brand and gives brand owners more control, as well as the opportunity for greater consistency and messaging.
A third example has to do with the large brands investing in manufacturing that is closer to home. Brands have historically outsourced the majority of their manufacturing to Asia and other parts of the world to access lower labor costs. The assumption was that brands, particularly within apparel, would no longer own manufacturing. However, we’ve seen this trend begin to reverse in recent years as a result of the growth of fast fashion, in which speed-to-market and the frequency of delivery to stores and the consumer have become critical.
We’ve also been seeing situations in which large retailers prefer to own particular capabilities and can amortize purchases across a large sales base. Home Depot, which is one of the biggest retailers in the Western hemisphere, acquired US Home Systems, which had been a provider of its kitchen and bath products. Similarly, it made an investment in The Company Store, giving it direct sourcing capabilities in home textiles that it previously did not have.
Finally, as Amazon has accustomed consumers to same- and next-day delivery through its increasingly verticalized logistics platform, many retailers are beginning to use M&A transactions as a tool to catch up. Target recently acquired grocery-delivery startup Shipt, which will allow customers to order groceries and other goods online and have them delivered directly to their homes from nearby Target stores. This followed their earlier acquisition of a company called Grand Junction, which also manages local and same-day deliveries.
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Linking Up: Vertical Integration Makes a Comeback
Vertical mergers have been stealing some of the thunder from horizontal deals of late. Explore the drivers of recent vertical transactions as well as their potential pitfalls, in our full report.