This article was first published in the October 2019 China edition of 
Accounting and Business magazine.

Amid geopolitical tensions and technological challenges, companies in South-East Asia are still showing a resilient appetite for mergers and acquisitions (M&A) deals, with a recent EY survey finding that 87% of respondents in the region expected the global M&A market to improve and 46% plan to pursue M&A opportunities over the next 12 months.

But acquisitions can be expensive if they are not properly planned, when the target is not a strategic fit to the overall business or one simply ends up paying an excessive price, says Harsha Basnayake, EY Asia-Pacific transaction advisory services leader.

‘There are many successful deals that have taken place – for example, the mergers that have happened in the banking sector in Singapore,’ he says. ‘But on the other hand, there are also businesses that purely relied on acquisitions for growth; when that’s the case, the constraint on culture is something that is significantly underestimated by many and such strategies have always come under stress at some point in time.’  

Manage your capital agenda

Because companies need to manage their capital agenda actively to invest or divest at the right time, EY recently published The Stress Test Every Business Needs, which aims to provide CEOs and CFOs with insights that will help them make more-informed decisions on capital allocation.

‘Having a static capital agenda, however appropriate for your current environment, is not enough in today’s uncertain world. Amid volatility, CEOs and CFOs should take the offensive in articulating why each business belongs in the portfolio and lay out clear performance metrics so investors and lenders have sufficient visibility into strategy and operations,’ says Jeffrey Greene, EY corporate development leadership network leader and one of more than 20 contributors to the book.

In uncertain times, companies cannot afford to tie up resources in suboptimal uses, yet too many still only undertake extensive portfolio management in reaction to cash needs or market developments, Greene notes. Rigorous and regular portfolio review processes will, he says, help management teams liberate capital, giving them the financial flexibility to quickly capture investment opportunities or to counter threats.

EY believes that to futureproof their capital agendas, companies should use a broad and strategic definition of stress that encompasses not only traditional macroeconomic, sovereign risks and commodity-related shocks, but should also watch out for technological disruption, activist shareholders and hostile takeovers. ‘We believe threats can come from downside risks, as well as from missed opportunities,’ Greene says.

Act like an investor

Management teams should occasionally look at their business from the point of view of an activist shareholder and start thinking and acting like an investor; this would help pre-empt questions such disruptors may have. Shyam Gidumal, who leads the global activist investor practice at EY, writes: ‘It’s the same principle as buying homeowner insurance even though you don’t expect a wide array of hazards to befall your property.’

‘This is a practice that is yet to take a strong foothold in Asian markets, but it is a good one to have at the board level when one evaluates business unit performance,’ says Basnayake, adding: ‘If business performance is assessed, not just in comparison to the rest of the in-house portfolio but also against external peers, the board could prompt management to take timely action and consolidate investment in businesses that provide the best outcome to all stakeholders.’

In Asia, many large companies are conglomerates, either state-linked or family-owned, which have diversified their portfolio as a natural hedge to mitigate the volatility in performance of the different businesses. But while it may have been seen as an appropriate strategy in the past, it also provides a platform to hide bad capital decisions or to not take timely action to recycle capital to businesses that are performing, notes Basnayake, who adds that the role of activist shareholders in some developed markets has ‘put the correct checks and balances for management action and provided “outside-in” analysis that they have carried out to challenge management decisions. In Asia, some of the more active controlling families or sovereign funds have begun to play this kind of a role in the background – but it has not been at a level we see in some of the developed markets.’

Greene advises that setting financial metrics that focus on earning returns in excess of the cost of capital will help embed a shareholder-value mindset. ‘Managers need to understand that capital will be allocated not to the largest business units, but to those with the highest risk-adjusted returns and best strategic fit,’ he says. ‘This approach rewards timely, well-executed acquisitions and divestments and penalises leaders that hold on too long to underperforming assets.’

Sonia Kolesnikov-Jessop, journalist