The urge to merge has never been greater among corporate occupiers. More 50,000 M&A deals have been completed in Europe since 2000, with a combined value of US$4.3 million (3.3 trillion). As the desire to enter into new and emerging markets, deliver new business lines and services, or create truly global and efficient scale has taken hold, M&A has become the strategy of choice. Indeed, a recent Jones Lang LaSalle survey found that 34 percent of the FTSE 350 companies viewed consolidation via M&A as one of their key strategic objectives between now and 2010.
The M&A market has witnessed a 21st Century boom. Thomson Financial note that some 31,000 M&A deals have been announced worldwide so far in 2007 and that at Q3 the market was up 50 percent on the equivalent period in 2006. Significantly Europe accounts for some 40 percent of these deals. The frenetic pace has only recently slowed as uncertainty around the full and lasting implications of the credit crunch prevailed.
An increasing proportion of global M&A activity (45.5 percent) has been cross-border in its geography, and has fuelled the emergence of truly global corporate occupiers across a range of sectors. In Europe, M&A has been adopted as a key strategy in gaining exposure to the CEE market. Thomson Financial note that there has been a 113 percent increase in the value of Eastern European M&A activity over the last 12 months — making the market in Eastern Europe larger than France or Germany in both monetary and volume terms.
Private equity firms have been a key feature of the market in 2007. From a property perspective their interest has been in deals where op-co / prop-co opportunities exist and the monetization of real estate assets is possible. The reverberations of the credit crisis mean private equity players have become less active recently, but there is no shortage of funding sources for M&A, with sovereign wealth funds being suggested as a significant driver of the market going forward.
While the characteristics and drivers of the European M&A market are clear, the practical implications of M&A for the Corporate Real Estate (CRE) function both pre- and post-transaction have not often been articulated. This paper addresses this by focusing on how to best position CRE teams to support the M&A process fully, maximizing the opportunity and lowering the corporation’s exposure to risk.
The Role of CRE in M&A
CRE teams have a pivotal role to play in supporting the wider organization through the enormous changes and challenges presented by M&A. The role of CRE teams during the M&A process is five-fold:
- Supporting and informing the due diligence process underpinning the transaction and determining deal price
- Improving the speed, efficiency and effectiveness of the integration process
- Assisting in the minimization of operational and financial risks to the organization pre and post integration
- Ensuring that the revised real estate portfolio is fit for purpose, has a common standard of quality and appropriate working styles
- Enabling the business to maximize capital release from surplus (and in some instances operational) real estate
Best in class CRE teams fulfill these tasks. In doing so, they not only add value to the business through the M&A process, but they also establish a stronger and more influential position for themselves within the business.
Five Ways to Maximize Opportunity and Strengthen Position
Within this broad framework of activities, there are five specific but inter-linked opportunities open to CRE teams to bolster both the effectiveness of the merger and create stronger board room endorsement of the CRE function. Best in class examples display a number of the following traits:
Identify opportunities to release capital and return funds back to the business. The acquisition of asset rich companies creates a clear opportunity to release capital. Often the assets acquired will be carried at depreciated historical costs and will not be fully reflective of the full market value either for current, or in some cases alternative, uses. This creates opportunities to secure debt against the properties, carry out sale and leaseback deals, or rationalize and dispose of surplus properties in order to release capital back into the business.
Reduce the ‘roof-tops’ and establish a fit for purpose real estate portfolio. Effective CRE teams develop a deep understanding of the operational needs of the restructured firm and use this to establish a ‘fit for purpose’ portfolio of the highest possible quality but with the lowest possible number of occupied units. M&A presents the opportunity to take a strategic view of the corporate portfolio and the ability to implement changes is enhanced by the broader climate of transformation. Buy-in is particularly strong if clear pay-back financially and operationally can be demonstrated to the business.
Every option to dispose of surplus space should be explored. Some corporations have decided that the best solution is to dispose of their surplus property portfolio wholesale to an outsourced provider. While there will be a risk premium to pay, many find it worth it for the certainty such an approach brings.
Instill and drive workplace transformation. The size of the occupied portfolio can also be reduced through the implementation of new workplace strategies. The adoption of alternative working styles – hot-desks, break-out areas, open plan seating arrangements and so forth – is also a vital instrument in creating an environment capable of attracting and retaining talent. This takes on added importance in organizations going through M&A where a lot of uncertainty and change already exists for employees.
The combination of two organizations typically leads to disparities in space utilization standards across the revised portfolio. The adoption of new common standards and the application of a consistent quality of space and fit-out across the portfolio brings wider business advantages by aiding the transition to a new, shared culture and identify for the merged firm.
Have a strong, unstinting focus on reducing operating cost. In our experience effective CRE teams are handed an aggressive mandate from the management of the restructured business to drive down operating costs. In addition to reducing the size of the portfolio, this can be achieved by consolidating existing teams, optimizing the timing of new or renewed lease commitments to align with favorable market conditions and even through the facilitation of outsourced of offshore service provision. An often overlooked opportunity arises from leveraging the benefits of increased scale to secure efficiencies in procurement and sourcing from all suppliers.
Use the challenges of M&A to strengthen the position, profile and effectiveness of the CRE resource. The strength and spirit of the internal infrastructure will determine how well a CRE team responds to the stresses and effects of transition and how it fares in the aftermath. Solid CRE platforms include skilled people with real estate, workplace design, finance, strategy, and relationship management skills. A behavioral element also needs to be considered. Effective CRE teams are highly attuned and responsive to the (changing) needs of the business during the process. They are prepared to give, and be accountable for, a view even when comprehensive information is unavailable. Such teams are multi-skilled, multi-tasking but strongly focused on supporting the business to implement change.
Five Ways to Reduce Pain and Risk
There is a long history of M&A failures. Research has suggested that these are the result of either transactional failures (that is, factors relating to the structure of the deal) or transitional failures like post-merger integration. Market leading CRE teams focus on five key issues to ensure that the sources of potential pain, and hence risk, are alleviated.
Get aligned with the corporate strategy and vision underpinning the deal from day one. Awareness of both corporate and M&A strategy is a first step in effective M&A preparedness. At all times the CRE strategy must be fully aligned with the wider businesses objectives. CRE leaders need to understand the factors driving a merger or acquisition, which almost always spring from a strategic business objective.
For example, the decision to buy or sell a company may stem from cost or revenue considerations. CRE teams can establish a strong understanding of the business strategy by connecting early and often with the company’s business leaders and senior management to understand their priorities and directions. CRE leaders also have a responsibility to challenge and seek clarity until a detailed and full understanding of the direction and needs of the business is achieved. In our experience, failure to challenge often leads to wasted effort and can exacerbate misalignment between CRE and the wider business.
Build a strong, focused process and platform. A willingness to understand and contribute to the M&A process is vital, but is worthless without the development of clear processes and an information platform from which business decisions can be made. The wider business will expect this as a core element of the support provided by CRE teams. Those that succeed tend to gather as much data on the existing and/or potential portfolio in a pragmatic and focused fashion and then communicate this continuously back to the business. The risks of not gathering good quality data on the portfolio or not providing accurate portfolio information can lead to acquiring companies being unduly pessimistic and may ultimately be reflected in the pricing of the M&A deal.
Effective CRE teams also use the experiences of M&A to revise and document processes so that they are able to move with speed and agility in the compressed time-frames imposed by a merger. This also enables a transparency within the business in respect of the real estate asset selection process. Furthermore, the completion proactively of a portfolio plan reduces the number of distractions that might compromise the team’s ability to function once a merger announcement has been made.
Focus on correct accounting procedures to ensure legacy impacts are eradicated. Property represents a significant capital commitment whether it is owned or leased — and the accounting for corporate property needs to accurately reflect this. The recent transition to International Financial Reporting Standards (IFRS) creates additional issues that CRE teams must plan for and address.
Mergers and Acquisitions – Finding the Hidden Value in Real Estate
The first issue relates to the valuation of the real estate assets held by either entity in a merger. All fixed assets, including property, must be initially recorded at cost. Thereafter, there is a choice of continuing to account for property at cost or to revalue it to ‘fair value’. Fair value is defined under IFRS as the amount at which an asset could be exchanged between knowledgeable, willing parties in an arm’s length transaction. Fair value is required to be measured by reference to market-based evidence, and as such it can include the ‘hope value’ attached to alternative use.
The accounting around onerous leases associated with M&A also requires careful treatment, although it hasn’t been markedly altered by the transition to IFRS. The first action for any CRE team is not to avoid the problem of onerous leases — empty the space and make a provision for it in the accounts. This provision should take full account of all the exit costs around the lease; professional fees; incentives; market rents; void running costs and dilapidation expenses. Finally, effective CRE teams undertake sensitivity analysis on the assets, establishing a range of potential values that can be attributed to the assets and allocating a probability to each of them to derive an anticipated exit value.
Hire additional resource to ensure agility and responsiveness. Few, if any, organizations have all the elements of a delivery model in-house so having partners who can step into the breach quickly and function as part of the team is essential. This has been further exacerbated by the steady streamlining of CRE functions over recent years. When one adds in the time and people pressures associated with the majority of M&A deals, it is not surprising that good CRE leaders often seek to bring in support and expertise from external sources.
Understand and exploit the synergies between the real estate portfolios and leave no stone unturned in value extraction. Market leading CRE teams look beyond the relatively short-term horizons of pre-deal due diligence and post-deal integration. They consistently identify opportunities to generate efficiencies within and release value from the real estate portfolio and actively promote the size of these opportunities to the key stakeholders within the newly created business. This characteristic is continually on display as the new business develops and evolves further and establishes CRE teams as significant contributors to the financial well-being of the organization rather than merely operational facilitators.
Effective CRE teams also recognize that real estate contributes to the opportunity that the corporation has identified in terms of achieving the maximum value from the corporate transaction. Often an acquisition is undertaken to achieve 2+2=5 in terms of revenue, so CRE teams must ensure that the bricks and mortar support that goal in order that staff can create and innovate as soon as possible after the merger. This increased productivity can easily eclipse any savings made in real estate several times over.
Summary
M&A has been, and will remain, a clear strategy adopted by corporate occupiers to achieve the growth, market penetration and financial performance expected of modern business. This article has unpacked the role that best in class CRE teams play in maximizing the opportunities and minimizing the risks associated with M&A. Adoption of at least some of the ten characteristics outlined within this paper can assist CRE teams in making an effective and recognizable contribution to the M&A process.
While there are very real challenges and pressures in any M&A process, they should not be viewed with fear or trepidation by CRE teams. A responsive, pragmatic contribution grounded in a real understanding of corporate strategy and which identifies and communicates real added value to the business, goes a long way to achieving the strategic position that all CRE teams desire.
About the Authors
Lee Elliott is Director of EMEA Research for Jones Lang LaSalle.
Shelley Frost is a Regional Director within EMEA Corporate Solutions for Jones Lang LaSalle.
David McMillan is Director of Corporate Solutions EMEA for Jones Lang LaSalle.
Shirley Ghan is a senior analyst within the EMEA Forecasting & Economics team, which is part of the broader Jones Lang LaSalle EMEA research team based in London.