WORLD-LEADING CORPORATES CONTINUALLY SURPRISE US. IN ORDER TO STAY IN THE ELITE THEY COMMUNICATE MORE AND MORE VISIONARY IDEAS. THEIR MARKET CAPITALIZATION IS LARGELY IMPACTED BY THE PERCEIVED SCOPE AND GROWTH OF FUTURE OPERATIONS, SO THE MORE ABSTRACT & DARING THEY ARE, THE MORE INTEREST THEY RAISE AND HIGHER IS THEIR POTENTIAL. THE WINNERS ARE THOSE WHO RISK A LOT, BUT IN A SMART WAY – CASE OF ALPHABET INC.

Alphabet Inc. is a financial holding, the epicenter of creativity and innovation of incredible scope. Google Inc. currently represents the majority of this holding, while other companies are still in relatively early phases of their development. These are Access, Calico, CapitalG, GV, Nest, Verily, Waymo, X and many other projects, which are about to be spin-offs / carve-outs in the near future. The activity focus is on information organization, investment banking, IT infrastructure, biology and aging, healthcare, home management, transport and logistics, television etc.

Already the name (Alphabet Inc.) symbolizes the organization’s mission, placement of so called »alpha bets«. Albert Einstein once said: »The best investment is investment in one’s knowledge.« and it seems that Alphabet Inc. took this statement seriously. They bet more and more intensively on the combination of technology and learning – machine learning and artificial intelligence.

The potential of these two technologies can be well understood from a simple chess experiment. The computer was given the game instructions and develop its own knowledge of playing based on own iterations. In less than 4h of playing the cumulative knowledge already exceeded the amount of cumulative chess knowledge developed by people through centuries of playing this game. Chess is only one of the examples, in reality there are numerous potential applications. Speaking from the monetary perspective, the value of the market is estimated in trillions of US dollars. The two technologies may result in a double digit GDP growth of the world.

We are probably not even aware of the progress that is about to be made in next years. The cumulative knowledge base will get new dimensions, since the knowledge begins to grow at significantly faster pace. Practically, in line with the IT infrastructure development. Inventions such as Quantum computers, however, will speed things up. New knowledge will open the door to a world of completely different life.

A well-known Chinese magnate and businessman, Jack Ma, at one of the public speeches said: “It is more important that you are the first one, than that you do things perfectly.” With this statement he highlights the importance of the »first mover effect«, the entrepreneurs are still under-aware. Not only that Alphabet Inc. is normally among the ground-beakers, its innovation in combination with market dominance actively address also the so-called »trend setting«.

If so far Google Search was considered as the leading tool for searching information on computers, phones, tablets and other media; the company is opening a new, even more promising chapter. With the integration of artificial intelligence and machine learning they a targeting a more strategic role in one’s life, becoming personal assistants. This will drastically improve the role Google Inc. plays in our lives and of course simplify our operationally challenging everyday. Despite the fact that Amazon’s Alexa and Apple’s Siri came first and were until recently leading by active users, it appears that the winner of this battle is going to be Google Inc., also due to the cross-product synergies.

Innovation is just a base. In order to make an idea a success story, much more is needed. Among others, also the ability of market penetration. Recall how Google Inc. in the past used not only organic approaches, but also corporate acquisitions to speed up the market integration at just the right time. Today, Android probably would not be so well-known and widely used if Motorola Mobility acquisition would not take place back then ($ 12.5 billion, 2012) and accelerate the penetration. The same applies to the acquisition of Nest Labs (USD 3.2 billion, 2014), which enabled the company to develop its presence in households in the IoT segment; and the acquisition of YouTube ($ 1.7 billion, 2006), which enabled Google Inc. to successfully responded to the transfer of traditional television to the world wide web and significantly increase its advertising potential. Mind also the takeover of the Israeli company Waze ($ 1.15 billion, 2013), which significantly improved the Google Maps with more advanced travel time calculation, suggesting the most optimal routes, etc .; or the acquisition of the HTC Pixel Smartphone Division ($ 1.1 billion, 2017), which strengthened the development team in some critical areas and may seriously jeopardize Apple’s Iphone profit cake. Advanced strategic management and bold thinking result in more than 200 other corporate acquisitions made in the last 10 years – Gradient Ventures and the Google Assistant Investment Program play an increasingly important role.

Alphabet Inc. understands very well how important it is to actively monitor and set trends. People’s habits are changing rapidly all the time, opening up new market opportunities. Being the first in key segments such as machine learning and artificial intelligence opens the door to the potential of enormous value generation in the future. Capital un-intensive business requires management to focus its efforts on growth – thus the tendency to focus on end users, user experience, brand perception, customer loyalty, customer satisfaction, etc.

Past financial figures confirm that the tactics is right. Past growth rates are high (Net sales CAGR2014-17: 18.9%; EBIT CAGR2014-17: 16.6%), which partly also reflects smart allocation of resources and the increasingly active penetration of emerging emerging markets such as India, South Asia, China and others.

Source: Alphabet Inc. Consilue analysis.

Despite impressive financial statements, many investors believe in hidden reserves. The complaints relate to the monetization of solutions, excessive share of more expensive equity in the financial structure, unnecessary exposure with short-term financial investments, etc. As a result, the capital market position of the company is not optimal. Measures of protection against hostile takeovers, such as, the issue of multi-class shares with different management rights, which give the founders the main managing role in the company, additionally worsen the situation.

Source: Alphabet Inc. Consilue analysis.

The chart above shows year-on-year increase in surplus cash »Money and short-term financial investments« (31 Dec 2017: USD 102 billion) and its financing. In other words, a substantial portion of equity is used to invest in US bonds and similar short-term liquid instruments. For some stupidity, for others a masterpiece. The fact is that it is very difficult to judge the situation on limited outer data. One of the theories that advocates the current management’s behavior is that the reasons for the significant surplus should be sought in the context of tax benefits. Companies like Alphabet Inc., Apple Inc., Microsoft Inc., Cisco Inc. and others hold a cumulative 0.5 trillion dollars of surplus cash in their balance sheets. Their bargaining power against the tax regulator is strengthening every year and call for a more favored one-time tax treatment, co called »tax holidays«. They wisely wait for the right moment to come. In times of crisis, the saying »Money is the king.« is well-known.

Critics respond with counter-arguments. One of them, for example, is that Google Inc. is with its balance sheet full of surplus funds becoming an important player in the world of investment banking, a world of sharks. Investor doubt in safety of these funds, due to the company mysterious behavior and (little) amount of attention.

From the value point of view, the lever of Alphabet Inc. (Google Inc.) is not really the amount of excess cash, but rather the ability to invest it in a very smart way. Not only within the technology sector, but also wider. The financial holding has a unique weapon in their hands – Google search queries. The latter can be demonstrated with, for example, comparing the number of Google search queries and the Bitcoin (BTC) price development. The correlation between one and the other is extremely high and, as in many other cases, provides a good basis for investment decision making.

Source: Alphabet Inc. Consilue analysis.

Corporate strategy – it is about our path. How we are achieving our goals. How wide and open we look at things. How capable we are to appropriately address macro trends. How we recognize and manage advantages, weaknesses, opportunities and dangers. How we strengthen purchasing power within the industry. How we make advantage of our corporate competences, competitive advantages, capabilities etc.

Google’s strategic management is in many views exceptional. Advanced future-thinking, technology, innovation and creativity. In everyday life, things are of course much more complex than the chess game, but something is certain. Development goes on with the speed of light. The ideas we have been acquainted with a decade ago in science fiction movies are now part of our everyday life. But ideas are not all, they are only the beginnings. Its the corporate strategy who decides whether they will play an active role in our lives or not. Corporates need to do unique, break-through things. Today we need to think about how the life will look in twenty years. We need to think about the virtual reality, personal assistants, gene modification, molecular designing, personalized medicine, (cell)growing of meat etc. Dare to risk, but in a smart way – just as the leading companies do.

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P/E MULTIPLE OF TURKISH COMPANIES HIT THE 9 YEAR LOW IN 4Q 2018 AS A RESULT OF INCREASED POLITICAL AND MACROECONOMIC RISKS IN TURKEY AND WIDER IN THE MIDDLE EAST. M&A ACTIVITY HALVED ALREADY IN 2016-2017 , MAINLY AS A RESULT OF BIG, INFORMED PLAYERS’ ABSENCE. MANY ARE QUESTIONING THEMSELVES “IS IT NOW THE TIME TO BUY A TURKISH COMPANY OR WE ARE WITNESSING A TEMPERED BOMB?”

Good conditions for corporate acquisitions in Europe

Relative power of companies in the developed world increased in the period after the financial crisis. Economic conditions in 2016, 2017, 2018 were/are prosperous, while the access to money is relatively easy and cheap. M&A activity in the developed world is on the other side reaching historical heights. Many companies gathered free cash resources and are thus facing questions such as which company to buy, when, at what price and how to properly address the risks.

Impact of macro on corporate valuations in Turkey

Valuations of Turkish companies are for some time already at the spotlight of the foreign financial analysts and companies with the inorganic grow (M&A) ambitions.  Turkish BIST 100 P/E multiple dropped in first 8M period of 2018 from 9x to 7x and hit the lowest levels in last 9 years. Its maximum was in 2013, when the multiple reached 12x.

A fast look into the multiples may indicate a good entry point. However well-informed big M&A players pressed a brake. Main fears are gathered around the potential impact of future macroeconomic & political risks on business operations. Let’s point out few key developments:

• Turkish Lira is continuously loosing its value against the EUR or USD for last 15+ years. The Aug 2017 – Aug 2018 decrease is significant and amounts to 40+%. Futures (CME) in Aug 2018 forecast a significant further drop also for the following years, while the costs of hedging are increasing steadily.
• Inflation rate in July 2018 reached 15,85% p.a. From Mar 2018 it is up for 5+% points and is increasing exponentially. Current inflation levels are the highest from Jan 2004 and are significantly above the long-term target inflation rate.
• Turkish companies are in average well-exposed to FX risks. They hold significant amounts of loans in EUR and USD.
• Significant credit risk eruption seriously threatens Turkish companies. Excess of serious liquidity problems may occur due to the maturity gaps between investments and loan financing.
• Country risks grow rapidly. 5Y credit default swap for Turkey increased for 350 basic points compared to the BOY 2018 and reached 500 basic points in Aug 2018.
• Average cost of debt for companies is high. Average interest rate for company loans reported by Turkish Central Bank reached 21,75% p.a. in Jul 2018.
• Payment discipline problems as well as payment terms are on the rise. Liquidity ratios of Turkish companies are worsening. Average trade receivables outstanding (TRO) in 1H 2018 amounted to 121 days, nevertheless 46% of business partners demand a significant increase.

No matter the environmental and industry analysis, the final conclusions related to the feasibility of the M&A activity is determined based on the individual case and in line with the corporate value-maximization principles. Besides the underlying case findings, the decision whether to involve in the M&A activity and at what price heavily depends among others also on motives, strategy and alternatives. One should be well aware of risk-benefit profile and accept the decision based on the well-informed decision making process.

Let’s look at the case study of a B2B multinational industrial company and how they addressed the question of increased risks linked to the operations in Turkey.

The background of the corporate acquisition:

Acquirer holds a dominant niche position in Europe and wider. It is considered as a reliable, high-quality supplier with a wide portfolio of own products. The company is active in the CapEX intensive industry. It reached its leading market position due to the fact that they were able to internationalize its business operations faster and thus reach the economies of scale and scope, which nowadays represent hard-to-beat market entry barrier. Part of the success can also be attributed to banks, which were for a long period exposed to above-average indebted company.

Turkish target is a direct competitor of the acquirer and was founded as a result of the acquirers’ clients activity, to decrease their dependency and regain the negotiation power. Once the target started to threaten the performance of the acquirer more seriously, the company adjusted the regional pricing policy and thus strengthen its competitive pressures. Due to the limited financial power and negative macro development, the competitor offered the acquirer the option to acquire the company.

Corporate market value estimate of the target in the context of recent macro developments & risk perception:

Comment: Target’s market value estimate is attractive, especially if considered in the context of historical pricing. Only from the BOY 2018 the company lost more than a quarter of its value. P/E multiple of the target is also cheaper than the reference industry / market multiple, reflecting the acquirer’s competitive pressures. Market value estimate is approximately on the net asset value, which is used as a post-acquisition strategy base. The commercial side of the deal is stimulative for the acquirer.

Corporate acquisition related risks and post-acquisition strategy 

In order to limit the effect of high risks on future business operations and value generation, operational restructuring is planned.

• After the corporate acquisition part of the capacities double. The plan is to move them to other continents, where the acquirer already supplies some (other) products from its portfolio to certain clients. Local production will open new business development opportunities and good base to increase the value generated / revenue synergies.
• After the corporate acquisition products for existing Turkish and Middle East clients are to be produced on more efficient production lines of the acquirer within the EU. To guarantee sufficient flexibility the supply will be coordinated through the local warehouse.

Corporate acquisition enables also realization of selected new business opportunities. Projects relate to Turkish and Middle east clients and are only available to local producers with sufficiently advanced know-how. These projects are planned in line with the value creation principles. In other words, due to high operational risks only execution of projects with returns above the weighted average cost of capital take place.

Base scenario (symbolic graphics; imaginary numbers are used):

Comment: The corporate acquisition results in synergies as presented above. Additionally created value supports the decision to acquire a company.

Worst-case scenario (symbolic graphics; imaginary numbers are used):

Comment: New business opportunities are due to the environmental challenges limited. Operational restructuring works as a shield to protect against eruption of risks after the corporate acquisition. The core value is thus significantly less exposed to Turkish risks.

Market entry (corporate acquisition) is attractively priced and is from the perspective of the acquirer a good business decision, while post-acquisition strategy limits the effect of further negative risk development. Additionally, the acquirer also plans to:

• minimize the exposure to Turkish Lira (change most of the existing commercial agreements to EUR; hedge the TRY-EUR FX rate risks)
• minimize the exposure to risks related to Turkey (continuous excess cash pay-outs / reinvestment, optimization of net working capital and financing mix)

The recent developments of risks in Turkey, enabled the acquirer to 1) execute the business acquisition (acquire the competitor), 2) consolidate the business operations and improve the operational efficiency, 3) speed up the the Middle East market entry and develop the regional presence. In the given case the transaction size matches the net asset value, which the acquirer used to relocate certain duplicated capacities (fixed assets) to other continents. The focus of the post-acquisition strategy addresses high risks and provides the answer how to restructure the operations to maximize the value. Despite the fact that the majority of companies decided to put their M&A activity in Turkey on hold, the given macro situation offered the acquirer an attractive business opportunity.

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