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Posts By : Duncan Kerr

Accumulate to innovate: Staying ahead in the innovation arms race

Last year Siemens, the 170-year old industrial conglomerate, announced the creation of something that had a strong whiff of back to the future about it.

The innovative German company hasn’t yet, unfortunately, created the world’s first time travelling train. But on October 1 it did launch a business that speaks as much to its past as it does to its future.

Indeed  in founding next47, a new unit designed to foster innovation and accelerate the development of new technologies, Siemens is focusing even more than it has in the past on partnering and investing in innovative start-ups to enhance its future growth and development.

“Siemens itself was a start-up in 1847,” said Joe Kaeser, president and CEO of Siemens. “With next47, we’re living up to our company founder’s ideals and creating an important basis for fostering innovation.”

Siemens has been partnering and investing in start-ups for the past 20-years or more. But in next47 – a play on the year Siemens was founded – the company has consolidated all its existing start-up activities, empowering the unit and essentially giving this business greater strategic importance to the entire company than ever before.

What’s interesting is that Siemens is not alone.

For years many of its blue-chip company peers – from Intel and IBM to Unilever, Google and more recently GE – have been partnering with and investing in some of the brightest start-ups in much the same way.

Unilever Ventures, the consumer goods conglomerate’s venture capital and private equity arm, was founded, for instance, in 2002. Intel Capital, by comparison, has been going since 1991.

Back then the innovation arms race was only really just getting going. And yet in the last decade this race has accelerated phenomenally, transforming the global economy in ways few knew or perhaps thought were possible.

From AI and machine learning, to distributed ledger technology, augmented reality, robotics, cybersecurity, energy storage and 3D printing, large, mature companies are today seeking out some of the most innovative start-ups in an ever increasing array of profoundly impactful areas.

Consequently, corporate venture capital investment – the means through which these companies tend to invest in or acquire start-ups via their own dedicated divisions – has rocketed in recent years.

Last year, for instance, corporate venture capital investment touched $85bn globally – roughly double what it was in 2014, according to Global Corporate Venturing.

It looks set to keep soaring.

An increase in acquisitions of innovative start-ups by larger, more established competitors is seen as one of the top themes in M&A over the next 12 months, according to over 2,000 company CEOs, CFOs and other senior executives who participated in the recent Capital Confidence Barometer survey we conducted on behalf of EY.

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EY CCB: An rise in acquisitions of innovative start-ups a top theme

Ask the same executives the same question but our over a longer timeframe and the acquisition of start-ups may be nearer the top.

Part of the reason why is the recognition that internal research and development alone struggles to deliver the type of innovations companies want, when they want, and at a cost that they want to see.

Combine that with the fact that the type of environment that fosters innovation – one where staff can collaborate and operate under the freedom to create, experiment and ultimately fail – is not typically to be found flourishing in large, mature multi-billion dollar companies.

At least, not in most.

Part of Siemens’ objective for next47 is to provide existing group employees, entrepreneurs as well as external start-ups and established companies with the “freedom to experiment and grow” without the organisational restrictions so often symptomatic of a company its size.

In some sense, Siemens is just opening its doors to bring the innovations that can and do happen outside, in.

And while much of that focus is on attracting the ingenuity and flare that start-ups can bring, large mature companies are also getting in.

The first of next47’s projects is with European aircraft maker, Airbus. By 2020 they aim to show the technical feasibility of hybrid/electric propulsion systems for small to medium-sized passenger aircraft.

Innovations driven by and among large companies can of course be just as profound as any developed by start-ups, but to stay ahead in the innovations arms race, better ultimately to work together as one.

And who knows, anything might be possible – even time travel.

Deal or no deal: Protecting acquisitions amid manic market moves

Three to 12 months is a long time in global markets where so much can change in the blink of an eye.

And yet three to 12 months is the average time it takes to close a merger or acquisition – opening-up an acquirer to the risk markets may move against them.

In such unpredictable times as these this risk is increasingly real, potentially making any acquisition more expensive or, in extreme cases, unravel.

Take, for example, how markets reacted last year to the UK voting to leave the European Union and the election of Donald Trump as US president. Sterling lost almost 20% of its pre-referendum value in the weeks after, while Trumps election sent bond yields soaring in anticipation US interest rates would rise.

While such market moves only really occur when unexpected events hit, the regularity of these seismic events is undoubtedly worrying.

Indeed, over the next 6-12 months, high volatility in currencies, commodities and other capital markets is considered the greatest economic risk to the core business of companies, according to over 2,000 CEOs, CFOs and other senior executives who participated in the recent Capital Confidence Barometer survey that we conducted on behalf of EY.

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At the same time, a near-record number of the companies that participated in the survey said that they plan to acquire in the next 12 months, with most of them believing that the main theme in M&A this year to be an increase in cross-border dealmaking.

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So at a time when there is a resurgence in appetite for cross-border M&A and fear of higher currency and capital market volatility, what’s a deal-hungry CEO to do?

One option making something of a comeback is for companies to use derivatives to help mitigate the financial risk costs in an acquisition.

Foreign currency forwards – a derivative essentially enabling the buyer or acquiring company to purchase or sell a set amount of foreign currency at a specified price in the future, thereby protecting themselves against any wild market swings – is one such hedging solution. But it is so-called deal-contingent FX forwards, which offer buyers greater optionality, that are specifically re-emerging again.

Whereas a company must pay for a FX forward irrespective of whether or not the acquisition is completed. With a deal-contingent forward, the company can walk away – without paying to unwind the agreement – depending on how the acquisition actually progresses.

If that sounds too good to be true, the catch or downside is that deal-contingent forwards are expensive, costing between 2-5% of the notional value of the transaction – far more than a FX forward.

It’s a tough call to know whether it is worth it or not. But amid more volatile markets, what price does a company put on being protected?

Similarly, just as currencies can appreciate during the time it takes to close a deal, financing conditions can of course change rapidly too.

Most large-scale M&A transactions are financed initially using a bridge loan before being refinanced on the bond markets, but if interest rates rise during this time the cost of finance does too.

To manage this risk derivatives called forward-starting swaps offer something of a solution, essentially enabling the acquirer to lock-in current rates for an asset or liability and on a deal-contingent basis.

Similar to a deal-contingent FX forward, a company can walk away from the hedging agreement depending on how the deal progresses.

Such interest rate derivatives have been used for some time in infrastructure and project financing, where the long-dated nature of it means it is particularly susceptible to interest rate changes over time.

They haven’t, as yet, become as prevalent in the shorter-dated corporate bond markets. But interest is expected to grow. After all, interest rates can only go one way after being so low for so long.

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