Every organization has a business model, mission and vision set forth during its establishment. At a later time, because of the favorable business environment, does it make sense to diversify into new businesses (with new culture, new product lines, new resources)?
As a 12 year "Private Limited" product centric organization with over 600 million in total revenues from 2 countries, their organizational goal is to maximize shareholder value. So, if they do diversify, what are the steps should we keep in mind? Do you suggest to invest more in the expansion of the profitable core business? I'm talking about diversifying towards non-related businesses [like, for example, an automotive (manufacturing) company diversifying towards retail!]
The organization does have surplus cash (to diversify through M&A for under 100 million businesses) and can raise funds because of their sound management and profitable business performance. Since inception, the business is performing EBITDA at 20%, but took a dip during recession (-15% EBITDA) and now back to profit-making (5% EBITDA) with healthy earnings forecast.
The most simplistic approach is to make sure that whatever you spend will generate a return higher than ROE (for the shareholders). Forget accretion/dilution -- if you only invest cash, you are always gonna get accretion. Really focus on answering the question: "Why should the company diversify with shareholders' money when shareholders can diversify themselves by investing that money in other companies (see M&M theory)?" The answer to that question should be something along the lines of ROE (or ROIC) being higher as a result of "synergies" (or other capabilities/competencies) that make it better for the company to diversify than for the individual investor to do so himself.
Just to clarify. M&A is one of their options. They do have resources to start a business from scratch on their own
Worst thing you can possibly do for your shareholder is to overpay for a growth business. BCG's two-by-two matrix (have a cash cow and invest in growth) doesn't work for M&A.
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