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Number 59, Summer 2016
2 5 11
Bracing for a new era of The tech bubble puzzle How a tech unicorn
lower investment returns creates value
17 22
Mergers in the oil Weve realized a ten-year
patch: Lessons from strategy goal in one year
past downturns
McKinsey on Finance is a Editorial Board: David Copyright 2016 McKinsey &
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& Company. This publication Dan Lovallo, Werner Rehm, to be used as the basis
offers readers insights into Dennis Swinford, Marc-Daniel for trading in the shares of any
value-creating strategies and Thielen, Robert Uhlaner company or for undertaking
the translation of those any other complex or
strategies into company Editor: Dennis Swinford significant financial transaction
performance. without consulting appropriate
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Table of contents
2 5 11
Bracing for a new era of The tech bubble puzzle How a tech unicorn
lower investment returns Public and private capital creates value
The conditions that led to markets seem to value tech- Delivery Hero CEO Niklas
three decades of exceptional nology companies differently. stberg describes how
returns have either weakened Heres why. his company disrupts the
or reversed. A wide range way we eat.
of stakeholders will need to
adjust their expectations.
17 22
Mergers in the oil patch: Weve realized a ten-year Interested in reading McKinsey on
Lessons from past downturns strategy goal in one year Finance online? Email your name, title,
Past collapses in oil prices Gerard Paulides, who led and the name of your company to
have prompted a deluge Shells $66 billion acquisition McKinsey_on_Finance@McKinsey.com,
of deals. As activity looks set of BG, describes the and well notify you as soon as new
to pick up again, companies thinking, the process, and articles become available.
that acquire in order to cut the intensity behind the deal.
costs are likely to be the most
successful.
Cozyta/Getty Images
Despite repeated market turbulence, US and lower investment returns. On both sides of the
Western European stocks and bonds have delivered Atlantic, returns could even be below the longer-term
returns to investors over the past three decades 50- and 100-year averages, especially for fixed-
that were considerably higher than long-term aver- income investors. We project that total real returns
ages. From 1985 to 2014, real returns for both in the next 20 years could be between 4.0 and
US and Western European equities averaged 7.9 per- 6.5 percent for US equities and between 4.5 and
cent, compared with the 100-year averages of 6.0 percent for Western European equities. For
6.5 percent and 4.9 percent, respectively. Similarly, fixed-income returns the drop could be even bigger,
real bond returns over the period averaged falling to between 0 and 2 percent for both US
5.0 percent in the United States and 5.9 percent in and Western European bonds. While the high ends
Western Europe, compared with 100-year averages of both ranges are comparable to 100-year averages,
of 1.7 percent and 1.6 percent, respectively.1 this assumes a return to normal levels of GDP
growth and interest ratesand returns would still
We believe that this golden age is now over and that be considerably lower than what investors have
investors need to brace for an era of substantially grown used to over the past three decades.
Public and private capital markets seem to value technology companies differently. Heres why.
Aggressive valuations among technology companies rent deca-corns. Also noteworthy is the fact that
are hardly a new phenomenon. The widespread high valuations predominate among private,
concerns over high pre-IPO valuations today recall pre-IPO companies, rather than public ones, as was
debates over the technology bubble at the turn of the case at the turn of the millennium. And then
the centurywhich also extended to the media and theres the global dimension: innovation and growth
telecommunications sectors. A sharp decline in in the Chinese tech sector are much bigger forces
the venture-capital funding for US-based companies today than they were in 2000.2
in the first quarter of the year feeds into that
debate,1 though the number of unicornsstart-up All of these factors suggest that when the curtain
companies valued at more than $1 billionover comes down on the current drama, the consequences
that same period continued to rise. are likely to look quite different from those of
16 years ago. Although the underlying economic
The existence of these unicorns is just one significant changes taking place during this cycle are no
difference between 2000 and 2016. Until seven less significant than the ones during the last cycle,
years ago, no venture capitalbacked company had valuations of public-market tech companies are,
ever achieved a $1 billion valuation before going at this writing, mostly reasonableperhaps even
public, let alone the $10 billion valuation of 14 cur- slightly low by historical standards. A slump in
Exhibit Todays public tech valuations are roughly in line with the general market globally.
Price-to-earnings multiple
90
Tech bubble Era of unicorns:
80 pre-IPO companies
valued at >$1 billion
70 Global technology market1
60
50
40
30
20
10 Global market2
0
Jan Jan Jan Jan Jan Jan Jan Jan Jan Jan
1998 2000 2002 2004 2006 2008 2010 2012 2014 2016
Source: Datastream
much more. During the technology and telecom- nonstate-owned, and nonstate-owned companies
munications bubble of 2000, the global tech-sector are consistently valued 50 to 100 percent higher
valuation peaked at just under 80 times earnings, than their state-owned peers in the same segments.
more than 3 times the valuation of nontech equities.
And over the five years after the bubble burst in This time, its different?
2001, the tech sector enjoyed a valuation premium Where the picture today is most different from
of, on average, 50 percent over the rest of the 2000 is in the private capital markets and in how
equity market (exhibit). Even with a focus limited to companies approach going public.
Internet companiesthe sector most often sus-
pected of runaway valuationsthere is no obvious It wasnt until 2009 that a pre-IPO company reached
bubble among public companies at present. a $1 billion valuation. The majority of todays
unicorn companies reached that valuation level in
Nor do these companies valuation premiums just the past 18 months. They move in a few
appear excessive to the general market when viewed distinct herds: roughly 35 percent of them are in
in light of their growth expectations. Higher the San Francisco Bay Area, 20 percent are
multiples are in most cases explained by higher in China, and another 15 percent are on the US
consensus forecasts for earnings growth and East Coast.
margins. The market could be wrong in these expec-
tations, but at least it is consistent. Notable shifts in funding and valuations have
accompanied the rising number of these companies.
China is a notable exception, though equity valua- The number of rounds of pre-IPO funding has
tions in China always need to be viewed with increased, and the average size of venture invest-
caution. Before 2008, Chinese tech companies were ments more than doubled between 2013 and
valued on average at a 50 to 60 percent premium 2015, which saw both the highest average deal size
over the general market. Since then, that premium and highest number of deals ever recorded.
has grown to around 190 percent. Why? In part Increases in valuation between rounds of funding
because the Chinese online market is both larger have also been dramatic: its not unusual to see
and faster growing than the United States, and funding rounds for Chinese companies involving
the government has ambitious plans to localize the valuation increases of up to five times over a
higher-value parts of the hardware value chain period of less than a year.
over the next few years.3 The growth in Chinas
nonstate-owned sector is another part of the story. Whatever the quality of new business models
Many of the new technology companies coming emerging in the technology sector, whats
to the market in the past five years have been unmistakable is that the venture-capital industry
markets of today and those of 2000, both periods Journal, April 14, 2016, wsj.com.
2 The lions share of the more than 160 pre-IPO unicorns is in the
are marked by excitement at the potential for
United States and China. See, for example, The unicorn
new technologies and businesses to stimulate mean- list: Current private companies valued at $1B and above, CB
ingful economic change. To the extent that Insights, updated in real time, cbinsights.com.
3
valuations are excessive, the private markets would China said to plan sweeping shift from foreign technology to
own, Bloomberg, December 18, 2014, bloomberg.com.
appear to be more vulnerable. But perspective is 4 Jeremy Abelson and Ben Narasin, Why are companies staying
important. The market capitalization of the US and private longer?, Barrons, October 9, 2015, barrons.com.
Chinese equity markets declined by $2.5 trillion
in January alone. Any correction to the roughly half David Cogman (David_Cogman@McKinsey.com)
a trillion dollars in combined value of all the is a partner in McKinseys Hong Kong office, where Alan
unicorns as of their last funding round is likely to Lau (Alan_Lau@McKinsey.com) is a senior partner.
Niklas stberg, an energetic 35-year-old Swede, is and investors have cast a skeptical eye on the
the CEO and cofounder of Delivery Hero. Based unicorn phenomenon. stberg recently discussed
in Berlin and financed with venture-capital money, with McKinseys Thomas Schumacher and
the company is built around an online platform Dennis Swinford the start-up landscape, the impor-
that matches restaurants with hungry customers. tance of innovation grounded in data, and
Delivery Hero has grown to operate today in his companys role as a disruptor of an inefficient
33 markets across five continents, processing restaurant industry.
14 million takeout orders each month and
offering customers recommendations, as well as McKinsey on Finance: Valuations of pre-IPO
peer reviews of restaurants. tech companies have come under scrutiny lately,
particularly the emergence of so-called
With a valuation of $3 billion, Delivery Hero is also unicorns. Whats going on, in your perception?
one of about 170 unicorns: start-ups with
valuations above $1 billion. Given the number of Niklas stberg: Im sure a number of those
new companies that crashed when the turn- unicorns shouldnt be unicorns. As always, earlier-
of-the-century tech bubble burst, many executives stage businesses come at a higher risk. But I am
McKinsey on Finance: So if home cookers and Niklas stberg: We try to give them as much
the telephone are your major competitors, who value as we can, and its part of our vision
really worries you? to do so. Besides attracting more customers, we
reduce their operational costs, since they
Niklas stberg: We do also have competitors dont need to have someone answering the phone,
in our own space. Uber, for example, and Amazon for example. We also provide them with a
and Yelp have similar efforts under way. Its a point-of-sale system replacing the cash register
big space, so why wouldnt they try? Even Facebook and we compile useful statistics. That will
could enable online food ordering via chat bots, not only save some thousands of euros per year
which could completely change the industry but also help them provide better food and
yet again. And, indirectly, guys like Facebook could service to their customers.
Niklas stberg
Education OnlinePizza
MSc in industrial engineering and Cofounder and chairman
management, KTH Royal Institute of (November 2007May 2011)
Technology and ETH Zurich
Fast facts
Career highlights Provided capital and advice to several
Delivery Hero European start-ups as an angel investor,
Cofounder and CEO including Beekeeper, GetYourGuide,
(May 2011present) and Peakon
restaurants. That is part of building up our logistics thing and multiply it across units. On the other
to enable a better service. Restaurants still do hand, giving people autonomy and authority
the cooking, naturally, but we track their orders. and responsibility also has an amazing value. What
We offer quality assurance through metrics rarely works is to be 100 percent one approach
like user ratings and reorder rates. And we tell or the other. The trick is finding the right balance.
restaurants which dishes on their menus are
good for delivery. We also make much more money We give local CEOs autonomy and authority to
on thataround 10 per order, less the cost encourage entrepreneurshipand they fight
of delivery. with blood and sweat to win in the market. But
you have to set the rules of the game. And
For investments like that, we track the data and you have to set the culture of your company. That
optimize performance, shutting them down quickly balance can be fragile. For example, if you
if it becomes clear they cant meet our expecta- set the wrong incentive scheme and you place
tions. We spent nine months on an earlier delivery- autonomy at the local level, people are more
space investment, based on a different concept likely optimize for their incentive schemes rather
and setup, for example. We did as much as we could than for their businesses. And, suddenly,
to improve its performance and invested close to youre sitting there on a conference call wondering,
10 million in the project. But it wasnt meeting our Is this the right decision that hes suggesting,
expectations, so we shut it down and took the loss. or is this the right decision for him? And you dont
Now, maybe we could have realized that sooner really know. Thats why, first of all, its impor-
and lost just 6 million, but other companies might tant to find people with an owner mentality rather
have dragged out the investment and spent than managers whose careers and financial
100 million on it. The point is, if youre going to interests are the top priority. Then give them an
fail, you want to fail fast. You invest to validate incentive scheme that reflects ownership as
or invalidate the concept and then shut it down closely as possible.
if necessary.
Finally, were a data-driven culture. Decisions
McKinsey on Finance: You appear to have based on data are the glue that holds us together.
a highly federated business model with a number And if data are your starting point, then a CEO
of CEOs of individual delivery businesses. in Argentina, for example, cant just argue that some-
How does that work? thing should be done a certain way because every
Argentinians doing it that way. We might not agree,
Niklas stberg: Centralization is always but we can do the A/B testing and see what the
more efficient in a way because you can do one data tell us. CEOs get the final decision, but if they
Mergers and acquisitions in the oil and gas sector out to strengthen their competitive positions as new
may be coming into fashion again. In the current era opportunities emerge.
of low prices, a confluence of events makes acquir-
ing more attractive. Pricing hedges that had locked They may find that the strategies that worked when
buyers into higher prices are rolling off. Debt prices were rising wont work as well when prices
levels are high, particularly among independent are low. Our analysis of the value-creation perfor-
exploration and production companies with mance of deals during a previous period of low
exposure to US shale productionat nearly ten prices, from 1986 to 1998, and the period from 1998
times earnings before interest, taxes, depreciation, to 2015, which was characterized mostly by a
and amortization. And like most commodities rising-oil-price trend,1 bears this out (Exhibit 2). Of
industries, the oil and gas sector is prone to consoli- all these deals when prices were low, only mega-
dation during the downside of its business cycle deals,2 on average, outperformed their market index
(Exhibit 1). This raises the likelihood that some com- five years after announcement. Periods of flat
panies will be available at distressed prices. prices appear to call for a focus on cost synergies and
Healthy companies may have been slow to start scale. In contrast, in the 1998 to 2015 period, when
deals, but theyll clearly want to be on the look- prices were generally rising, more than 60 percent
Exhibit 1 Historically, oil-price down cycles have led to an increase in M&A activity.
Real oil price (2006 dollars) Price in money of the day dollars Transactions
120
110
100 Shale
revolution
90 US corporate
80 restructuring
70
60
50 1st wave of
Breakup of
industry 2nd wave of
40 Standard Oil restructuring industry
30 restructuring
20
10 Creation of
megamajors
0
1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010
Source: BP Statistical Review of World Energy 2003; S&P Global Platts; Eric V. Thompson, A brief history of major oil companies in the Gulf
region, Petroleum Archives Project, Arabian Peninsula and Gulf Studies Program, University of Virginia; Thomson Reuters; Daniel Yergin,
The Prize: The Epic Quest for Oil, Money & Power, New York: Free Press, 2008; analysis of data provided by McKinsey Corporate Performance
Analytics, a McKinsey Solution
Exhibit 2 Flat-price periods call for deals that differ from those in rising-price periods.
Range of TRS outperformance relative to MSCI Oil, Gas & Consumable Fuels Index, Median
5 years after deal,1 compound annual growth rate, %
2.5 0
Build megascale,
2.0 3.0 0.6 4.6
n=4
0.1 4.3
Build density
within a basin, 3.5 2.2 4.0 9.3
n = 36
9.1 7.4
Enter new basins,
13.1 1.3 3.6 10.3
n = 24
1.2
Enter new
resource types, N/A 3.8 9.8
n = 13
0 2.3
14 12 10 8 6 4 2 0 2 4 4 2 0 2 4 6 8 10 12
1 Deals prior to 1995 are measured against MSCI World Index, while deals announced after Jan 1995 are measured against MSCI Oil, Gas &
Take the merger of Exxon and Mobil. Announced in the path for significant growth, especially in the
1998, the deal had a strong focus on executing liquefied-natural-gas business.
postmerger integration, which enabled the com-
pany to capture $10 billion in synergies and In the rising-price period, there were no megadeals
efficiencies within five years. That exceeded the to be included in our data sample. But a number of
$2.8 billion savings estimated when the deal major acquisitions in the period used value-creation
was announced. The savings resulted from job cuts levers similar to those of the earlier period. For
and stricter, centralized controls on capital example, Anadarko Petroleums 2006 acquisitions
spending and allocation across the postmerger of Kerr-McGee and Western Gas Partners for
companyupstream, downstream, and tech- $23 billion created large-scale positions in the deep-
nology. Over the following decade the deal opened water Gulf of Mexico and US Rocky Mountains.
When Royal Dutch Shell announced plans last action, and the challenges of implementing large
year to acquire BG Group,1 the Britain-based oil and mergers and acquisitions. What follows is a tran-
gas producer, the deal represented both Shells script of that conversation, edited for publication.
largest M&A deal ever and one of the first energy
mergers in an era of low oil prices. Although McKinsey on Finance: The oil and gas sector
the acquisition came as oil prices continued to fall, would seem to be ripe for deal making. Whats the
investors roundly approved of it. historical view of the role of M&A in oil and gas?
Gerard Paulides, who led the team that planned the Gerard Paulides: Historically, the sector has done
acquisition and worked on its completion, says big M&A deals (rather than just regular asset
the strategic discontinuity in the energy sector is transactions) when there have been big discontinu-
more fundamental than finding new resources ities. In the late 1990s, the discontinuity was oil
or taking out costs as oil and gas remain volatile and at $10 a barrel, and the focus was on managing costs.
the mix of energy sources changes. He recently sat In the early 2000s, the discontinuity was the
down with Ivo Bozon and Dumitru Dediu to discuss perception that the world was going to run out of oil
deal making in the oil and gas sector, the BG trans- and gas at some stage. The focus at that point was
you have five external team members available, McKinsey on Finance: How does the long-term
principals from the bankers, the lawyers, the nature of the oil and gas industry correlate with
strategic advisers, then you have a good teambut how you think about short-term market reactions?
you need to handpick them. The more you can Does the market often get it right at the start,
allow them to do their job and mobilize as their point or does it need to see a deal play out over time?
of view drives them, the better off you are.
Gerard Paulides: Obviously, financial-market
Reporting lines are also important. An M&A requirements need to be followed during the entire
team leader should have a direct reporting line to process, ensuring timely and complete disclosure
the CEO and CFO and also establish a relation- of information. If the market reacts differently than
ship with the board. The head of strategy, if there is you expect, then either you didnt explain the
one, should be a part of any dialogue around deal very well or you didnt see an issue that the
deals but shouldnt be a conduit for that M&A dia- market does. You need to respond to that. I
logue between the team and the CEO. If youre also think that in oil and gas its much too easy to
talking about big deals on a global scale, you can say, Were a long-term industry, its a short-
only work with one decision maker. term blip. Lets ignore it. The financial markets are
After the deal is announced, the intensity changes, Gerard Paulides: You can spend a lot of time
because then 99 percent of the company and without being intense. We had about 20 subject-
the market know what youre doing. They expect matter-expert work streams in the BG deal. At
you to allocate time to it. In the beginning, any moment, any of those work streams might be
There were certain points in 2015 and 2016 when McKinsey on Finance: What are the biggest
I couldnt open a newspaper without reading some risks to the success of a deal like this?
write-up or some subject-matter-expert review
and everyone knows what youre doing, including Gerard Paulides: Failing to recognize the intensity
your entire family and all your friends. You of the integration needed. Or, if we go back to
probably cram three years into one. And you almost what used to be business as usual, spending as if we
think, What happened in the last 18 months? hadnt done this transaction. Market conditions
We were at Easter, and then it was Christmas, and can make it easier or harder. If oil prices go direc-
then it was Easter again. Thats intensity. tionally more up than down, life will be easier
but that carries its own risk. An improving market
McKinsey on Finance: On the BG deal, what was can bail you out too easily, without the intensity
the markets initial reaction? of the reset and the portfolio rebalancing. You may
forget your original intentions.
Gerard Paulides: The BG acquisition was a
unique fit for Shell, and the timing and opportunity
were there. The markets reaction to the deal 1 Valued at $86 billion at the time it was announced, according to
was complete and wholesome, and investors have Dealogic, the transaction was ultimately worth more than
$60 billion when it was completed on February 15, 2016, and
embraced it as a good match. The debate was
represented some 40 percent of Shells $140 billion market
not about strategy or the rationale for the deal or capitalization on that date. The change reflected variability in
the portfolio opportunity that the deal would currency prices, oil prices, and Shells share price.
create with divestments. All that was quickly under-
stood. That was why we started the whole exercise, Ivo Bozon (Ivo_Bozon@McKinsey.com) is a senior
partner in McKinseys Amsterdam office, where
because it all makes sense.
Dumitru Dediu (Dumitru_Dediu@McKinsey.com) is
an associate principal.
The debate was about price. With oil prices
dropping from above $100 a barrel in early 2015 to
Copyright 2016 McKinsey & Company.
below $50 a barrel in early 2016, its difficult to All rights reserved.
price the opportunity. You need to work your way
through that. So you have your base valuation,
you have your financial metrics, you have your
synergy on top of that, and then you have
your reset opportunity for the company. And most
of the debate was around the reset opportunity
and the pricing.