Transformative Transactions: Q&A With McKinsey’s Chris Hagedorn

Chris Hagedorn, senior partner at McKinsey’s Transformation practice and leader of the firm’s transformational M&A work, speaks to Global Finance about how his firm works with clients at a time of high debt costs, tight labor markets, and a scarcity of available talent. This interview has been edited for clarity and conciseness.

Global Finance: How important is the transformation practice at McKinsey?

Chris Hagedorn: In today’s volatile environment where the pace of change is rapid, more companies than ever are seeking transformation to unlock untapped potential and address significant external challenges. Over the past decade, we’ve worked with over a thousand organizations. We serve clients on a broad range of topics, but remain grounded in a simple but important premise: wear the hats of the board, the CEO and C-suite to fundamentally help clients achieve a substantial lift in performance.

There are three parts to how we think about transformation. First, there’s the technical, or financial, side. We strive to deliver better bottom-line results. Second is culture: understanding the mindsets and behaviors of the entire workforce. Third is about sustainable capabilities. It’s one thing for me, a consultant, to bring a team in and help improve procurement practices. But we always aspire to leave our clients in a better state going forward, so they can build the capabilities of the organization through general management skills or specific functional skills, whether it’s commercial procurement, human resources, you name it.

GF: At what point in the acquisition process do you become involved?

Hagedorn: I have several long-standing clients who come to me and say, “I’m thinking about doing a transaction. Can you help me? Can you help me formulate the strategy and identify targets?” Once those targets materialize, and the CFO and the CEO start to make approaches, then we’ll come in and serve them on the due diligence-related activities to confirm value and the transformation work.

The most probable case where we get involved is when a company announces the signing of a deal; it’s usually three to six to nine months prior to closing. They will come to us either on an exclusive basis or for competitive request-for-proposal consulting support. We then help them integrate and achieve their value-capture and transformation activity goals. I personally enjoy being involved up front and seeing the whole movie play out. But, often, we’ll get a call and hear, “I just announced a deal, and I think we need what you can provide.”

GF: Are you seeing more mergers and acquisitions involving self-funded public companies and private equity firms?

Hagedorn: For the last two years, M&A activity has been about half of what it had been 24 months prior. The cost of debt has been a major reason why activity has slowed significantly. When I’m talking to my clients, my colleagues, and seeing all the data points, there’s trillions of dollars in excess cash sitting on the sidelines and building up on balance sheets.

Eventually, private equity will lead coming out of this. They need to take transactions on. We’re in a relatively stable environment, and it provides an opportunity for private equity firms to step back into the deal arena. Public-company transactions will come back, too. There’s a lot of interest from those with strong balance sheets and little debt that want to put excess cash to work with companies that are in a distressed situation.

GF: Do cross-border deals require a different approach?

Hagedorn: The regulatory environment needs to be thoroughly considered when you’re doing a cross-border transaction. I have a lot of cross-border experience. During my days at Peabody Energy, we did a lot of transactions in Australia. I looked at targets in places like Indonesia and other corners of the world. And in my client service work, I’ve advised a global set of high-tech companies coming together, where both the acquirer and the target operated on six continents.

When faced with that, you need a systematic approach. It’s not one-size-fits-all. The organizational aspect is always crucial. Aligning workforce structures and integrating teams across different regions is essential. The more geographically diverse the companies, the more important it is to navigate regulatory requirements and cultural differences. You must take a totally different approach in the US than you would in France or in China. The more geographically diverse two companies are, the more critical it is to understand all the cultural aspects before you bring them together and launch value-creation activities.

GF: Many CFOs say meeting revenue targets and succession planning are the two things that keep them up at night. Does this come up in your consulting work?

Hagedorn: It certainly does. The CFO conversations I was having 24 months ago were 90% focused on the top line. They were also concerned about talent, which is in massive short supply, especially in Western Europe and the US.

Now, every time I pick up the phone or visit one of my CFO clients, they’re asking about costs and productivity. They’re asking about what they can do to make sure that their bottom line and their margins are healthy. They’re still concerned about the top line, for sure; it’s a seesaw effect. Suddenly, they’re looking at massively higher interest rate payments and going from positive free cash flow to negative in a short amount of time.

Labor markets will come more into balance in the next 12 to 18 months, but the most important aspect is making sure CFOs have the right talent in place. Most of the CFOs that I serve today say, “I don’t have enough vice president and senior vice president talent at the quality level that I would like in order to drive the activities and value creation activities that I would like to drive.”

GF: Which sectors do you find most challenging?

Hagedorn: I could probably think of five or six different sectors that I am certain the rest of my colleagues would probably say, “Oh, no, Chris, this one’s harder.” But outside of mining and resources, which include oil, gas, chemicals and utilities. I would say anything that has a high regulatory overlay. Telecom, for example, requires a significant level of government scrutiny. Also, pharma. There can be certain aspects around a new drug release that can make or break the enterprise value of a target. Many complications come into the mix.

But I would argue that geopolitics create a lot of challenges. Large multinational companies coming together that operate in many emerging jurisdictions have different political facets. Having worked in China and Mongolia, trying to set up joint ventures with state owned enterprises, I know firsthand that in the mining space, it is incredibly complicated. When you bring together two behemoths like BHP and Anglo American, having to manage all those puzzle pieces—it’s like Jenga. It must all fit together in the right way. There are sometimes asks that are unexpected and can be enough to blow up a transaction.

GF: How does the advice you give acquirers differ from what they might get from a financial advisor?

Hagedorn: For most transactions, we work side by side with investment bankers. We get into the next-level details on markets, operations, and performance. Investment bankers, tax advisers, and the other professionals involved in completing deals typically don’t go as deep.

Our value add is to be able to understand the levels of performance inside the company and dissect the opportunities in new markets that can lead to growth, improve the cost structure, and reduce fixed costs. That’s not a banker’s bread and butter. On the flip side, we’re not tax advisors or brokers, and so there’s a fundamentally different role to play, but a synergistic one.

GF: Where does shareholder value creation fit in?

Hagedorn: It is the number one consideration by far above all else, although sometimes there are situations that cause it to not be the number one consideration. And shareholder value creation can come in various forms. It was the reason an acquiring CEO recently wanted to pursue a deal. However, when we looked at the amount of free cash flow that it would consume to achieve the synergies, the free cash flow dip was significantly underwater for them. And so it just wasn’t possible for them to pull off the transaction. Shareholder value creation was the overriding thesis, but the journey to getting there was going to be impossible for them with their current balance sheet and financial structure.

Any time I advise my clients, I tell them, “usually you can get the most value in about 24 months.” And in that short time, it’s imperative to focus on value creation and EBITDA. That is almost always the guiding north star. You will find that there are other considerations that should be prioritized. Some companies, in the first year of the transaction, will say, “I don’t want to actually reduce the workforce even though I know I have excess employees by 15%.”

So, it’s not always a linear equation to say, “I just want to focus on ultimate shareholder value creation out of the gate.” There may be some other considerations around employee culture that are actually part of the value proposition of the enterprise that eventually maximize shareholder value.

GF: Do you ever tell clients not to do a transaction?

Hagedorn: Yes, it happens. Just a few months ago, a potential acquirer could have made a deal work, but the downside wasn’t more than the upside, and we said, “We view it as risky for you to proceed with this transaction.” And they didn’t pursue it, even though they held joint management meetings, set up data rooms, and conducted due diligence. Sometimes, the best deal is the one you didn’t do.