Are Mergers & Acquisitions a thing in crypto?
Let's enter the Defi consolidation phase
You may or you may not know it, but Mergers & Acquisitions are a key part of today’s economy. Ranging from consolidation purposes to founders’ over-sized ego purposes, M&A happen every day and are often the fuel allowing companies to grow externally. Yes, externally, because most of the companies hide their failures to grow organically under the carpet and mandate bankers to work on a 100 pages bullshit pitch that investors are barely reading. To my fellows Junior Bankers out there, I feel you all, I was a pitching robot not so long ago.
In its early days, the crypto ecosystem didn’t have to bother with any merger or acquisition because it was busy growing organically. Crypto-related companies (such as Binance, FTX, etc.) have lately begun their consolidation phase, integrating new features vertically to onboard as many customers as they could. The race to be the crypto conglomerate of the next decade is indeed playing right there. That’s why we have seen in the past 2 years an urge in M&A crypto-related projects, pushed by mastodonts like Binance (which acquired Coinmarketcap) and FTX (which acquired Blockfolio). And you know what? Now it’s time for the Defi projects consolidation phase.
Don’t worry bankers, this does not mean more work for you, your 90h a week is enough. No, in the upcoming trend of Defi mergers & acquisitions, investment bankers are now waifu pfp anon devs while the buyers are, well, also waifu pfp anons. Actually, in regard to the recent merger of Fei and Rari and the different M&A-like actions undertaken by Defi protocols (like the Ohm proposal here), I believe it’s relevant to think of how this huge tradfi financial service will be transposed in such an ecosystem.
To be honest, this paper is mostly my mental gymnastics, based on my experience in M&A and my understanding of crypto markets rather than a truly sourced writing. Examples of such initiatives are rare if any (aside from the Fei Rari merger), but to be honest, this article is mostly the revenge of the M&A nerd in me.
Valuation
In Tradfi M&A, valuation is a key point because it will give you the figures to make your assumptions and to build your IRR models, as well as the basis for your acquisition offer. I won’t be too long on this point, but bankers use several valuation methods to determine a price range with which they are comfortable. Precedent transactions comparable, public peers, or DCF are common ways to value a company, but those are inherent to the tradfi economy. Indeed, with public peers and transaction comps, you are valuing a company on historical data, and building with these data a valuation range based on an EBITDA multiple (generally). For example, you found those precedent transactions traded at a median of 10x EBITDA. Also, the public peers are trading at 12x EBITDA. The company you want to value has an EBITDA of $90m. Then, you can estimate the valuation of the company in the $900m – $1,080m range. That’s of course simplified, but you get the idea.
Now, how can you apply this framework to crypto projects? I think you can’t. Transaction comps are not fitting with the crypto market simply because there isn’t any acquisition in this market (we are talking about protocols here, not companies like Binance, FTX, etc.). Then, you may think that public peers are applicable. Indeed, everything’s publicly listed in crypto. But again, I think we can’t use it. Most of the public peer metrics are based on financial statements items like EBITDA, Revenues, and others. Also, forecasts on public comps are pushed by Equity research teams of Investment banks. So, in an industry not Financial Statements centric like crypto, the public peer strict method is not relevant. We could also think about valuing a company on the P/E ratio, but again, in my opinion, it just gives a sense of if a company is over or under evaluated, but not its true value.
DCF method has been for many the way to build valuation models for protocols, building assumptions on Cash Flows, growth, volume, and perpetual growth rate. You can find one here. Honestly, that’s just pure speculation rather than a true valuation. Indeed, how could you build relevant long-term assumptions on such a volatile market, forecasting how the volume will be in 10 years when you can’t even know if the pepe pfp you are talking with on Twitter is a fed or a 14yo dev?
All of this just to say: valuation is a meme in crypto M&A. More than a meme, I think that a strict valuation framework is just a TradFi thing. Indeed, mergers & acquisitions are not equity-based but token-based, so I think this would be case by case depending on how and what the protocol is doing.
For example, if OlympusDAO was to buy an Ohm fork (Spartacus proposal here), they should bid a bit below RFV, but at a premium to the current token price. It would allow them to acquire treasury cheaper than its true value while incentivizing holders with a premium they may not have collected otherwise. Now looking at the FEI Rari merger, there wasn’t any valuation. They simply established TWAP prices at which 1$ of Rari could be swapped for 1$ of TRIBE, and yeah, the merger was completed. Pretty straightforward right?
To sum up, on this part, the inherent state of the market makes the tradfi valuation framework irrelevant. By not acquiring equity but rather “operations” which could be treasury, community, or tech, the valuation seems protocol-based rather than standardized. This could change with the market maturing, or it may not, but I hope we will have more M&A in crypto to sharpen this valuation framework.
Shareholding structure
This part is a tricky one, but I’ll try to keep it short because it’s not so relevant here. Traditional companies are in no way comparable to crypto, mostly because their shareholding structure and their inherent shareholding rights are quite different. Listed companies in traditional markets have an equity-based shareholding structure. Let’s keep it simple by not introducing warrants, preferred equity, or convertibles into the equation, but owning shares (i.e equity) of a company gives you rights over its operations and if enough, also a seat at its board. Thus, growing your share stack could give you a force positioning over certain internal decisions, but also come with additional responsibilities and duties. Depending on the jurisdiction, a shareholder owning more than 30% (normalizing it here but may change depending on the country) requires you to submit a takeover bid over the whole company under certain conditions. In brief, having a high shareholding in traditional companies is binding.
In crypto, shareholders, or let’s call them hodlers, are more distributed in a way that we can hardly see individuals owning more than 10% of the tokens. Normal you may say as crypto aims at DecENtRAlIzing. I think that above all, owning a too bigger stack is not profitable in crypto because there is no decision power over the company. Also, a single wallet holding a big chunk of the supply can be frightening for other holders, making them lose confidence in the protocol and dumping tokens. The truth is that today, few people are active in governance, and owning 10-15% of the supply is enough to influence every proposal. It’s then easy to bypass on-chain stalking by owning the supply through multiple wallets, or even with OTC deals. Nevertheless, I might assume here that the “shareholding” structure of crypto projects incentivizes much more for the distribution of power than in traditional companies.
Then, buying out a project is much more of a pain in the ass, mainly because you can’t simply acquire all tokens and say “Hey, this protocol is mine now”. Then, we can imagine that only friendly mergers could happen. Clever, isn’t it?
Financing
Financing is for sure the most important part behind bid price in traditional mergers, but also the main reason why analysts have to stay till 4 am in front of excels to tweak assumptions all night. Financing structure alone can make your merger accretive (EPS increase after the merger) or dilutive (the opposite). We will see here that crypto-to-crypto mergers financing tools are much more straightforward than their traditional counterparts, which use a mix of debt, cash, and equity. The mix has to be well thought out and is often case by case. For example, if the company has a lot of cash on hand (eg. Apple), they may choose to use cash only. But everyone’s not Apple, and cash is important to finance short-term operations and one-time costs, so you may not want to burn it. Also, issuing equity for a merger is not always a good thing, because it will dilute shareholders and make their displeasure. Finally, debt is the cheaper way to finance an acquisition but comes with covenants and yearly interests, so it's sometimes better to avoid it. Well, you’ll have understood, financing structure is a hell of mental gymnastics for a trad merger, but crypto spares us that.
I have thought about this part a lot and came to the idea that crypto mergers don’t necessarily need financing. Taking Fei-Rari as an example, protocols merged in a friendly manner without incurring any costs but allowing for a token swap from $RGT to $TRIBE. Of course, this could be assimilated to a sort of equity financing acquisition, but swiftly and well, on a simple token swap UI. It is also important to note that $TRIBE holders have been granted the right to exchange their tokens at Intrinsic Value for FEI, reducing the dilution. Here is a sensitivity table for what $TRIBE dilution would look like following different assumptions. For your knowledge, as of the 3rd of March, 5.2m of $RGT have been swapped at the predetermined exchange rate of 26.7 $TRIBE per $RGT.
Now, to speak more broadly, I believe financing in crypto mergers and acquisitions will also be protocol and operation-based. If you want to acquire a treasury, you may use yours to buy the other one cheaper than its value (eg. Ohm’s proposal to acquire Spartacus treasury). But if you want to acquire/merge operations, you may choose a token swap using reserve supply and dilution. Finally, with DAO’s debt entering the crypto space, we could see more financing solutions incurring no dilution and self-repaying debt. TradFi frens must be jealous.
Merging operations
Merging operations is often the pain point in such initiatives. On paper, the merger is legitimate by the so-called synergies, expanding footprint, acquiring R&D capabilities bla-bla. In reality, most are unsuccessful because cultures don’t fit, overlapping divisions are suppressed putting employing on the spot, and well, all synergies on paper suddenly disappear. As said earlier, mergers or acquisitions are the results of shareholders’ megalomania to build companies ever larger, without taking the time to integrate companies acquired 6 months earlier. Unfortunately, crypto-to-crypto acquisitions are subject to the same difficulties, but with very different challenges. Today’s crypto projects are organized around several key factors. The product, which is the thing you want to merge with, the teams, and let’s say the UI also (even if it is not that important compared to other factors). But crypto also add a new layer of complexity on the chessboard: merging communities and DAOs. It’s no secret that community is a very valuable asset in such an industry because it’s what will drive visibility and loyalty sentiment to projects. Don’t get me wrong, communities won’t dissuade people from selling useless tokens, but deceiving your community is definitely what will make you crush your project. Well, see how the frog nation just created chart support near to 0 on $ICE token.
The good thing is, in my opinion, crypto founders are currently a bit more rational than their Trad pairs. So far, we don’t have many examples of successful mergers as Fei-Rari is the only one that came through. On paper, synergies are clear, with vertical integration of a stablecoin protocol to bootstrap Fuse pools. In practice, we’ll see how this is executed, but I’ll give them the benefit of the doubt. Also, in this merger, they’ve decided to elude the “merging community” problem by keeping independent communities under a newly created DAO. Does it mean that they’ll just keep separate Discords or whatsoever, while letting people vote on the same governance proposals? I can’t see the interest here, but they might know more than I do.
Last point but not least, regulation. Indeed, traditional mergers are subject to antitrust authorities’ approval and a whole line of boring papers to fill and people to ask permission. What’s the point in crypto? For the Fei-Rari merger, it could be a pain point, even more because Fei is a stablecoin protocol and we know how regulators hate stablecoins. For other ones? The future will tell, but I am sure that as we go further in the parallelization of both economies, there might be some prerequisites to tick before merging. So, for all protocols looking to merge, you better make it quick.
Final thoughts
I’ll close the thinking with this one. Why should we care about M&As? In web 3, codebases are open (most of them), so you can basically fork every protocol you wanna integrate. This will allow you to elude the bothering integration and DAO merging part while giving you the keys for building the Defi conglomerate you want by yourself. Users would then be able to choose to go with the original or the fork, and not be dragged into a merging operation they didn’t vote for. That’s how web3 should work isn’t it? Nevertheless, that does not mean that M&A are pointless since this path also has its drawdowns. A protocol may not want to add a huge workload to its dev team, even more in the case of a technical protocol to fork. Also, my conviction is that merging communities could be a great asset, making it larger and more diversified. After all, we should all be frens, right?
All in all, it’s clear that this trend is still nascent and thus highly experimental. With more mergers, we’ll see better processes, understand when it’s beneficial and when it’s not. Who knows, maybe I could even be able to reconvert into a web3 banker.
I’m done here, so thanks everyone for making it this far, it means a lot. I’ve tried to simplify this thing as much as I could, mostly because M&A operations are not common knowledge and may not be very interesting for people outside of it, but hope you enjoyed it guys. Also, big shoutout to @0xcarnation which was my devil advocate and helped me elaborate on this one.
Take care!