The Importance of ROCE in Mergers and Acquisitions

Analyst Interview
May 25
5 min read

When companies merge or one buys another, it’s a bit like a high-stakes marriage you want to make sure it’s a good match that creates value for everyone involved. That’s where Return on Capital Employed (ROCE) comes in. This metric measures how well a company uses its capital both debt and equity to generate profits, making it a key tool for evaluating M&A deals. From picking the right target to assessing risks and structuring the deal, ROCE shines a light on whether a merger or acquisition will pay off. Here’s why ROCE matters in M&As, with real-world examples to bring it to life.

Why ROCE Matters in M&As

ROCE is like a financial GPS for M&As it helps you navigate the deal process by showing how efficiently a company turns its capital into profits. Here’s how it plays a role in three key areas:

1. Measuring Value Creation

ROCE is a go-to metric for figuring out if a deal will boost the combined company’s profitability and shareholder value. Here’s how it helps:

Target Selection: A company with a high ROCE is like a star player—efficient at generating profits from its capital. Acquiring such a company can lift the buyer’s overall profitability. ROCE helps you spot targets that are already firing on all cylinders.
Synergy Potential: Mergers often promise synergies—cost savings or revenue boosts from combining operations. ROCE analysis can show where these synergies might come from, like shared resources or expanded markets, that could push the combined ROCE higher.
Post-Merger Integration: After the deal closes, tracking ROCE helps you gauge how well the merger is working. If ROCE drops, it might mean integration hiccups or missed synergy goals.

2. Risk Assessment

M&As come with risks, and ROCE helps you spot them before they derail the deal:

Overpaying: A target with a sky-high ROCE can look tempting, but it might lead to overpaying if that ROCE isn’t sustainable. You need to check if industry trends or competition could erode those returns.
Integration Challenges: Merging companies with wildly different ROCEs can be tricky. If the target’s ROCE is much lower, blending operations and cultures could drag down the combined company’s efficiency.
Hidden Costs: Acquisition costs, financing fees, or restructuring expenses can eat into ROCE. Factoring these in upfront ensures you’re not blindsided by a hit to profitability.

3. Negotiations and Deal Structuring

ROCE isn’t just about analysis it’s also a tool for sealing the deal:

Valuation Basis: ROCE can help set a fair price for the target by showing how efficiently it uses capital. A higher ROCE might justify a premium, guiding negotiations.
Contingent Payments: You can tie part of the payment to ROCE-based performance targets (called earn-outs). This incentivizes the target’s team to keep delivering post-merger.
Performance Measurement: ROCE can be a key performance indicator (KPI) to track the deal’s success over time. Watching ROCE trends helps you spot issues early and course-correct.

ROCE isn’t the only factor in M&As, but it’s a critical lens for evaluating value, risks, and deal terms.

Real-World Examples: ROCE in M&A Deals

Let’s look at 10 real M&A deals to see how ROCE shaped the decisions and outcomes.

1. Reliance Industries & Chevron Corporation

Deal: Reliance Industries (RIL) acquired a 49% stake in Chevron’s Permian Basin shale oil and gas assets in 2016.
ROCE Impact: Chevron’s ~20% ROCE in the Permian was a big draw, signaling efficient, high-yield assets. RIL aimed to boost its own ROCE by tapping into Chevron’s expertise and profitable operations.

2. Unilever & Dollar Shave Club

Deal: Unilever bought Dollar Shave Club in 2016 for $1 billion.
ROCE Impact: Dollar Shave Club’s ~25% ROCE came from its disruptive subscription model. Unilever saw a chance to improve its own ROCE by leveraging this digital expertise in the e-commerce space.

3. Amazon & Whole Foods Market

Deal: Amazon acquired Whole Foods in 2017 for $13.7 billion.
ROCE Impact: Whole Foods’ ROCE was modest (~5%), but its premium grocery offerings fit Amazon’s high-margin strategy. Amazon aimed to lift ROCE through logistics efficiencies and broader market reach.

4. Salesforce & MuleSoft

Deal: Salesforce bought MuleSoft in 2018 for $6.5 billion.
ROCE Impact: MuleSoft’s ~30% ROCE, driven by its API integration platform, made it a gem. Salesforce saw potential to boost its own ROCE by integrating MuleSoft’s tech to grow its cloud ecosystem.

5. Walt Disney & 21st Century Fox

Deal: Disney acquired 21st Century Fox in 2019 for $71.3 billion.
ROCE Impact: Fox’s ~15% ROCE came from its strong content library. Disney aimed to improve its ROCE by scaling its streaming services and leveraging content synergies.

6. Microsoft & LinkedIn

Deal: Microsoft acquired LinkedIn in 2016 for $26.2 billion.
ROCE Impact: LinkedIn’s ~20% ROCE, driven by its professional network and data insights, was a draw. Microsoft saw ROCE upside by integrating LinkedIn’s data into its enterprise solutions.

7. Alphabet (Google) & Fitbit

Deal: Alphabet acquired Fitbit in 2019 for $2.1 billion.
ROCE Impact: Fitbit’s ~10% ROCE reflected its wearables market share. Alphabet aimed to boost its ROCE by integrating Fitbit’s tech into Google Fit and monetizing health data.

8. SoftBank & Arm Holdings

Deal: SoftBank acquired Arm Holdings in 2016 for $31 billion.
ROCE Impact: Arm’s ~30% ROCE came from its dominance in chip architecture. SoftBank saw potential to improve its ROCE through Arm’s licensing fees and IoT growth.

9. Facebook (Meta) & WhatsApp

Deal: Facebook acquired WhatsApp in 2014 for $19 billion.
ROCE Impact: WhatsApp’s ~40% ROCE, driven by its massive user base, was a key factor. Facebook aimed to boost its ROCE by integrating WhatsApp into its ad-driven ecosystem.

10. Adobe & Marketo

Deal: Adobe acquired Marketo in 2018 for $4.75 billion.
ROCE Impact: Marketo’s ~25% ROCE from its marketing automation platform was a draw. Adobe saw ROCE upside by strengthening its marketing cloud and competing with Salesforce.

Key Takeaways

ROCE measures efficiency: It shows how well a company uses its capital to generate profits, making it a key metric for M&A analysis.
Value creation: High ROCE in a target signals potential to boost the combined company’s profitability and shareholder value.
Risk management: ROCE helps spot risks like overpaying, integration challenges, or hidden costs that could hurt the deal.
Deal structuring: ROCE informs valuations, earn-outs, and performance tracking to ensure a successful merger.
Use it wisely: ROCE is powerful but should be paired with other metrics and qualitative factors for a complete picture.

Wrapping It Up

In the high-stakes world of M&As, ROCE is like a trusty compass. It helps you pick the right target, spot synergies, assess risks, and structure deals that create value. By focusing on how efficiently a company uses its capital, ROCE sheds light on whether a merger will be a blockbuster or a bust. Pair it with other financial metrics and a deep dive into the industry, and you’ll be better equipped to navigate the complex world of M&As with confidence.