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Don’t destroy value with M&A

ANALYST REPORTS SUGGEST that 66% to 70% of all acquisitions fail, and large experienced corporates like Hewlett Packard are not immune to failures of this kind. On 3 October 2011, it acquired British IT firm Autonomy for $10.1bn, but the deal has depleted HP’s value as the company announced an $8.8bn non-cash impairment charge relating to Autonomy in November 2012.

HP’s chief executive Meg Whitman (pictured) claimed in November that it discovered suspect accounting practices at Autonomy after it bought the company.

Autonomy founder and CEO Mike Lynch blames the problems on the loss of Autonomy’s staff from HP following the acquisition, which he believes stifled its ability to maintain its entrepreneurial start-up spirit. He argues that they quickly became disillusioned with working as part of a much larger organisation whose strategy reversed the intended software and services focus of the acquisition in order to concentrate on PCs and printers.

The ongoing saga between Lynch and HP demonstrates what can happen when an acquisition goes wrong. In this case, it could be argued that HP’s board and management failed to sufficiently scrutinise Autonomy’s accounts before the deal was signed. Former public limited company CFO Bob Beveridge, who now works as an independent director and audit committee chairman, believes that this might have been the case. As suggested by Lynch, he also feels that the companies failed to integrate properly because they had two different cultures.

“HP’s board seems to have decided that the acquisition was strategically important, but they seem to have underestimated the challenge of taking on a completely different business with a completely different culture,” says Beveridge. He adds that there should always be a rigorous and comprehensive due diligence exercise that is designed to “identify the potential risks or problems; and if this is not done properly, the acquirer is faced with unexpected consequences post-acquisition”. In other words, a lack of stringent due diligence and a failure to integrate the target company won’t add the value that the acquirer wished to obtain from the deal.

There are many reasons why mergers and acquisitions (M&As) fail. Peter Simons, research and development technical specialist at the Chartered Institute of Management Accounting, says that the aforementioned failure rate for M&As is about right, and they often don’t succeed because the acquirer hasn’t got the story behind acquisition right – as well as failing to conduct some robust due diligence. Supporting that should be an appropriately structured deal, resources and funding.

In order to ensure that value is derived from the deal, the reasons behind it have to form a business case that stands up to scrutiny, based on facts and figures. The price and the implementation plan need to be right too, and amongst other things the acquirer has to have the capacity to deliver the desired outcomes, which have to be measurable in order to ensure that the anticipated value is gained.

Timing is vital

Simons also advises that the timing for an acquisition is very important: “You have to have the timing right, but the good guys can make it happen no matter what it is.” Companies that are looking to acquire others, for whatever strategic reason, need to avoid buying at the peak of the market – or when it’s on the way down – as he thinks that “you ideally want to make a purchase when you are on the upswing”. So it’s important for CFOs to play a crucial and leading role in the pre-acquisition analysis.

“If a company is a ship in heavy, turbulent seas, the CFO, especially one with experience in strategy and not just accounting, is the keel and the rudder offering stability, sound analytics and discipline both up- and down-stream to the CEO, the board and other executives at his level,” says Gene Kamarasy, CFO partner at Randstad’s professional services firm Tatum.

He therefore argues that the creation and maintenance of value do not begin after the signing of the acquisition deal – they have to start through the process by “ensuring that the hypotheses regarding, for example, the potential savings are realistic and adequately tested, and CFOs are the secret weapon to keep everyone’s feet on the ground during the excitement of the transaction”.

CFOs with strategy development experience are a secret weapon because they can help the acquiring company to ensure that realistic prices are paid in order to be sure that the company can achieve positive results post-acquisition. Kamarasy adds they can also drive the post-acquisition process, which will involve integrating the two entities and their teams by guiding them towards where value can be created between them. Studies by McKinsey and Deloitte have revealed that “if the expected synergies and cost-savings have not been secured during the first 180 days, the probability of identifying them and reaping their benefit falls to below 10%”.

Erik Harrell, CFO and chief strategy officer of Opera Software, adds: “I believe that CFOs have a very valuable role to play in the strategy of the business. I am a proponent of CFOs owning both strategy and mergers and acquisitions because I have played a key influencing role in terms of the strategic areas we should go into, and I have been in a position to work with my M&A and strategy teams and Opera’s business leaders to lead and oversee the execution of these transactions.”

For example, Opera Software purchased Mobile Theory in February 2012, and a couple of years before that – in January 2010 – it acquired mobile publisher technology platform Admarvel, which itself performed well in the US by gaining clients such as CBS News and Fox News. So with his team he decided to undertake a strategic evaluation in the summer of 2011 of Admarvel to consider how value could be added to it for the benefit of its “publisher-customers, accelerate revenue growth and in order to play a greater role in the mobile advertising value chain”.

As a result of this analysis, Harrell and his team realised that there was an opportunity to create value in the demand side of the advertising business. “It was felt that we should build a sales team to bring advertising dollars in to help our mobile publishers to monetise their content further (as a complement to their own direct advertising sales efforts),” he says. So by working with the head of his company’s advertising, business plans were put into place to organically build a sales team, and he launched an evaluation of potential acquisition targets in the US, “and this is how Mobile Theory came about”.

In this case, it was important to have a link between strategy and M&A. Harrell believes that “you don’t want to do M&A deals that don’t link in with your strategy, and you need people that link the two”. He adds that this is the advantage of having a CFO that leads both the management and development of strategy as well as M&A activities. This is because, in his view, CFOs tend to be very structured individuals, and therefore are well positioned to create and add value during the M&A process by being systematic about how deals are done, how deals are structured, and how the post-acquisition integration is organised and executed.

Set performance targets

Harrell adds that, by not buying a company outright and using earn-outs to encourage the acquired companies to meet certain performance targets, Opera Software has done well: “We have been able to take on smaller entrepreneurial businesses and they have been able to thrive within the Opera umbrella.” Between 2010 and 2013 Opera Software has acquired four companies, and he claims that they have contributed to significant revenue increases: “Our revenues in our advertising business have gone from $0 million to an $80 million run rate from 2009 to 2012, and Mobile Theory achieved $5.7m in 2011; they are now at a $36m run rate based on Q4 2012 revenues.”

David Bird, the managing director of Leasedrive, has both a financial background and has managed M&A projects. His company acquired Velo in 2006 and claims it added real value to his business. “It was a well-planned and carefully executed transaction, and the lesson we took from that experience was that it is imperative to make sure that you have the customers onside all the way through the transactions,” explains Bird. To achieve this, the acquired company must ensure there is continuity of staff and management team. So it’s worth noting that most of the senior executives of Autonomy left shortly after the firm was acquired by HP.

There is a need to ensure the continuity of business processes, service delivery and pricing, in order to avoid alienating customers. Bird’s advice is therefore to avoid rushing the transition of any of these important customer-facing issues. When you do identify a need to change, you must ensure you have a plan with your customers to make certain they feel fully involved in any change process. Indeed, as suggested by Harrell, it’s also vital to ensure that the acquired company’s management team remains on board before and after the deal is completed and the acquisition plan implemented.

An example of why it’s important to bear customers in mind when planning and implementing an acquisition is provided by independent board-level adviser professor Bryan Foss. He argues that, in insurance M&As, the first proposition put before shareholders has always been cost reduction rather than revenue or profit improvement, “and this has the result in creating early staff losses, process improvements, property releases and more”. The result is that “customers are often lost, but hopefully not so many as are affordable while other financial gains are made.”

Nothing is certain

Yet all the risk management and strategic thinking in the world cannot overcome one major issue. No matter how much due diligence has taken place, there can never be a full picture of how well the two companies will work together until post-acquisition. Not everything is revealed about the target firm’s management until the last minute, but some acquirers will still go ahead regardless – even if they feel something is amiss.

But if there is a suggestion that something isn’t quite right, it’s often best to have the guts to walk away. To ensure success, Paul Newton, founder and CFO of Performance Horizon Group, says culture and people must be placed at “the centre throughout the buy-out and transition of ownership”. Without a longer-term vision for the business, “culture and motivation slide, so too will financial performance and ultimately the gauge that determines the valuation”.

So driving value through the first months must be supplemented with longer-term goals. And FDs who prove they can make deals work tend to find their career options expand.

Graham Jarvis is a freelance journalist

EXTRA OPINION: A very private practice

Most historical studies have found that 70% of deals have failed, if you look at shareholder wealth creation, accounting performance and management turnover. However, lately, acquirers have shown slightly better performances.

The more recent studies focus more on private deals in which it is easier to create better value. The median value for shareholders is indeed negative, with the split being 60:40, but the ones that get it right can generate substantial value which is why we often see a positive average.

Many firms list on the public market because they are looking for additional currency for growth. When you pay with you own shares, you don’t have to raise the cash. But the acquirer has an incentive to use stock only when its shares are fairly valued or overvalued. If your own share price is depressed, you are unlikely to use stock. If you then pay with stock, you are likely to also overpay for the target.

Clearly, you have to perform as much due diligence as you can as an acquirer. You must have trusted advisers and ensure you are getting the best information possible. There is also the issue of trust between the management teams. This contains most of the value – particularly in technology.

Anna Faelten is deputy director, M&A Research Centre (MARC) at Cass Business School

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