Wednesday, July 28, 2010

SAP Looking for More Strategic Acquisitions after Sybase Takeover

According to a report in Die Welt, SAP, the listed German software group, is interested in further acquisitions after the takeover of California-based rival Sybase. Jim Hagemann Snabe, the co-chief executive of SAP, told the newspaper that strategic acquisitions remain part of the strategy after the Sybase deal, but added that one should not expect a string of takeovers similar to the mentioned recent deal.

A separate report in German daily Frankfurter Allgemeine Zeitung noted that SAP announced that it has secured 92% in Sybase after filing a EUR 4.6 B takeover offer.

Under the new leadership, SAP realized they needed to get more aggressive with acquisitions against the king of M&A, Oracle. I would expect SAP to participate in every deal to be made in the Information Technology domain going forward. Oracle who is always looking for bargain prices might find future deals more contested and difficult to creat economic value with higher valuation multiples.

SAP could look at firms in the hosted cloud infrastructure space cherry picking Infrastructure-as-a-Services (IaaS) and Platform-as-a-Service (PaaS) companies. Another segment is enterprise search and content managent to augment their platform with unstructured data access, management and mining to complement their Sybase and Business Objects acquisitions.

Lexmark Looking Around the World for M&A. Isn't it Too Late?

According to several reports in the media, Lexmark International (NYSE: LXK), the Lexington, Kentucky-based office printing solutions company, could make more acquisitions following its recent Perceptive Software deal, CEO Paul Curlander said today.

During the company’s 27 July earnings conference call, Curlander was asked whether Lexmark plans to use its cash on hand for more deals or repurchasing stock. Curlander said acquisitions and related opportunities are “our first strategic use of cash.” The Perceptive deal which closed in June is “taking up a lot of our time in the current year,” he continued. Beyond completing that integration, he added, “Our thinking hasn’t changed, and clearly we’ll look around the world for strategic opportunities.”

CFO John Gamble said the Perceptive deal had a net cash impact of USD 267M, leaving Lexmark with about USD 1B in cash and marketable securities at the end of its latest quarter.

Lexmark makes a prime takeover candidate in the printing industry. Many of its bigger competitors including Xerox looked at Lexmark several times but the CEO was adamant about going alone. The company recently started leading with Managed Print Solutions (MPS) to convert fleet management deals to its technology. However, a services-led transformation for a firm of Lexmark size against Canon/HP/EDS, Xerox/ACS and RIcoh/IKON makes virtually impossible to survive in the industry. The CEO might regret that he had not sold the company during the consolidation wave at its peak.

Saturday, July 24, 2010

When It Comes to M&A Execution, It's Oracle vs Oracle

The $10 billion Oracle spent on acquiring Sun, BEA, and Hyperion will end up looking like small potatoes as the company gears up for a $70 billion buying spree.

According to an interview by CNN and following article by Fortune magazine, at the Fortune Brainstorm Tech conference in Aspen on Thursday, Oracle President Charles Phillips declared that "we'll probably double what we spent on acquisitions" over the next five years compared to the last five. That would total roughly $70 billion, a dollar figure that had his interviewer, Fortune's Adam Lashinsky, asking if that could possibly be right. "If things hold up," Phillips said, "we could easily do that."

Apparently, Phillips didn't clear the number with the rest of the folks in Emerald City, Oracle's (ORCL) gleaming tower complex in Redwood City, Calif.

"Oracle does not have a five year acquisition budget. We don't even have a one year acquisition budget," a company spokeswoman said in a statement the next morning. "While it is highly unlikely that we will spend anything approaching $70 billion in five years, we will be opportunistic and, if market conditions warrant, we will buy additional companies that further our strategic goals and address our customers' needs." He also said Oracle had no plans to acquire, in response to specific questions at the conference, Fortune noted.

Phillips' comments came after a question about whether Oracle still believes consolidation is necessary in tech — and if Oracle is going to be leading the charge. Phillips said yes, and that you could expect Oracle to play in a number of areas: hardware, content, and "vertical markets that no one's ever heard of."

Duke Energy Intends to be Major Player in Consolidating US Utilities

Duke Energy Chief Executive Officer Jim Rogers said that consolidation in the US utility market is long overdue and that the company will be a major player in the process.

To indicate his willingness to make big deals, Rogers said at the Clean Energy Ministerial in Washington DC that the company was very interested in acquiring E.On's Kentucky assets, but was beaten out mainly over price by rival PPL (NYSE:PPL).

When asked about Duke's renewable energy business, Rogers said he sees no reason to spin off or even consider selling it as it provides better bottom-line growth to the company than its regulated assets. In fact, Rogers said it is a good time to continue buying renewable energy assets.

A Duke Energy source said that the company is in talks with its Chinese partners to create a solar energy joint venture that would allow Duke and its Chinese partner to roll out mega projects. The source said Duke hopes it can form a major joint venture with ENN Group, Huaneng Group and another partner that has not yet been publicly announced.

Late last year, ENN Group and Duke Energy signed an agreement creating a 50:50 joint venture to co-develop solar energy projects in the US. ENN Gropp has an on-going partnerships with Duke Energy in terms of technology development and market expansion, said an ENN insider focused on overseas market expansion.

"Such partnership is not limited by our joint venture," said the insider, who added he was unaware of any further solar energy joint venture plan Duke might have for China. He did did not rule out the possibility of further partnerships in solar energy projects in China between the two companies.

Though aware that Duke is talking to other potential Chinese partners, including Huaneng Group, a technology-focused insider at ENN noted that Duke’s potential cooperation with Huaneng could probably focus on wind power projects or smart grid skill development rather than solar energy.

The Duke source said the company has already reached an agreement with China’s sovereign wealth fund CIC to finance mega solar and other renewable projects. He said such a project could combine the best US corporate practices with China’s ability to manage and build out huge projects.

Friday, July 23, 2010

Autonomy (AU) to Announce Large Acquisition: Open Text (OTEX) Tipped As Possible Target

Autonomy, the UK-based enterprise software group may announce a large acquisition very shortly. Open Text, the listed Canadian software company, as a possible target. These are the two remaining independent Enterprise Search and Content Management players. Both have been struggling organically given the worst economic cycles in enterprise software spending while trying outgrow each other to get acquired first. However, a bid by Autonomy will have serious challenges - both as rival bidders and internal execution-related. I had expected the announcement on the analyst call yesterday which did not happen.

Yesterday Autonomy has announced its second quarter results; Some management highlights from the earnings relesease:

• Record six month revenues of $415.3 million (within the range of analyst expectations of $412-417m), up 28% from H1 2009 with overall organic growth at 14%

• Six months organic IDOL revenue growth at 24%; organic growth excluding professional services at 18%

• Gross profits (adj.) at $363.4 million, up 26% from H1 2009; gross margins (adj.) at 88%

• H1 2010 operating margins (adj.) at 44%

• Record H1 profit before tax (adj.) at $182.7 million, up 24% from H1 2009

• Record H1 fully diluted EPS (adj.) of $0.53 (within the range of analyst expectations of $0.52-0.55), up 22% from H1 2009 (IFRS: $0.42, up 17%)

• Q2 DSOs decreased to 82 days (Q1 2010: 93 days, Q4 2009: 88 days)

• Cash conversion for the second quarter was 98% (Q2 2009: 66%), and for the first half of 2010 was 93% (H1 2009: 72%)

According several analysts following the firm including Paul Morland and Richard Nguyan, there are some positives and negatives about the details of the quarter:


• Sustainable momentum in OEM revenue (17% group revenue) with FY10 growth of 30%+ thanks to strong OEM activity over the last two years;

• Large standardisation deals (>$1M), more profitable, maintain a good momentum (Q2: 25, Q1: 19, Q4 09: 24, Q3 09: 13);

• Focus on M&A. Management have consistently stated that the firm would make an acquisition in second half to expand further its product footprint. As with previous deals (Verity, Interwoven), a move could provide Autonomy with additional scope for growth and improve margins via cross-selling opportunities within the installed base, noting the group’s excellent execution track record.


• Decelerating overall organic growth (Q2 13%, Q1 17%, Q4 09 18%) due to decelerating product revenue (66% group revenue) and

• Increased sales and marketing expenses which may slow the pace of profit increase.

• Cash conversion is worse than it should be and some unusual balance sheet movements may be masking warning signals such as high DSOs and falling deferred income.

• The rising working capital trend is not adequately explained either by growth or the acquisition of companies with low working capital that needs several quarters to normalise. Debtors appear to be higher than they should be and creditors lower.

• The model Autonomy uses to defend its low cash conversion ignores creditor movements and looks flawed to us.

• A focus in presentations on high growth rates that are largely due to acquisitions is misleading.

• The phrase “very strong cash collections” seems out of place when debtors and DSOs are on upward trends.

• Consider that Autonomy’s closest competitor was bought by Microsoft in 2008, and yet no one appears to have shown any interest in acquiring Autonomy.

• Stated organic growth rates regularly exceed our own estimates.

• Many balance sheet movements at the time of acquisitions are hard to explain and do not appear to reconcile with the cash flow statement.

• Recent deals (e.g. Microlink) appear to lack business logic.

Autonomy’s poor Q2 results will inevitably force the firm to grow inorganically. Given the firm’s rich valuation, Autonomy’s buying OTEX would make sense. Autonomy’s own story on paper sounds great: Class-leading IDOL technology with multiple vertical applications; defensive end-markets such as government, very high margins, impressive earnings growth and a strong balance sheet. However, I believe there are plenty of reasons to believe that the reality may not live up to the spin from the management. If Autonomy ends up acquiring OTEX (which is an acquisition machine itself with about the same size), I would stay away from the stock until the dust settles….because this would be just too big to swallow…almost two drunk men trying to stand still by leaning against each other.

Thursday, July 22, 2010

IBM to Buy More Software Firms. Can IBM Compete with Oracle?

IBM is looking for more buys, the Wall Street Journal reported. The unsourced 19 July report, part of the paper's Heard on the Street column looking at how venture backed start ups have little choice buy to look for strategic suitors, stated that IBM has recently made a series of buys of software companies and is looking for more acquisitions.

IBM did not impress Wall Street analysts earlier this week with its earnings release due to:

1. Disappointing Services signings:  IBM signed contracts totalling $12.3bn (-12%) in Q2, 13% below  consensus.

2. Slowdown in Software at 2% growth (+6% excluding IBM PLM) despite easy comps (Q2 09: -7%) and Oracle's strong performance in infrastructure software suggesting a better environment

3. Sluggish demand in Europe with sales -6% (-1%cc) to $7.4bn while Americas were up 2% to $10.2bn and Asia Pacific +9% to $5.4bn

4. Reshuffle of senior management that we think may set the stage for succession of current CEO Sam Palmisano (59 year-old, CEO since 2002).

However, IBM has successfully transformed the revenue mix: services and software now accounts for 80% of revenues and 90% of profitability. Their increasing focus on software acqusitions should help fuel profitable growth provided they go for substantially larger deals competing with Oracle.

IBM shares were down 4.3% in aftermarket trading. Investors likely to remain cautious on recovery pace in my view.

Computer Sciences Corp to Spend $ 250-500 M Annually on Acquisitions

Computer Sciences Corp (NYSE: CSC) of Falls Church, Virginia, is seeking to increase its acquisition spending, according to Mike Mancuso, chief financial officer. The Wall Street Journal quoted Mancuso stating that the IT-services group plans to spend USD 250-500 M on average, annually, over the next three years to acquire businesses working in cyber security, healthcare and cloud computing.

Computer Sciences Corp was holding cash of USD 2.8 billion as of 2 April this year, the report said. The article containing the information was focused on an apparent new willingness of companies to make acquisitions.

CSC has been falling behind among top Businsess Process Outsourcing players that have been consolidating too. They had no choice but to jump on the bandwagon of inorganic growth. Depending upon the industry and domain, we will likely see increased number of acquirers with deep pockets chasing similar deals and inevitabely pushing transaction multiples and valuations higher.

EMC Seeking Acquisitions with $10.8 Billion Cash

The company who bought my previous firm, Document Sciences, EMC CEO Joseph Tucci said yesterday that the information technology infrastructure provider will look for “a string of pearls” – smaller acquisitions in 2010 probably no larger than USD 400m - as it considers buys in the year ahead.

Tucci, noting that the company has a sizeable potential acquisition base, with plenty of cash, said what he considers small may seem larger from other perspectives.

"I’ve always said I favor a 'string of pearls' as opposed to a massive acquisition,” Tucci told investors and analysts during the company’s second quarter earnings call, responding to a question on the size of potential targets.

“I think from a revenue standpoint, the highest – biggest company we bought had USD 400 million in revenue or something thereabouts,” he said. “So when you talk on a base of USD 16.5bn plus, certainly that’s not – I don’t call that big. Okay? But obviously in dollar value, I would say you’re correct. That would be a trend that you should think we’re going to continue. It’s worked really well, and it’s what I like."

David Goulden, company CFO, said the company has USD 10.8bn in cash, and spent USD 341m buying back company stock in the second quarter, bringing the number to USD 500bn for the year; it will likely spend another USD 1bn in stock buybacks by year end, he noted.

Thursday, July 15, 2010

Indian Outsourcers: How Well/Long Will They Perform Based on Labor Arbitrage Alone?

The following post from today's Financial Times promises continued financial success with Indian Outsourcers. However, on Tuesday Infosys reported earnings that are below analyst expectations. In my opinion, offshore model based on pure labor arbitrage economics does not create a sustainable source of economic value.  I tend to see IBM, HP/EDS and even Xerox/ACS having better chances of winning by applying proprieatry tools and technologies to brokoen or hard-copy centric worklfows and processes to first reengineer then digitize and automate forever. Perhaps Infosys might be signaling what lies ahead....

Things are looking up in the world’s back office. Accenture, the IT and consultancy firm, lifted operating profit by 10 per cent year-on-year in the third quarter; bookings from financial services clients are at record levels. In India, number two outsourcer Infosys is guiding for top-line growth of around 20 per cent in the year to March. Analysts, undeterred by the fact some of their own jobs have been outsourced to Bangalore, are big fans: Accenture, Infosys and Tata Consultancy, India’s industry leader, each carries a single sell recommendation to 20-40 buys.

Outsourcing is an easy industry to like. Theoretically at least, it thrives on economic downturns – when banks, governments and other clients find it cheaper to outsource than maintain their own bloated back offices – as well as in good times. The cost base, being mainly people, is flexible. The marketplace, while heavily tilted towards the US, is global. And the formula works. From 1996-2004 Infosys was increasing earnings at an average clip of 60 per cent a year; in the subsequent five years growth was still running at 36 per cent. The Indian trio, including Wipro, have generated total returns of 60-100 per cent in the past year.

But, as Infosys’ third-quarter numbers showed on Tuesday, even the gilded can stumble. Results fell short of analyst expectations; this follows a year where earnings growth decelerated to a mere 4 per cent. Increasing tentacles into budget-slashing nations such as the US and UK suggest slimmer margins. Tata Consultancy, for example, won the contract to administer the UK’s new personal pension accounts, worth maybe £600m, when other bidders could not make the numbers stack up.

Wages, devouring 44 per cent of revenues, remain the industry’s Achilles’ heel. No matter. The sector, having outperformed the broader Indian market massively last year, has lagged this year but global IT spending will grow 5 per cent, Goldman Sachs reckons. Add in some currency tailwinds and it will be hard as ever to keep the irrepressible bulls down.

Who Will Buy with its $1.8 Billion? Is a Target too?, the San Francisco-based software services company, may use tuck-in buys versus larger deals for growth and could also be a target, according to a Citigroup research report.

The analyst report stated that the company has a$ 1.8 Billion cash and 412 Billion market cap and noted that there are several types of deals it could do, for example, tuck-in deals of CRM companies such as Xactly, Apttus, or Eloqua; or deals outside's existing "ecosystem" such as Lithium and Jive or R&D related deals.

The research report stated that it can't be ruled out that may be a target for larger IT businesses, but that analysts think only California tech giants Oracle or Google would be possible acquirers.

In my opinion, following the integration of the Sun deal, Oracle will continue making buys at full speed in the CRM, Business Intelligence and Enterprise Content Management but only if the price is right. Given the co-CEOs recent press annoucements, SAP may be another bidder in the same domains.

A Citigroup analyst said Google to be prioritizing M&A options linked to advertising. In addition, the report named Washington-based Microsoft, New York-based IBM, and Germany-based SAP AG as possible bidders.

Wednesday, July 14, 2010

Hewitt/Aon Merger: Will a Rival Bid Swoop In?

Chicago-based Aon announced on Monday plans to acquire Hewitt for .6362 Aon shares and $ 25.61 in cash per Hewitt share, or about $ 4.9 Billion. Hewitt is “highly confident” about Aon’s financing.

Aon will likely wait until after securing shareholder approval to issue notes to fund the acquisition of Hewitt Associates, according to our sources.  The companies do not have a specific target date for the shareholder votes, but they could take place by late October or early November with the notes issued soon afterwards. The firms do not expect antitrust problems in either the US or Europe.

The cash portion of the transaction will be funded with a $1 Billion term loan and $1.5 Billion in notes, backstopped by a $ 1.5 Billion bridge facility from Credit Suisse and Morgan Stanley. Aon will likely issue a combination of five and ten year notes. This source reiterated comments by Aon’s CFO on Monday that Aon has no plans to draw down on the bridge facility.

The deal came together after Aon and Hewitt held internal discussions on the directions of their businesses. Aon debated growing its insurance brokerage business, but concluded it was more important to more evenly balance revenue between the brokerage and consulting businesses.

Once the deal closes, about 60% of Aon’s revenue will come from its brokerage and 40% from human resources outsourcing and consulting, compared to 80% and 20% prior to the deal. Aon will now more closely mimic the revenue mix of its rival, Marsh & McLennan.

Management is headed to the southeastern US today to meet with leading investors to brief them on Aon’s new direction, the first source said. We expect institutional shareholders to back the expansion of Aon’s consulting business.

On Hewitt’s side, over the years the company explored the idea of making acquisitions, including buying Aon’s consulting business or moving into the insurance brokerage business. Hewitt may have also talked about selling at times.

However, Hewitt’s CEO, Russell Fradin, told investors on Monday that the company was not for sale when Aon approached with an offer. Hewitt did not run a sale process in response to the inquiry, Aon’s CEO, Greg Case, told investors on the same call. Likewise, Aon did not make overtures to other human resources consultants, the first source added.

Potential rival bidders include Accenture, IBM and Marsh & McLennan, although a hostile offer is highly unlikely. Until the end of August, Hewitt only has to pay a $ 85M termination fee if the company receives a superior offer to Aon’s.

Marsh & McLennan likely would have moved to acquire Hewitt in the past if it was interested in buying the business to expand its Mercer human resources unit. Several firms have looked at Hewitt over the years.

Now that Hewitt’s management team and board have committed to selling, a rival bidder may be hesitant to swoop in because a hostile offer could push Hewitt’s primary assets – its consultants – to leave the firm. Aon and Hewitt’s chief executives are longtime friends and the firms held extensive talks on how to merge.

We expect more deals at accelerated speed. Our most attractive target remains Hay Group.

Consolidation in Consulting: PWC in talks to buy Diamond Management & Technology Consultants. More Deals Expected.

According to Wall Street Journal, PricewaterhouseCoopers, the New York consulting firm, is in discussions to buy Diamond Management & Technology Consultants for around $50M partly in reaction to Aon's deal to buy Hewitt Associates for around $4.9 Billion.

Consulting firm Deloitte of New York is also looking for buys. Accordingly, there should be more consolidation in the consulting industry, with companies looking for buys that give them a global presence, diversify them and more products and services to sell.

The WSJ report noted that Accenture and Towers Watson &Co, along with Deloitte and PWC should get more aggressive in buying smaller consulting firms. Hay Group remains as an attractive potential target. PricewaterhouseCoopers Chairman Robert Mortiz said the company is looking at a number of buys and it wants bigger, transformational deals and niche buys.

Consolidation in Consulting Industry: Aon Agrees to Buy Hewitt

Only a week after A.T. Kearney, Booz called off merger talks, according to WSJ and other media sources, Aon Corp. agreed to buy Hewitt Associates Inc. in a cash-and-stock deal valued at about $4.9 billion in another sign of consolidation in the management-consulting industry.

The two are the latest consulting-industry players to flirt or agree to a deal in recent weeks as firms seek to get bigger to woo more global business. The industry is still suffering from recessionary aftershocks. While work volume has rebounded, average billing rates remain depressed. As a result, bigger firms are looking for ways to grow through acquisitions. And some are finding opportunities to snap up bargains as smaller firms seek the heft to compete.

Midsize firms A.T. Kearney Inc. and Booz & Co. explored a possible merger for about six months before calling off talks last week. Deloitte LLP is hunting for acquisitions. So is PricewaterhouseCoopers LLP, which is in talks to buy Diamond Management & Technology Consultants Inc. for about $50 million.

We should see more consolidation in the consulting sector, where firms are looking for global scale, diversity and additional products and services to cross sell to their clients.

The industry's world-wide revenue sank about 10% last year to $170 billion, and we are looking at 2% growth per year over the next four to five years. Corporate clients are also evaluating consultants' services more skeptically.

At the same time, the biggest firms, such as McKinsey & Co., are gaining more clout, leaving midsized players vulnerable. The biggest 10 consulting firms controlled about 38% of global revenue in 2009.

Industry watchers expect such large firms as Deloitte, PwC, Accenture PLC and Towers Watson & Co.— itself the creation of a merger completed earlier this year—to get more aggressive about acquisitions, with smaller firms in their crosshairs.

One possible target may be midsized Hay Group. The Hewitt deal, the largest in insurance broker Aon's history, would nearly triple the size of the company's human-resources operations, making it a $4.3 billion business by revenue. Aon Hewitt, as the combined consulting and outsourcing operation will be known, would be run by Hewitt Chief Executive Russ Fradin.

Aon has acquired dozens of firms to expand the company's insurance and human-resources arms. The latest deal would give Aon a human-resources consulting operation to rival competing brokerage Marsh & McLennan Cos., whose Mercer and Oliver Wyman units had combined consulting revenue of $4.6 billion in 2009. In an interview, Aon CEO Greg Case said the Hewitt takeover means Aon will be able to offer management-consulting advice more effectively in 120 countries where it already provides risk-management and insurance services because Hewitt's consulting brand is stronger.

Mr. Case said he first approached Hewitt's Mr. Fradin a year ago because "our clients were asking for greater global reach" as they faced increasingly complex issues. Takeover talks intensified during the past two months, he added.

PricewaterhouseCoopers Chairman Robert Moritz expects more consolidation in the industry. "People are looking for ways to enhance revenue and gain market share, so acquisitions in your direct critical core competencies as well as expanding your portfolio are going to be a continued trend," he said.

Mr. Moritz is looking at a number of acquisitions. He said that he wants larger, transformational purchases as well as niche deals to bring specialized skill sets such as regulatory know-how.

He also noted that consultants are continuing to have trouble getting revenue growth through big across-the-board price increases. As we've seen volume increases we've tried to raise some pricing in a balanced way," he says. He said that he expects the pricing pressure to continue for the next couple of years as customers "expect more for less."

Thursday, July 08, 2010

The Five Types of Successful Acquisitions

Have come across a great summary of five different ways to cut successful M&A deals by McKinsey; I tend to find McKinsey's work generally too academic without operational, practical depth but this one has passed the test;  Companies advance myriad strategies for creating value with acquisitions—but only a handful are likely to do so.  Interestingly, I have made a number of successful ones that fit in each category...but some did not and were not accretive in the early years.  I am sharing the article along with highlights from my own experience:

There is no magic formula to make acquisitions successful. Like any other business process, they are not inherently good or bad, just as marketing and R&D aren’t. Each deal must have its own strategic logic. In our experience, acquirers in the most successful deals have specific, well-articulated value creation ideas going in. For less successful deals, the strategic rationales—such as pursuing international scale, filling portfolio gaps, or building a third leg of the portfolio—tend to be vague.

Empirical analysis of specific acquisition strategies offers limited insight, largely because of the wide variety of types and sizes of acquisitions and the lack of an objective way to classify them by strategy. What’s more, the stated strategy may not even be the real one: companies typically talk up all kinds of strategic benefits from acquisitions that are really entirely about cost cutting. In the absence of empirical research, our suggestions for strategies that create value reflect our acquisitions work with companies.

In our experience, the strategic rationale for an acquisition that creates value typically conforms to at least one of the following five archetypes: improving the performance of the target company, removing excess capacity from an industry, creating market access for products, acquiring skills or technologies more quickly or at lower cost than they could be built in-house, and picking winners early and helping them develop their businesses. If an acquisition does not fit one or more of these archetypes, it’s unlikely to create value. Executives, of course, often justify acquisitions by choosing from a much broader menu of strategies, including roll-ups, consolidating to improve competitive behavior, transformational mergers, and buying cheap. While these strategies can create value, we find that they seldom do. Value-minded executives should view them with a gimlet eye.

Five archetypes

An acquisition’s strategic rationale should be a specific articulation of one of these archetypes, not a vague concept like growth or strategic positioning, which may be important but must be translated into something more tangible. Furthermore, even if your acquisition is based on one of the archetypes below, it won’t create value if you overpay.

Improve the target company’s performance

(HA>Affiliated Computer Services acquisition by Xerox Global Services, my old employer)

Improving the performance of the target company is one of the most common value-creating acquisition strategies. Put simply, you buy a company and radically reduce costs to improve margins and cash flows. In some cases, the acquirer may also take steps to accelerate revenue growth.

Pursuing this strategy is what the best private-equity firms do. Among successful private-equity acquisitions in which a target company was bought, improved, and sold, with no additional acquisitions along the way, operating-profit margins increased by an average of about 2.5 percentage points more than those at peer companies during the same period.1 This means that many of the transactions increased operating-profit margins even more.

Keep in mind that it is easier to improve the performance of a company with low margins and low returns on invested capital (ROIC) than that of a high-margin, high-ROIC company. Consider a target company with a 6 percent operating-profit margin. Reducing costs by three percentage points, to 91 percent of revenues, from 94 percent, increases the margin to 9 percent and could lead to a 50 percent increase in the company’s value. In contrast, if the operating-profit margin of a company is 30 percent, increasing its value by 50 percent requires increasing the margin to 45 percent. Costs would need to decline from 70 percent of revenues to 55 percent, a 21 percent reduction in the cost base. That might not be reasonable to expect.

Consolidate to remove excess capacity from industry

(HA>A major deal I am currently working on in an industry over-regulated, hyper-competitive with over 30 firms, price competition, all players destroying economic value ie ROE below inflation)

As industries mature, they typically develop excess capacity. In chemicals, for example, companies are constantly looking for ways to get more production out of their plants, while new competitors continue to enter the industry. For example, Saudi Basic Industries Corporation (SABIC), which began production in the mid-1980s, grew from 6.3 million metric tons of value-added commodities—such as chemicals, polymers, and fertilizers—in 1985 to 56 million tons in 2008. Now one of the world’s largest petrochemicals concerns, SABIC expects continued growth, estimating its annual production to reach 135 million tons by 2020.

The combination of higher production from existing capacity and new capacity from recent entrants often generates more supply than demand. It is in no individual competitor’s interest to shut a plant, however. Companies often find it easier to shut plants across the larger combined entity resulting from an acquisition than to shut their least productive plants without one and end up with a smaller company.

Reducing excess in an industry can also extend to less tangible forms of capacity. Consolidation in the pharmaceutical industry, for example, has significantly reduced the capacity of the sales force as the product portfolios of merged companies change and they rethink how to interact with doctors. Pharmaceutical companies have also significantly reduced their R&D capacity as they found more productive ways to conduct research and pruned their portfolios of development projects.

While there is substantial value to be created from removing excess capacity, as in most M&A activity the bulk of the value often accrues to the seller’s shareholders, not the buyer’s.

Accelerate market access for the target’s (or buyer’s) products

(HA>Our Objectiva acquisition back at EMC Document Sciences or Tektronix acquisition back at Xerox)

Often, relatively small companies with innovative products have difficulty reaching the entire potential market for their products. Small pharmaceutical companies, for example, typically lack the large sales forces required to cultivate relationships with the many doctors they need to promote their products. Bigger pharmaceutical companies sometimes purchase these smaller companies and use their own large-scale sales forces to accelerate the sales of the smaller companies’ products.

IBM, for instance, has pursued this strategy in its software business. From 2002 to 2009, it acquired 70 companies for about $14 billion. By pushing their products through a global sales force, IBM estimates it increased their revenues by almost 50 percent in the first two years after each acquisition and an average of more than 10 percent in the next three years.2

In some cases, the target can also help accelerate the acquirer’s revenue growth. In Procter & Gamble’s acquisition of Gillette, the combined company benefited because P&G had stronger sales in some emerging markets, Gillette in others. Working together, they introduced their products into new markets much more quickly.

Get skills or technologies faster or at lower cost than they can be built

(HA>ACS acquisition by Xerox Global Services)

Cisco Systems has used acquisitions to close gaps in its technologies, allowing it to assemble a broad line of networking products and to grow very quickly from a company with a single product line into the key player in Internet equipment. From 1993 to 2001, Cisco acquired 71 companies, at an average price of approximately $350 million. Cisco’s sales increased from $650 million in 1993 to $22 billion in 2001, with nearly 40 percent of its 2001 revenue coming directly from these acquisitions. By 2009, Cisco had more than $36 billion in revenues and a market cap of approximately $150 billion.

Pick winners early and help them develop their businesses

(HA>We sold our software company Document Sciences to EMC)

The final winning strategy involves making acquisitions early in the life cycle of a new industry or product line, long before most others recognize that it will grow significantly. Johnson & Johnson pursued this strategy in its early acquisitions of medical-device businesses. When J&J bought device manufacturer Cordis, in 1996, Cordis had $500 million in revenues. By 2007, its revenues had increased to $3.8 billion, reflecting a 20 percent annual growth rate. J&J purchased orthopedic-device manufacturer DePuy in 1998, when DePuy had $900 million in revenues. By 2007, they had grown to $4.6 billion, also at an annual growth rate of 20 percent.

This acquisition strategy requires a disciplined approach by management in three dimensions. First, you must be willing to make investments early, long before your competitors and the market see the industry’s or company’s potential. Second, you need to make multiple bets and to expect that some will fail. Third, you need the skills and patience to nurture the acquired businesses.

Harder strategies

Beyond the five main acquisition strategies we’ve explored, a handful of others can create value, though in our experience they do so relatively rarely.

Roll-up strategy

Roll-up strategies consolidate highly fragmented markets where the current competitors are too small to achieve scale economies. Beginning in the 1960s, Service Corporation International, for instance, grew from a single funeral home in Houston to more than 1,400 funeral homes and cemeteries in 2008. Similarly, Clear Channel Communications rolled up the US market for radio stations, eventually owning more than 900.

This strategy works when businesses as a group can realize substantial cost savings or achieve higher revenues than individual businesses can. Service Corporation’s funeral homes in a given city can share vehicles, purchasing, and back-office operations, for example. They can also coordinate advertising across a city to reduce costs and raise revenues.

Size per se is not what creates a successful roll-up; what matters is the right kind of size. For Service Corporation, multiple locations in individual cities have been more important than many branches spread over many cities, because the cost savings (such as sharing vehicles) can be realized only if the branches are near one another. Roll-up strategies are hard to disguise, so they invite copycats. As others tried to imitate Service Corporation’s strategy, prices for some funeral homes were eventually bid up to levels that made additional acquisitions uneconomic.

Consolidate to improve competitive behavior

Many executives in highly competitive industries hope consolidation will lead competitors to focus less on price competition, thereby improving the ROIC of the industry. The evidence shows, however, that unless it consolidates to just three or four companies and can keep out new entrants, pricing behavior doesn’t change: smaller businesses or new entrants often have an incentive to gain share through lower prices. So in an industry with, say, ten companies, lots of deals must be done before the basis of competition changes.

Enter into a transformational merger

A commonly mentioned reason for an acquisition or merger is the desire to transform one or both companies. Transformational mergers are rare, however, because the circumstances have to be just right, and the management team needs to execute the strategy well.

Transformational mergers can best be described by example. One of the world’s leading pharmaceutical companies, Switzerland’s Novartis, was formed in 1996 by the $30 billion merger of Ciba-Geigy and Sandoz. But this merger was much more than a simple combination of businesses: under the leadership of the new CEO, Daniel Vasella, Ciba-Geigy and Sandoz were transformed into an entirely new company. Using the merger as a catalyst for change, Vasella and his management team not only captured $1.4 billion in cost synergies but also redefined the company’s mission, strategy, portfolio, and organization, as well as all key processes, from research to sales. In every area, there was no automatic choice for either the Ciba or the Sandoz way of doing things; instead, the organization made a systematic effort to find the best way.

Novartis shifted its strategic focus to innovation in its life sciences business (pharmaceuticals, nutrition, and products for agriculture) and spun off the $7 billion Ciba Specialty Chemicals business in 1997. Organizational changes included structuring R&D worldwide by therapeutic rather than geographic area, enabling Novartis to build a world-leading oncology franchise.

Across all departments and management layers, Novartis created a strong performance-oriented culture supported by shifting from a seniority- to a performance-based compensation system for managers.

Buy cheap 

(HA>Timing is eveything when cuttingM&A deals, I could not emphsize how critical this is when it comes to creating economic value for shareholders.  This is precisely why now it is time to make acquisitions especially for small to medium size businesses targeting companies in Europe which what most Asian and Middle Eastern firms have been doing)

The final way to create value from an acquisition is to buy cheap—in other words, at a price below a company’s intrinsic value. In our experience, however, such opportunities are rare and relatively small. Nonetheless, though market values revert to intrinsic values over longer periods, there can be brief moments when the two fall out of alignment. Markets, for example, sometimes overreact to negative news, such as a criminal investigation of an executive or the failure of a single product in a portfolio with many strong ones.

Such moments are less rare in cyclical industries, where assets are often undervalued at the bottom of a cycle. Comparing actual market valuations with intrinsic values based on a “perfect foresight” model, we found that companies in cyclical industries could more than double their shareholder returns (relative to actual returns) if they acquired assets at the bottom of a cycle and sold at the top.3

While markets do throw up occasional opportunities for companies to buy targets at levels below their intrinsic value, we haven’t seen many cases. To gain control of a target, acquirers must pay its shareholders a premium over the current market value. Although premiums can vary widely, the average ones for corporate control have been fairly stable: almost 30 percent of the preannouncement price of the target’s equity. For targets pursued by multiple acquirers, the premium rises dramatically, creating the so-called winner’s curse. If several companies evaluate a given target and all identify roughly the same potential synergies, the pursuer that overestimates them most will offer the highest price. Since it is based on an overestimation of the value to be created, the winner pays too much—and is ultimately a loser.4

Since market values can sometimes deviate from intrinsic ones, management must also beware the possibility that markets may be overvaluing a potential acquisition. Consider the stock market bubble during the late 1990s. Companies that merged with or acquired technology, media, or telecommunications businesses saw their share prices plummet when the market reverted to earlier levels. The possibility that a company might pay too much when the market is inflated deserves serious consideration, because M&A activity seems to rise following periods of strong market performance. If (and when) prices are artificially high, large improvements are necessary to justify an acquisition, even when the target can be purchased at no premium to market value. Premiums for private deals tend to be smaller, although comprehensive evidence is difficult to collect because publicly available data are scarce. Private acquisitions often stem from the seller’s desire to get out rather than the buyer’s desire for a purchase.

By focusing on the types of acquisition strategies that have created value for acquirers in the past, managers can make it more likely that their acquisitions will create value for their shareholders.

I would love to hear about your M&A deals; Does your experience align with the conclusions above?
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Sunday, July 04, 2010

How to Build Winning Alliances

If you are a corporate executive or a small business owner, alliances are even more instrumental to your economic success. In a business world that is increasingly global, volatile, and fast, alliances have become a more and more prominent aspect of business strategy, but many executives still aren’t paying enough attention.

Too often, firms enter into business with the wrong partner or for the wrong rationale, and they end up regretting the decision. An alliance may look great on paper but cultural differences between the parties or misaligned expectations can end the relationship sooner than later.

Here's how you can develop eduring alliances by focusing on three crtical success factors:

1. Selecting the Partner:

I have been deal-making for over 15 years in different geographies with companies of various sizes and I can’t emphasize enough the following:

Understand clearly why you need a partner – to access new clients, markets, technology, capabilities.

Determine the tradeables – for a sustainable alliance, both firms must benefit from it. You need to be able to articulate what your firm will uniquely trade in return for the other firm’s assets or capabilities.

Investigate your partner candidates - You should always choose the one with most balanced tradeable picture and best reputation possible. You will never get a second chance to make a good first impression.

Remember to invest as much of your time in selecting the right partner upfront. It is not companies that do business but it is the people!

2. Making the Deal:

Once you have selected the right partner, it is always a good idea to put everything in writing. In my experience, this is the most mechanical step in the process. However, you should always plan for an exit in a meaningful timeframe in any alliance.

Discuss and agree upon the arrangement - determine the scope of the partnership; goals, roles, and responsibilities for each party along with key milestones and other details; rules for intellectual property and financial arrangements.

Ensure line of business accountability upfront – If you work for a large firm, it is always a good idea to involve a sponsor now from a line of business who will be held operationally accountable for the success of the alliance. A best practice deal should include financial and operational targets that are tangible and trackeable.

Hire a great lawyer – You are inking the deal for the bad times. Recruiting the best lawyer you can afford could make a big difference if things go sour with your new partner.

3. Managing the Alliance:

New partners often find it difficult to work together especially in the early days of the relationship. There are several critical success factors to maximize the economic returns from the alliance:

Meet and greet all your partners - As soon as the alliance is signed, plan a series of events to introduce every member of the partner within your company. Never underestimate the human element of face to face contact and relationships. Talk about the alliance and explain its purpose and how it will work.

Identify and communicate who will manage the alliance and how - As early as possible, you and your ally from the partner firm should discuss how often you will meet, what process and project plans you will oversee along with the key people, targets, due dates, key deliverables, control mechanisms, etc.

Select a sponsor - Your chances of success with partnering particularly a large company rests on your ability to recruit a champion for the relationship. Select a senior individual who is exceptionally motivated about the alliance who can evangelize the alliance and mobilize resources and dollars in the partnered firm on your behalf.

Secure quick wins early – Winning alliances deliver results early so both alliance sponsors can proudly communicate the economic value of the tradeables internally. Remember that both sponsors have taken a personal career risk as well. If you are partnering with a large firm, there will be many other alliances competing for resources, dollars and management time. This is the best way to get your firm higher on the priority list.

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