M&A East: Add-On Deals

The Merger Verger just returned from M&A East, perhaps the preeminent middle market acquisition event of the year in this part of the world. M&A East is put on by the Philadelphia chapter of the Association for Corporate Growth and is very well done and very well attended.

While most of the attendees come for the rich networking opportunities, there are also work sessions and presentations … actual “content.”  The Merger Verger attended one roundtable session dealing with the large role that the Buy-and-Build strategy and add-on deals are playing increasingly in the private equity world.

We noted a number of interesting or useful points:

• The Buy-and-Build investment strategy has both the advantages and disadvantages of focus: wisdom, experience and increasing market power and multiple arbitrage on the upside; concentration and lack of diversity on the down side. Pick your poison.
• Market fragmentation can be an important attribute of a sector appropriate for Buy-and-Build but it requires some perspective and caution (read “better due diligence):
  • Is fragmentation the result of incremental market development over time or some fundamental customer or sourcing requirement?
  • A market that has long been fragmented may have an entrenched fragmented purchasing process on the customer side, making the synergy potential of national footprint harder or slower to realize.
  • As fragmentation decreases through consolidation, multiples can skyrocket.
  • Once the fragmentation has been wrung out, where will the next generation of growth come from?
• Some fragmented industries that were mentioned as undergoing PE consolidation: landscaping services, specialty physician practices, industrial crating.
• Add-on deals don’t have to smaller than the core operation although The Merger Verger notes that the integration can be more subtly complex with the egos of the newer larger company clashing with those of the smaller original company. We’re bigger and stronger than you. Yeah, but we were here first, doing fine on our own, thank you.
• When doing add-on deals, the question of branding looms large. It is highly possible that a small local brand carries more value in its market than a larger, more visible one. Landscaping services was an example of this.
• On the question of making acquisitions during economic downturns, most of the roundtable presenters felt that it was important to carry on. One presenter saw downturns as an opportunity to average down their purchase multiples.

• Conversely, both presenters and attendees noted that many middle market sellers don’t pay that much attention to multiples; they focus on price. (Multiples do not affect a seller’s retirement plans; raw dollars do.) In that context multiples can get ugly in a downturn.
• While the topic of integration was listed on the agenda, it got – as it often does – a short shrift. There is still this sense that getting through closing is the Win. It is not. The Verger repeats: you will have a vastly more predictable and successful outcome if you actively manage the “hows” of integrating your add-on deal:
  • How are we going to realize the strategic intent behind this deal?
  • How are we going to avoid the identified risks factors?
  • How are we going to keep the best producers of the target company?
  • Exactly how are we going to get our products selling through their channels?
  • How are we going to make their square product design (or production or management or culture or sales) peg fit into our round hole?
• Seller-entrepreneurs like the Buy-and-Build strategy:
  • They believe the buyer better understands “their baby”
  • It’s easier to get buy-in on visions and plans and investment
  • If the deal involves contingent payments, they have more faith in the the potential payoff
  • “Buy-and-Build” just feels a lot more appealing than “Slash and Burn”

Buyers like the B+B strategy.  Sellers like it too.  It may not be for every PE firm but it’s here to stay.

“Bravo,” says The Merger Verger.  And Bravo to M&A East.

How to Lose a Championship

It’s SuperBowl Weekend (woohoooo!) … that magical time of the year when all of life can be distilled down to sports maxims and 100-yard metaphors.

The Merger Verger’s favorite? This one:

Defense Wins Championships

Now, we get the universality of many sports maxims but as business guidance that one is a disaster, particularly in the context of M&A.

As every successful acquirer knows, good deals begin with good strategies. A good strategy gives rise to solid value drivers, which enable sharper focus and clearer future goals. It paves the way for asking more action-empowering questions in due diligence, which results in more effective solutions. And all that tends to lead to a more successful outcome for your acquisitions.

That part of M&A is as basic as it gets.

But…

Defense is Not a Strategy

Defense is an awareness, a tool for protecting your flanks (and your backside). It cannot and will not ever power you forward.

If the reason to do a deal is primarily defensive – to react impulsively to some competitor’s move or prevent The Other Guy from buying some company – what, pray tell, do you do with the target once you’ve got it? On what basis do you make future decisions when in the mere act of closing you accomplish the only strategic objective that your action permits: allowing you to say, “We won?”

Defense may shape the outcome of Sunday’s game. But its value in doing deals is basically nil.

If your primary strategic objective is to keep a target out of someone else’s hands, “man up” and walk away. The truth is that too many good deals go bad. A bad deal (meaning one based on a bad strategy)? That is one trophy you can enjoy watching The Other Guy win.

Role Models:

Success:      P&G acquiring Gillette

Failure:        eBay acquiring Skype

TBD:             CVS acquiring Aetna

Choosing the Right KPIs

One of the most common mistakes that less experienced acquirers make is to apply their company’s standard Key Performance Indicators (KPIs) to the newly acquired target or to the integration/transition process itself.

As The Merger Verger has harped on over and over again, integrating two companies is not like running one larger one. It’s just not. (If you still can’t accept that premise, I suggest you’ll get more out of Archie and Jughead than any further reading of TMV.)

There are three key elements of successfully executing an acquisition:

1. Keeping the underlying business running successfully
2. Keeping the acquired business running successfully (or getting it to that state)
3. Integrating the two successfully

Well, DUH! The point isn’t that that list represents any rocket science on TMV’s part but it evidences why the next concept is so important:

If you’re performing three different activities,
you measure and assess them using three different standards or sets of measurements.

That’s the key here: for your integration you need to “think different.”

Start with these questions:

• What is the strategic intent of my deal?
• What are the keys to achieving that intent?
• What are the impediments or risks to getting there?

The answers to these questions should be the basis upon which all your integration KPIs are developed, quantified and prioritized.

Read that again: KPIs for an integration are about achieving
the core purpose behind the deal: what to focus on achieving, what to focus on avoiding. They are not about measuring the integration against your normal yardsticks; they’re about measuring it against the point of the deal.

Needless to say (but I’ll say it anyway): the intent behind basically every deal is unique. So The Merger Verger can’t tell you what KPIs to monitor.   IT ALL DEPENDS!!

That said, if your acquisition is about revenue growth through expanded territory, for example, track your sales in that territory alone (particularly sales to existing customers’ locations in the new territory), look for growth rates based on new standards not old, watch your new-customer intact; track your regional cross selling, measure after-sale follow through and reorder rates. In each case quantify your KPIs at levels that are appropriate for the new business, not the existing.

If your deal is about new technologies, for goodness sake measure your retention of key innovators but also watch the degree to which existing customer services or solutions are being repositioned with new capabilities, track your training of existing staff on new systems and their translation of that training into sales calls and revenues.

Figure it out for yourself. But THINK DIFFERENT. Focus not on how you’ve done it before but on what and how you measure to achieve the new specific objectives of the deal.

God Is In the Details -1

What follows is an old but nonetheless very useful tale of integration woe:

1. In the late 1990s, US auto parts company Federal-Mogul acquired UK auto parts company T&N. (So far so good)
2. Acquirer decided to integrate the target’s aftermarket sales function into its own, resident in the United States. (OK, maybe)
3. Federal-Mogul discovered that its ordering system couldn’t recognize non-US telephone numbers. (Uh oh)

Now the specifics of this mess could not happen with today’s CRM systems but the message is still relevant: God is in the details.

It’s hard for The Merger Verger to determine from the available facts whence cometh a screw-up like this one but I see two possibilities: either (i) there was insufficient focus on the operational aspects of due diligence or (ii) there was reasonable data collection but insufficient analysis and findings based on that data.

A fair measure of due diligence is about gathering information. But much of it is about using information.

If you are an infrequent acquirer or new to the deal business, this is an absolutely critical lesson for you to take in.

Some due diligence is about making sure you have information that you, the new owner of a business, should have. An example would be papers relating to the target’s corporate formation. You get the data; you put it in a file; you forget about it. (This kind of information will come from the due diligence checklist supplied by your lawyers.)

Other due diligence is about confirming that you are getting what you pay for (and the corollary, that you are not overpaying for it). An example, here, would be a statement of aging accounts receivable. If the target has a third of its receivable stretching back to Moses’ time, you might want to rethink the price you’re paying. (This kind of information will come from the due diligence checklist supplied by your accountants.)

Lawyers and accountants provide essential guidance in the development of due diligence checklists. But much of the information derived from those lists has limited use or limited life to its usefulness.

Not so with the next form of deal information.

The final form of due diligence is about getting ready to own the new business. This is the area where Federal Mogul fell down. You must understand how the business works down to some very nitty gritty details and then apply those findings to shape how you are going to integrate the business.

In Federal Mogul’s case, they should have realized that the customer-facing requirements of the target could not be handled by their own existing CRM system. Knowing that, they could have avoided making an uninformed misstep in the integration process or reversed the move by integrating their own customer interface with the apparently more flexible system that T&N used.

Can their customer database handle non-US telephone numbers? It seems like an impossibly small item to worry about. But sometimes it’s not.

In words of two syllables or less:

Make sure you get the operational information necessary to know how to integrate your acquisition.

Once you have gathered the information, use it.

And … before you make big integration decisions, consider doing further due diligence.  Closing day is not the end of information gathering … not by any stretch.

Acting quickly is generally the right approach when integrating two businesses. But don’t ignore the asterisk: act quickly … on good information.

About the Art:

The coining of the phrase “God is in the details” is attributed to German/American architect Ludwig Mies Van De Rohe. Despite having built some fairly impressive buildings including New York’s Seagram Building, Mies is perhaps best known for his Barcelona Chair (top), which he designed in 1929.

May your own work stand such a test of time.

A Galaxy of Acquired Brands

Entering the new year, The Merger Verger is watching one particular transaction that has good strategic intent and sensible (bordering on downright modest) synergy goals written between the lines of the announcement hyperbole: Newell Rubbermaid’s (NWL.N) purchase of Jarden Corporation (JAH.N) for cash and stock.

Each of these companies has an enormous stable of consumer brands (on which more below); together the list is mind boggling. And each company has grown over the years through acquisitions. It is tempting to quibble (or even judge harshly) that Jarden acquired more like a financial buyer (using acquisitions to build critical mass) whereas Newell Rubbermaid acquired more like a strategic buyer. But that would be splitting hairs.

Both companies know how to do deals. And both companies know how to integrate them into a larger whole. So the deal could have gone either way. In fact, Jarden founder Martin Franklin said, “If we had the multiple and we had the market cap, we’d be the buyer.” But from an integration perspective, The Merger Verger sees it as good news that the “strategic” buyer has come out the winner. (It’s also good news that no one is bandying about that hideous old saw “merger of equals.”) All tolled, the chances of this deal achieving its strategic intent would seem good.

 

The number of consumer brands represented by the combined entity in this deal (to be rechristened “Newell Brands”) is way too big to list but it is very impressive indeed. The key names are listed in the deal press announcement, available by clicking here.

Picking through the Year-End Commentaries

Those snappy thinkers at McKinsey wrapped up 2015 with a nice piece entitled “M&A 2015: New Highs, and a New Tone.” There are some interesting observations that warrant highlighting.

First, let’s give credit. The full McKinsey & Co. article can be found by clicking here.

Examining share price data in the days surrounding the initial announcement of deals, McKinsey found that investors in 2015 continued to be neutral on large deals (as regards the buyer’s shares), which is a step up from years past when they were decidedly negative.

But The Merger Verger wants to know why and we’re given two very promising explanations:

1. Companies are being smarter about large deals, more and more looking at them from the angle of revenue growth than cost reduction. It
   always requires an investment to reduce costs but investors appear to be saying that paying multiples over market to get those reductions perhaps isn’t the best approach.
2. Not only are companies smarter about why to do deals but they are getting smarter about how to do them as well, as this quote from the article states quite succinctly:

“Companies may also be getting better at integration and capturing deal synergies. In our observation, the discipline, professionalism, and capabilities around integration have certainly improved.”

This warms the cockles of, you know, The Merger Verger’s heart and … under the theory of better late than never we offer the following illustration to support this post.

(Rumor has it that the foregoing is Dutch wisdom… more advanced thinking from the folks that brought us the nutmeg, tulip manias, legal dope and the Kröller-Müller Museum.)

Deal Magic Potion

Sorry…!

Another interesting article from the folks at CFO magazine, this one from R. Neil Williams, CFO of Intuit, maker of QuickBooks, Quicken, TurboTax and other financial management tools. Intuit (Nasdaq: INTU) has done 15 acquisitions over the last two years. In his short article, Williams looks at the question, “Is there a magic potion to a successful inorganic growth strategy?”

Short answer: no … but there are keys to the process. Interestingly, having answered “no” to his own question, Williams turns immediately to the importance of strategic logic. Let the Merger Verger state that another way: he gives first priority to strategic logic, admonishing readers to be aware of (and leery towards) shiny objects that invariably come before acquisition leaders.

Pivotal Quote (wherein Williams comments on his overarching observation about deals as a means to corporate growth):

The lesson was that the most successful mergers involved [targets] that had similar culture, style and operating process. The ones that only brought economic benefit were challenged to succeed.

The Short and Sweet from the Verger:

1. The best deals arise from a buyer’s strategic plan and they address an identified gap or shortcoming.
2. A thorough due diligence process must include an assessment of the culture, the values and the operating mechanisms of the target company.
3. When acquiring a company still managed by its founders/owners, make sure you and they see a common future for “their baby” under your leadership and get them really juiced about that enlarged potential.
4. Empower your integration team to move quickly, including making rapid decisions.
5. Determine as soon as possible the fundamental changes that you expect to make and then communicate clearly what will stay the same and what will change.

The full text of the CFO article is available by clicking here. One page, well worth reading.

If you’d like to see some of the deals that Intuit has completed over the last few years, there is good descriptive information on their website. Click here.

Final Note:

Magic potions are not a strong suit here at the Merger Verger but we can offer the following list of ingredients (sourced from an old friend).

Eye of newt, and toe of frog,

Wool of bat, and tongue of dog,

Adder’s fork, and blind-worm’s sting,

Lizard’s leg, and howlet’s wing.

You’re on your own for quantities and procedure.  Just be careful.

Beware of Dog

There was a very interesting article in the Wall Street Journal last week about the trend towards acquisition predators becoming targets, in a process referred to as “a bid for a bidder.” For shareholders of the “winning” bidder, it is the opinion of The Merger Verger that this kind of transaction has “BEWARE” written all over it.

Let’s look at what happens and why it makes the old Verger nervous.

As everyone knows, you do not want to examine the process of making sausage too closely, so with a contrarian view, let’s start there. Sausage maker Hilllshire Brands Co. recently agreed to buy processed food company Pinnacle Foods Inc. That prompted a poultry company, Pilgrim’s Pride Corp., to look at Hillshire … and bid for them. That then led meat producer Tyson Foods to bid for Hillside also. Tyson got Hillside but the Pinnacle deal (Remember Pinnacle? They were the original target here.) was called off.

So what’s wrong with all that?

First, if Pilgrim’s Pride and Tyson were so interested in Hillshire, why hadn’t they bid before the Pinnacle deal was announced? Certainly Tyson – an experienced acquirer – knew beforehand basically what they were bidding for in Hillside but the whole process smells more of playing competitive defense than strategic offense. In situations like this, strategic rationale and thorough due diligence can go quickly out the window. And both of these deal attributes are cornerstones of a successful integration. You lose your focus on them or weaken their role in the deal process and your shareholders will pay. And pay.

Speaking of paying, is there any research on M&A that doesn’t point out how hubris and paying too much are key failure drivers over and over and over? And when is someone going to overpay most readily? When they think they are behind a competitive 8-ball or when the bidding is taken through several rounds. Sadly, there is no hero status for the guy who says, “Screw it; it’s gotten too pricey.”

There should be.

Which brings me to … The Verger’s Law:

The probability of deal failure increases by the square of the percentage change in price from the initial bid.

Deal Rollatini

The process of rolling up acquisitions in a fragmented industry is pretty standard stuff these days. But it’s still worth looking at the topic because there are so many variables within the “sameness” of fragmentation that can go wrong.

One of the major potholes you can hit in rolling up smaller acquisitions is sourcing.  No, not your own sourcing; your customers sourcing you! And if you don’t pay attention to that issue, your robust roll-up can get flattened.

Here’s the scenario: Say you’re a private equity investor looking to launch a consolidation play.  You make an investment in a fragmented industry, with the seed acquisition that has all the right attributes including a cornerstone customer, say, a Honeywell or a GE with locations and opportunities all over the map.  Your aspiration is to consolidate the industry and grow that customer into an enormous national account.  Good concept.

Bad reality.

Customers that source products or services from a highly fragmented industry have built up buying practices to mirror the availability of supply.  All of their sourcing processes and sourcing infrastructure are based on purchasing from myriad local vendors.

So if your investment thesis is predicated on reshaping the long-standing business practices of a customer, The Merger Verger predicts that you will be in for some rough going.

It is one thing to do a deal and change the culture of the acquired organization; you own it.  But changing a customer’s culture is quite another thing.  So we strongly recommend that you not base your deal economics on changing any deeply entrenched buying patterns of your customers, however brilliant you think your new offering might be. You could be betting the farm on someone else’s willingness to change.  Never a good strategy.

Reward:

Deal Rollatini in the Works

If the title of this posting inadvertently led you here in search of Italian food, The Merger Verger appreciates your reading all the way to the end.  Your reward is here: Veal Rollatini with Marsala Sauce.  (Our only suggestion might be to add some fresh ricotta to the mix.)  Let us know what you think.

The Destructive Power of the Individual – Part 2

A previous posting looked at the issues that can arise when acquiring a company with a long-time owner/founder or (even worse) an owner given to self-love … what the shrinks call a “narcissist.”  Today is follow-up: some cautionary approaches to dealing with them because (ah, life) they are way too prevalent to ignore.

Long-time owners can bubble with positive pride about their companies but their management techniques can make it extremely hard to tweeze apart what they themselves have accomplished versus what the company has accomplished.  Particularly if the seller/owner is retiring to Madagascar, this lack of clarity can become a big issue.

And narcissists can be enormously charming individuals.  That can make spotting one a

real challenge.  The Merger Verger is no shrink so I will turn you over to others smarting than me for more details on diagnosing or identifying them (see links below).

What I will do here is offer some suggestions and words of caution on dealing with them.