IT due diligence and M&A integration: how much is enough?

Paul Pechersky

Telcordia Technologies Inc.

Morgan Stanley Dean Witter says that in 1997 the announced global utility industry mergers and acquisition (M&A) volumes were $115 billion, exceeding $90 billion in the United States alone and triple the level of 1989. U.S. utilities are attractive for many reasons. The United States is the largest electricity market in the world. It`s rapidly deregulating. There is a stable legal environment. There are relatively attractive risk adjusted returns. The industry is a platform for convergence (fuel, telecom, cable, water, security) deals. The scope of a combined company results in scale. And, finally, U.S. utilities have significant management talent.

So how does information technology (IT) support change in this dynamic environment? How is profit secured, company objectives realized and strengthened with IT in a strong supportive role? It is a step by step process. Relating to IT, organization, systems, processes, and resources are affected during pre-and post-acquisition activities. The acquisition process itself involves eight major activities:

– Decide who`s responsible

– Develop an acquisition plan

– Define acquisition criteria

– Identify potential acquisition candidates

– Make effective contact with candidates

– Perform thorough due diligence

– Negotiate terms that deep the benefits

– Reap benefits through post-acquisition integration

The IT department, however, requires thorough and exacting performance of due diligence and post-acquisition integration value proposition.

Understanding IT complexity

According to the Meta Group, most M&A efforts fail to deliver anticipated benefits in a timely fashion. Underestimating complexity of integrating IT is one reason. Gartner Group believes 80 to 90 percent of the midsize to large enterprises in their client base will be actively involved in some phase of M&A activity during the next three years, either as an acquirer, a target, or part of a divestiture. IT has become a competitive differentiator and is considered a tool for economies of scale and critical mass.

Poor pre-merger planning can largely offset the financial and operational benefits that make a merger seem attractive in the first place.

With the takeover trend seemingly relentless and paralleled by an accelerating pace of change in technology driven systems IT will be fulcrum between profit and loss. Unfortunately for IT, what looks to investment bankers like a heavenly marriage can be hell in the computer room.

No well-managed organization would pursue an acquisition without first performing significant due diligence on the target company. Typically due diligence activities focus on financials: receivables; cash flow; investments; etc. In addition, depending on the situation, the due diligence team may also look at business processes, customers, products and services, policies and procedures; intellectual property (patents); subsidiary legal status; partnerships and product pipeline. The typical team is composed of lawyers, accountants, marketers, and some recently graduated MBAs who do not necessarily have the skill or experience to adequately perform IT due diligence. As a consequence, in many situations, IT systems, processes, and organizational models are given only a superficial review.

Common pitfalls

Some of the most common IT issues that arise after a deal is done include:

– Increased software license costs;

– Inability to integrate the supply chain systems in time to avoid delays in receiving materials; producing products and services; and maintaining appropriate levels of customer service;

– Impact on revenue, reputation and stock price due to integration delays;

– Discovery of old, unsupported hardware and software that must be kept to support some regulatory, tax or other data no one knew about;

– Missing the window (no pun intended) to prepare for Internet-driven competition;

– Lock-in of higher-than-average cost structure due to merged duplicate infrastructure;

– Lengthened project times and deeper costs due to staff uneasiness, the difficulty of cultural integration and other personnel factors;

– Failure to achieve planned staff reductions because companies failed to discover a number of legacy systems;

– Disgruntled employees who may corrupt key data before they leave; and

– The inevitable call from the CEO to the CIO wanting to know where all those IT savings are that did not materialize from the “deal.” IT costs reduction targets are typically in the 30 to 50 percent range.

Additionally, mergers and acquisitions can create an imbalance between organizations resulting in constant change for up to 36 months.

Although there are many ways to slice and dice IT, experience has shown a thorough IT due diligence process will look at: LAN and WAN architecture, voice network and technology architecture, human resources, IT call center, infrastructure, contracts, application architecture, facilities and security (See “Due diligence” checklist.)

If you have performed an appropriate level of IT Due Diligence, you should understand:

– The suitability of integrating the target company`s IT resources;

– Areas that require management`s attention, before, during and after the actual acquisition;

– Potential situations under which you may wish to consider withdrawing a previously submitted proposal;

– The appropriate information to evaluate the reasonableness of the proposed agreement and revision, if necessary.

As a consequence this should help increase revenues; reduce costs; respond rapidly to market conditions; keep cost base low; provide flexibility to absorb changes; identify and evaluate potential IT roadblocks; and determine suitability of integration effort.

Understand the business drivers

Lest you think that just knowing the answers to the questions is enough, you`d better understand what`s really driving the deal. The most significant driver is market consolidation because business leaders want to leverage size and reduce per-customer costs. Fear, uncertainty and doubt (the FUD Factor) are sometimes behind management`s concern that growth can only be achieved by constant expansion.

Acquisitions are sometimes driven by the objective of capturing more market share to facilitate cross-selling and common branding. Emergence of a truly global economy has increased opportunities. External diversification allows for the rapid acquisition of intellectual capital, a wider range of products and/or technology such as infrastructure. Deregulation within the electric utility industry is a major driver.

As the work force becomes more mobile and globally oriented, there will be a tendency to acquire resources close to where they are needed. And believe it or not, the personal agenda of the leadership is to establish their “place in history” may be a driver.

The business objective(s) for doing the deal will directly impact IT, consequently the CIO must understand the “why” and determine the integration approach. There are several methods:

– Consolidation calls for the rapid and efficient conversion of one organization to the strategy, structure, processes and systems of the other.

– Combination entails synthesizing disparate organizations and technology pieces into a new whole.

– Transformation replaces both companies` processes, structures and systems with a new operating model.

– Preservation allows individual companies or business units to operate independently.

Typically, an integration effort will be a combination of the above. Real success will be determined by knowing the right mix. As a consequence, there are few issues that can or should be resolved without agreement between business management and IT regarding the goals of the business for the transaction.

After closing on the transaction, the important phase of supporting the acquired company and integrating it with the acquirer begins. Some of this effort may have been accomplished during due diligence and pre-closing activities. However, once the acquired company is part of acquirer, it is critical to the success of the acquisition to provide it with full support. The level of support is highly dependent upon the nature of the acquired company, its locations, size, and structure. No matter the variations, support is critical to ensure the maximum return on investment.

The cost-savings opportunities will in large measure depend on the post-merger integration strategy that the acquiring company`s management selects. With a consolidation strategy costs reductions and efficiency are key. If you plan to leverage a combination strategy, both organizations must have unique yet complementary capabilities. The transformation strategy seems to be the most difficult. It`s used to reinvent the company. Preservation essentially entails protecting the autonomy and retaining the operating processes of both companies.

Business process integration

It is critical that the acquiring company`s executive management articulates the goals for the integration. How quickly and completely is the acquired company to be assimilated? Will the acquired company retain any of its own identity? Which activities (business processes, systems, etc.) will be integrated, and in what order (e.g., financial, human resources, sales and marketing, supply chain, training, travel, security, administrative, communications, payroll and purchasing/ procurement)? What is the time frame for migration?

While a certain amount of due diligence should have been applied to understand the quality of the acquired company`s systems and processes, best practice is often subservient to speed and completeness of the integration. If both the acquirer and acquired companies business processes and systems are deemed to be inadequate, then the opportunity arises to integrate around a new IT solution to modernize and standardize both environments simultaneously.

DUE DILIGENCE CHECKLIST

A sampling of the things to look at in acquisition targets includes:

– Is there adequate support in key activities?

– What about disaster recovery?

– Is there an appropriate planning methodology in place?

– How robust is the overall technical architecture for reliability, maintainability, scalability, etc.

– Will the architecture support the company`s business strategy going forward?

– Are there appropriate staffing levels?

– Will the installed equipment`s future in-place value hold relative to end-of-lease term?

– Are the end-user developed applications supported and if so, is there a process in place to ensure IT can maintain the application if necessary?

– What standards are in place for applications, platforms, operating environments, networking, etc.

– Is there a good understanding of support costs?

– Are the processes sufficiently documented to survive the departure of the author?

– Are licenses transferable to new platforms?

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