VideoThree years ago, when progress Energy put its Progress Rail Services subsidiary up for sale, a potential buyer demanded a concession on price once it discovered, among other things, that the cost of integrating both companies' technology systems would be prohibitive.
Progress Energy balked at the reduced offer and the deal derailed, but the bidder had a point: at the time, Progress Rail's IT systems were fragmented, with 60 percent of the company on one transactional system and the remainder using other systems. Stung by that experience, Progress Rail took a hard look at its technology assets. "To get a higher value for the company, we needed to quickly implement a new IT system for our financial consolidations, divisional scorecards, and forecasting and planning," says David Klementz, senior vice president and CFO of the Albertville, Ala.-based locomotive parts, repair, and services company.
Within months, Progress Rail had consolidated its finance and reporting systems on software from SAS. In March, the company went public and was sold in an initial public bond offering to One Equity Partners LLC for $405 million, more than the original price of the failed acquisition.
Progress Rail learned what many other companies are finding — IT can be a deal-breaker. Once a barely observed line item in a merger valuation, IT is now a top-line consideration in almost every deal. If IT assets don't line up well from an integration standpoint, deals may be lowered in value or scratched altogether. But valuing IT assets and liabilities is a daunting exercise. "This is not just a question of looking at the IT infrastructures of two companies and saying,'Can we make this work?'" says Gary Curtis, global managing partner of strategic IT effectiveness in the San Francisco office of consulting firm Accenture. "There is always a time frame in which companies can make it work. The question is whether the time, cost, and trouble involved are economically and strategically right for the transaction to take place."
Cold Feet
When Curtis began dissecting IT systems 20 years ago, few people considered IT integral to a proposed merger or acquisition. "Technology was considered back-office stuff that could easily be merged," he says. But often many years would go by with no rationalization of those separate infrastructures, and multiple operational problems would bog down those legacy systems. So much for synergy.
But a greater awareness of the critical role that IT plays in a company's operations, sales, marketing, and customer service has made IT due diligence de rigueur. "There are very few industries in which IT isn't integral to product delivery, factory operations, and most other facets of the business," says Curtis. "Most products start and end with IT, and sometimes, as with financial services, the product essentially is IT."
Not everyone has gotten that message. According to an Accenture survey of 155 U.S. IT and business executives, only 17 percent of business executives rank IT integration as the most critical factor in the success of a merger, compared with 49 percent of IT executives.
Even companies in the technology sector often fail to appreciate the importance of IT. "Too many technology companies just don't do the due diligence on the integration issue," charges Tony Rizzo, research director at The 451 Group, a New York–based industry-analyst company. "When we do an M&A analysis, we dig into the post-sale integration of technology assets. We hammer companies on whether they will be able to pull it off. This isn't necessarily a dollar issue, but how quickly the company can get the integrated product out to market. If it tells us six months and it takes a year, we know the valuation was off. All too often, that is the case."
Eyeball to Eyeball
When two companies have completely incompatible IT systems or infrastructures — one a mainframe environment and the other a server-based system, for example — integration costs are substantial. The same can apply to companies with different data-management systems or networks. "I've seen deals in which neither company has a data center large enough to handle the needs of the combined entity," says Curtis. "If you can't make one data center out of two, you're looking at significant rebuilding costs, not to mention quite a bit of time and effort. If that's not in the valuation, the numbers will be off."
How can CFOs ensure a target's IT systems are valued correctly? Curtis says the typical methodology is to "sit the IT people of both companies in the same room, preferably a small group that can represent the economics and capabilities of both companies' systems. You then explore in great detail the lay of the land — IT infrastructure, applications, networks, support of the end-use community, and projects that are under way — to understand how well each of these work and where the problems are. The goal is to estimate the cost, time, and key risks from the pretransaction starting point to the end state of full integration."
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