Are You a Target?

Meet Patrick Albert, a broad-shouldered man who went to college in Schenectady, New York, loves Tokyo, and calls himself CFO and general manager, Pacific finance, of Momentive Performance Materials. His title is new, by the way. Albert was CFO of Tokyo-based GE Toshiba Silicones until this December. But when Apollo Management, the US private equity buyer, bought the company for US$3.8 bn and changed its name, it asked Albert to stay on. It's life in a very different world.

"Working for GE was like working for a giant mutual fund, and you could leverage off its resources," he says. "But we're not in a portfolio anymore." There's no cushion, no multinational resources — whether legal, risk management, or HR — to draw upon. Any problem must be fixed with capital coming directly from the owners. "Suddenly our jobs got a lot more important," says Albert. Apollo financed its purchase with US$3 bn in debt. In this environment, "getting the foundations right" is not a luxury. A strong system of cost control and financial reporting ensures survival, says Albert, or "we simply won't be able to do what we're meant to do, which is grow EBITDA."

Welcome to the M&A boom. There's a certain euphoria associated with the trend. But CFOs in targeted companies can be forgiven for having mixed feelings. In the hunted company, enormous change is immediate and the threat of job extinction looms.

But like Albert, CFOs can — and do — adapt quickly. They'll have to, as M&A activity will likely continue at a fast pace throughout the year. (See our list, "Targets Confidential," below.) Private equity money is the catalyst. Merrill Lynch analyst Stephen Corry, based in Hong Kong, notes that the major global private equity firms are cashed up to the tune of US$25 bn, and will probably spend that amount globally in the next year-and-a-half.

Some of that — a source at a major fund puts the figure at US$15 bn — will be devoted to Asian businesses. Private equity investors expect greater returns from Asia than elsewhere. The region, after all, has the lion's share of the world's growth economies and some of the better demographics for consumer market growth. Valuations in Asia, too, are still comparatively low. Current deals average between 7.5 and 8 times economic value divided by earnings before interest, tax, depreciation, and amortization (ev/ebitda), as opposed to the US and Europe, where valuations of up to 12 times ev/ebitda are common.

One route of buyout firms such as Carlyle, TPG-Newbridge, and Kohlberg Kravis & Roberts — all big players in the region — is to install a new CFO after the deal as a change agent in the purchased company. But replacements are not the rule. "I would say that being CFO is a vulnerable position," says Alain LeCouedic, partner with the Boston Consulting Group in Hong Kong. But, he adds, "CFOs who are seen as value drivers and who grasp the strategy of the new owner are just as likely to be seen as an ally."

This gibes with the view of Jamie Paton, managing director and co-head of Asian operations for 3i, a UK private equity fund. "The key issue in our business is to work in partnership with the existing management teams," he says. "For example, we'd like to be a long-term player in China but we'd like to do it in a Chinese way, for a Chinese market, and to market Chinese brands internationally. To do that, we need to work alongside Chinese management teams."

That may be so, but a retained CFO will have to play ball in an entirely different way. LeCouedic says that the best way to work with a new private equity management is to be brutally honest about the company's shortfalls and present a well-crafted strategy for fixing them. "Getting management to buy into this before the target is acquired is admittedly difficult," says LeCouedic, "but preparation is golden." Being able to demonstrate that such an effort was made will give management more leverage during negotiations and post-merger integration.

Martin Fahy, Asia-Pacific director of development for the Chartered Institute of Management Accountants, sees this scenario playing out as private equity funds target underperforming units of Asia's large industrial conglomerates. Such transactions are likely, he argues, since many of Asia's tightly held conglomerates are looking to sell non-core assets and may believe that funds will give them a better deal than their own competitors. "If the PE money walks up with a proposition to buy," says Fahy, "it gives you a quick exit." Fahy says a private equity firm will then either install a journeyman CFO or stick with a capable CFO who can drive topline growth and improve margins. That CFO should also be adept at raising debt to finance the deal and staying on the right side of debt covenants.

As Albert's experience implies, one key to longevity is a healthy respect for governance in the post-merger company. But are there any iron-clad rules? It's more art than science, the experts say. Oliver Stratton, an M&A partner with Bain & Company, advises private equity firms on screening potential targets and has seen many post-merger integrations in the region work — and not.

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