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Acquiring By the Book

Through well-planned, midsized mergers, Textron paves the way for profitable growth.
Stephen Barr, CFO Magazine
February 1, 1999

When Textron Inc. acquired British golf- equipment and turf-care company Ransomes Plc for $284 million last year, it was a testament to the usefulness of the "M&A Status Report" that serves as a playbook for Textron's external growth strategy.

Ransomes was noted in the first report that then-new CFO Stephen L. Key stapled together for Textron senior executives in 1995, though its mention was little more than a prayer. The British company hadn't shown any interest in being acquired. But its brand names, including Cushman utility vehicles, fit nicely with the specialty-products section in what Textron loosely calls its industrial division. (Among the division's brands: E-Z-Go golf cars.) So there on the M&A report Ransomes appeared. And there the company remained for two years, until August 1997, when its president called to talk about a joint venture. He was asked about joining the Textron fold instead. He didn't say no.

Many companies keep close tabs on their acquisition prospects. But few have systems as elaborate, or as accessible, as the biweekly Textron report. The summary, now grown to 20 pages or so, is used during regular management meetings to keep the topic of acquisitions current and teeming with possibilities. "We review every single idea, even a gleam in somebody's eye, to see if it fits with our strategic objectives," says Key, who estimates that nearly 200 potential deals are mentioned in the report each year. Many are quickly crossed off. Some languish there for years until, as in the Ransomes case, opportunity knocks.

"The mere fact that Ransomes stayed in the report is an indication that if it were for sale, we'd be interested," Key says. "We were watching and monitoring, but we don't want to invest a lot of time on something unless it's reasonably possible that it can get done."

The New Conglomerates
For Textron, the acquisition was a fairly typical "bolt-on"--an addition to an existing business. Textron estimates it provided about $5 million in synergies for the full year, through a combination of European manufacturing operations, reduction of costs, and leveraging of purchasing power with suppliers.

Last year was a busy one for Textron M&A in its industrial and auto businesses. With the acquisition in May of $200 million (in sales) automotive-fasteners manufacturer Ring Screw Works, Textron advanced its position as market leader in fasteners. The $431 million acquisition of David Brown Group Plc in October gave Textron critical mass in its fluid- and power- systems businesses, and provided a springboard for future deals. So did the purchase in June of $72 million (in sales) Midland Industrial Plastics, building the auto-trim business in Europe.

Since 1995, the $10 billion Providence, Rhode Island, company has bought or sold a total of 37 businesses. Rather than megamergers, Textron has focused on midsized purchases within its four core business sectors: aircraft, automotive, industrial, and commercial finance. Only eight exceeded $70 million, with the largest being $435 million. But taken together, the purchases added $2.5 billion to annual revenues--and helped extend the string of Textron quarterly profit rises to 37 (as of press time).

Textron, the quintessential conglomerate in the 1960s, grew then by acquiring large, unrelated businesses within a mix of defense, consumer, and industrial lines designed to dampen sensitivity to economic cycles and assure reliable earnings flows. Faced with the Cold War's end and a desire to concentrate on growth industries in the 1990s, however, Textron became less flamboyant and more focused. The weaponry, milling machines, and greeting-card and other consumer lines are gone, as is, most recently, the Avco Financial Services subsidiary (sold for $3.9 billion), which had unacceptably low returns. Now, Textron is regrouping around narrower business segments in which it has proven its ability to generate high returns. And as it aggressively expands-- growth by acquisition is a prime ingredient for most of the new multi- industry breed--Textron also seeks a blend of long- and short-cycle operations.

"The secret," Key says, "is the ability to manage [our] business mix by actively acquiring and divesting, coupled with some strong operating management that can actually diagnose and fix problems."

The old conglomerates' voracious appetites often reflected high price/earnings ratios that allowed their stock to be used as currency in buying low-multiple targets, often without synergy in mind. These days, Textron and peers like AlliedSignal Inc. and Tyco International Ltd. focus on low-risk, high-growth additions to existing lines, financed with low-cost, long-term debt. James P. Samuels, a senior managing director at NationsBanc Montgomery Securities LLC, calls it "a very effective strategy for delivering consistent results by buying businesses they know and expanding their market share."

When Key arrived four years ago, Textron had largely gotten out of the merger mode; it lacked a formula for the 1990s environment. "The company had been talking about making acquisitions and trying to grow externally, but they didn't have the ability," says Lehman Brothers multi-industry analyst Phua K. Young, who calls Key the "missing link.


" Having executed more than 30 deals in three years as ConAgra Inc.'s chief financial officer, Key had strong opinions about Textron's M&A. He didn't like that it was a corporate function, for one thing, so Key created a team-oriented M&A process among the sectors.

"I subscribe to the 'you catch them, you clean them' philosophy," he says. "Corporate will make sure that the acquisitions are in accord with strategy, but at the end of the day, the businesses are responsible."

Because Key loves doing M&A work in-house, he "asked people to start thinking about what companies they'd like to acquire and why." So now Textron's own people, and not investment bankers, generally value deals in their industry, and the functional managers who plan the acquisition's integration are in charge of due diligence.

Venison, Not Rabbit
In addition to making extensive use of the "M&A Status Report"--which includes strategic rationale for potential deals, financial and valuation estimates, and projections of how targets might do within Textron--Key lists three basic ingredients of the approach he has introduced.

1. Clear criteria. Targets are expected to fit a clear financial model: double-digit revenue and earnings-per- share growth, return on equity above 17 percent, return on invested capital over 15 percent, and debt-to-capitalization ratios no greater than the mid-30s. Desirable candidates also would contribute to earnings per share immediately or have significant earnings growth potential; achieve economic profit (earnings above the 11 percent estimated cost of capital) within three years; and produce a return on invested capital of at least 15 percent. Turnarounds weren't sought, nor were expensive hostile targets. "Our financial criteria are the teeth that create the friction," Key explains.

2. A strategic link. The new, decentralized M&A groups received marching orders reflecting the corporate plan. Specifically, with Textron seeking to strike an overall balance between long- and short-cycle businesses, the company told business units that the first acquisition targets should be short-cycle companies. More overseas enterprises were sought, and growth of the undersized industrial sector was encouraged. For one thing, Key reassigned Jack Curran, Textron's most experienced dealmaker, to the $3 billion segment.

3. Integration plan. Each acquisition team was asked to develop and maintain an action plan that would spell out potential synergies, financial projections associated with each action, and who would be responsible for getting a deal done. Often, Textron predicates price negotiations on what the teams learn about a target's operational efficiencies and new sales opportunities.

The "M&A Status Report" also serves to keep the sector teams thinking cooperatively. "There's no faster way to derail the acquisition process in a decentralized company than to have a division head spending nine months of work bagging a rabbit and have corporate say, 'I'm sorry, we're only eating venison tonight.' That's not in accord with our strategy," says Key. "If that happens, the word will go out very quickly: 'Don't waste your time on acquisitions. Go about growing your business.'"

Stephen Barr is senior contributing editor of CFO.

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SIZE MATTERS
A lesson for 1999: Big deals often get discounted on Wall Street in this booming environment for deals, M&A experts are increasingly trusting investor reaction as a fair indicator of the chance of success. And investor reaction is increasingly skeptical.

The McKesson Corp.- HBO and Proffitts-Saks deals are two of 1998's mergers below the Top-10 level that created sizable sell-offs at the acquiring company. "It's becoming less unusual," says Wharton School visiting professor Mark Sirower.

Even one darling of the merger game, consumer- products maker Newell Corp., lost nearly $1 billion in market capitalization when it announced its $5.8 billion purchase of Rubbermaid Inc. in October. With 16 acquisitions since 1993, Newell had been building a reputation as a shrewd acquirer that quickly digests small companies with goods it can market to its current customers. Rubbermaid, in contrast, is bigger and comes with a troubled past.

"It's strange to see Newell lose so much of the premium," says Sirower. "This is a company we look to as having the answers to how to do acquisitions." Newell's stock price was continuing to trade lower into December.

But Newell CFO William Alldredge says he figured the market would downplay Newell's acquisition record and worry instead about the large scale of the deal-- something many CFOs may face as megadeals become more commonplace.

"We were not surprised by the outcome," he says of his company's stock-price fall. "Because of the size and opportunity, we were willing to put up with more near-term dilution. This is one of those acquisitions that will truly let us make a quantum leap forward." S.B.




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