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To avoid the usual snafus, Flowserve attacks merger integration swiftly and with overwhelming force.
Stephen Barr, CFO Magazine
June 1, 2001
For Flowserve Inc., the numbers coming out of Europe were troubling. The Dallas-based manufacturer of industrial pumps, valves, and seals was in the throes of integrating its largest acquisition ever--the $775 million purchase of Ingersoll-Dresser Pumps (IDP) last August--and the shipments were behind schedule after two plants had been merged into one.
Renee Hornbaker, CFO of the $2 billion company, needed to know why.
As a member of the seven-person integration steering committee, she grilled the integration team member in charge of closing a U.K. facility and moving its production capacity to the Netherlands. The problem, she discovered, was that it was taking longer than expected for workers to learn the systems around the new manufacturing lines, which created an order backlog.
Within 48 hours, the committee authorized more training; by the end of the quarter, the Dutch plant had caught up on its back orders. For Hornbaker, it was just another integration emergency resolved.
"Merger integration is war," says the deal-making veteran who, while in public accounting, worked on the 1988 leveraged buyout of Beatrice Inc. by Kohlberg, Kravis & Roberts. "You must pursue it relentlessly, and not let the day-to-day become a distraction." She adds that "not a day goes by when there isn't some discussion or analysis of our integration effort."
Because for Flowserve, which completed eight smaller acquisitions in recent years, there is no alternative to winning this latest war. In what has been a fragmented industry, the successful integration of IDP, a former division of Ingersoll-Rand Co., is at the heart of the company's effort to become the world's leading provider of flow-control equipment used in various manufacturing processes.
"Flowserve got everyone to take notice," says Merrill Lynch & Co. analyst Donna Takeda. "No one has done anything this life-altering before. People in the industry are watching to see if they can pull it off."
Investors are betting the company can. Although restructuring costs continue to dilute earnings and plant-consolidation difficulties have hurt sales, the stock is up almost 60 percent since the transaction was completed last August.
MOST DEALS ARE DOOMED
A recent study by KPMG Inc. of the 700 most-expensive deals from 1996 to 1998 revealed that just 17 percent of them enhanced shareholder value. Flowserve itself was the product of a merger--the 1997 union between BW/IP Inc. and Durco International Inc.--that produced its share of headaches.
Hornbaker nevertheless remains convinced that Flowserve can prevail with IDP--partly because this latest deal represents a true acquisition, and even more because the company is so intensely focused on the integration challenges. "If you overpay, that's fatal," she acknowledges. "But most deals fail in the integration." And the key to success, she explains, is to pay attention to the integration effort every step along the way.
Hornbaker is not one to let any detail slip by. Over the years, Flowserve has amassed an extensive, 65-page due-diligence checklist, and relies mostly on senior department heads to look under the hood. Specialists lend a hand with technical expertise, but Hornbaker believes that outsiders alone would miss some crucial details. Once, for instance, Flowserve thought a target had access to global markets, but learned that a major territory had been licensed. Another time, it uncovered substantial asbestos-related liabilities.
THE IDP DEAL
In February 2000, Flowserve announced that it was buying IDP for $775 million in cash. Hornbaker, working with Flowserve's general counsel, persuaded Ingersoll-Rand to leave $25 million in cash in the business rather than drain the subsidiary, as many sellers do. They also got concessions on employee pension and postretirement health-care costs. "The contract negotiations are every bit as important as the up- front purchase price," says Hornbaker.
Nonetheless, the first few months proved tough. Because Flowserve stock was not an attractive currency to Ingersoll-Rand, the deal was financed with $1.4 billion in senior subordinated notes and bank credit. That meant the company's debt load was increasing nearly 10- fold, and the banks required that Flowserve suspend its dividend. The news was greeted with a sell-off on the day of the announcement and over the next 30 days, which is often the kiss of death for an acquisition.
The company also faced a Justice Department antitrust probe, which guaranteed that the deal would not close as soon as hoped.
The lag prevented Flowserve from communicating with IDP employees and discussing its plans for the combined companies. That led to some disruptions in the business and allowed competitors to poach some key IDP people who otherwise would have been kept on. "We were disappointed that so many would be willing to go," Hornbaker says.
On the other hand, the delay has allowed for greater precision in the integration planning. There has been more time to make the new job assignments and calculate severance packages for the 1,100 positions that would be eliminated. The same has been true for assessing which plants should be kept open and making plans for shutting down the others, as well as for developing common messages that would be used to address the concerns of employees and customers alike.
Flowserve's integration effort has been led by a 25-member team of employees from finance, production, sales, human resources, systems, and other disciplines. Among the IDP alums who joined the team is the division's CFO, Joe Kachurak. The approach involves establishing 11 major projects--related to each of the plants that were closed--along with separate projects for integrating the headquarters, the sales forces, and the repair and service centers.
To forge a commitment to executing these integration plans, Flowserve set up a unique incentive compensation system for the team members. They forgo their annual bonus. Instead they will be eligible for three to six times that bonus if they exceed the cost-reduction target of $70 million, complete the job in less than 14 months, and spend less than $150 million on integration costs.
Hornbaker points out that all three performance guidelines have to be met to earn at least the minimum bonus. "They can't just accelerate the timing of the integration by throwing more costs at it," she notes.
INTEGRATION IS ONGOING
When the IDP transaction finally closed in August after Flowserve reached an agreement with antitrust regulators, Flowserve moved quickly to announce the progress it had already made. IDP's former headquarters was to be closed, as were a pump operation and four repair and service centers. Duplicate sales and sales-support personnel and certain back- office staff had been targeted for layoffs, and discussions were under way with union leaders about closing three manufacturing locations overseas.
In the integration war, Hornbaker calls these the "quick wins" that will account for the bulk of the promised savings. Over time, there will be additional cost reductions in procurement as Flowserve buys more from certain suppliers and can negotiate lower prices. But consolidating plant-manufacturing lines is more time-consuming and difficult, and rationalizing the product lines is not included in the original integration plan.
"We don't count on top-line benefits with this integration," says Hornbaker. Although Flowserve and IDP have many competing products, some have been in the field for decades and require ongoing support. Telling a customer that has just one type of pump in a facility to take another type from now on "would be unreasonable," she says.
In turn, Flowserve anticipates that it will eventually realize revenue synergies from offering a more complete product line and being able to sell more items to its existing customers. Yet neither those revenue gains nor accelerated earnings growth have shown up in Flowserve's financial results.
In the first quarter, ending March 31, Flowserve reported lower revenues and a net loss of $8.5 million that included $19.1 million in integration expenses, though operating income and margins had improved. (The company realized $14 million in savings for the quarter.) "With revenues down, the operating numbers show that we're delivering integration savings to the bottom line," says Hornbaker.
At the same time, CEO C. Scott Greer acknowledged in a press release "dissynergies" related to the plant consolidation in the Netherlands and elsewhere. "Currently, we are in the hardest part [of the integration]--moving production, inventories, and people to new locations and resolving learning-curve issues," he stated. "As expected, this has created some temporary inefficiencies. These have temporarily prevented some facilities from achieving the planned production run-rate and negatively impacted the timing of our shipments."
Hornbaker expects those kinks to be straightened out by the end of the second quarter, when Flowserve should have achieved a savings of $70 million, and analysts are enthusiastic about its prospects once the IDP integration is done.
A sure sign of investor satisfaction is that Hornbaker is now being asked when Flowserve will make another big acquisition. "We had to be successful to get credibility with Wall Street to do the next transaction," she says. And with the IDP integration expected to be wrapped up by midyear, that could mean sooner rather than later. Which for Hornbaker means back to the battlefield.
Stephen Barr is senior contributing editor of CFO.