M&A: The Good, the Bad, the Ugly

Longtime equipment-financing executive Irv Rothman prefers not to grow through mergers and acquisitions. But he’s made the most of the opportunitie...
David McCannNovember 14, 2012

Irv Rothman isn’t a particular fan of growth through acquisition. He’d rather build a company organically, like Apple has mostly done.

“People buy companies because they’re in a hurry,” says the chief executive officer of Hewlett-Packard Financial Services, a $3 billion, wholly owned subsidiary that manages $12 billion in leased IT assets for the technology giant and its customers.

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Not Steve Jobs.

“Jobs took the best and brightest, sent them off to skunk works, and they developed breakthrough products that got the stock over $600 a share. He wasn’t in a rush, and he didn’t acquire much. I subscribe to that more than the M&A approach,” says Rothman, a former CFO and author of the new book, Out-Executing the Competition (John Wiley, 2012).

Yet much of his career has been shaped by his response to acquisitions he’s been involved in. Pay attention, CFOs who want to one day run a company.

In 1996, when he was finance chief at AT&T Capital, the parent company decided to divest its captive financing company in tandem with the spin-off of its telephone switch business to Lucent. AT&T instructed the subsidiary to put itself on the block. “There’s something a little strange about being told to sell yourself,” Rothman wrote in the book. “It took a long time to finish the deal.”

The eventual buyer, Nomura Securities, offered an excellent per-share purchase price. But Rothman was uncomfortable with Nomura’s plan to take its profit up front by pulling $3.5 billion in receivables out of the company’s $12 billion asset base. “How do you get back to $12 billion?” he wrote. “In our business, assets amortize away even as you add new ones. You have to write double the amount of new business, $7 billion, to close that gap. The assumptions were way too aggressive.”

So Rothman left the company and, in literally a matter of days, got his first CEO gig, launching a captive financing subsidiary for Compaq Computer. A year later, when the captive had an asset base of only $100 million, Compaq bought Digital Equipment Corp. DEC had been using GE Capital to handle its U.S. financing, and GE, as Rothman tells it, wanted to buy Compaq’s nascent financing operation so it could keep handling the DEC assets.

Rothman turned the tables on GE, offering to buy out its DEC financing business for $400 million, while separately hammering out a $100 million deal to acquire DEC’s European joint-venture partner financing company.

That was before he asked Compaq’s board to give him the half-billion dollars to do the deals.

“I had never been so nervous in my life as at the thought of having to make my case,” he wrote. “You don’t ask the board of the second-biggest computer company in the world [after the DEC acquisition] to hand over $500 million to a largely untested, if not unknown, management team.”

Rothman convinced Compaq’s chairman, legendary venture capitalist Ben Rosen, that it was unhealthy to have multiple companies representing Compaq for customer financing. It was a big upheaval for a just-launched business, but, Rothman wrote, “One company worldwide ­­ I just knew that was right. You can’t be afraid to fail. I feel I’m going to make more right decisions than wrong; if I don’t, I won’t be long in the CEO’s chair.”

The gambit, and Compaq Financial Services generally, were so successful that in 2001, when Hewlett-Packard bought Compaq, it asked Rothman to engineer the melding of the two companies’ financing subsidiaries. Rothman agreed ­­ provided he could implement his own business model, with his own team, and without moving the company away from its New Jersey home.

With all the conditions agreed to, Rothman wasted no time unplugging the business model of HP Technology Finance. The main problem with that operation, in his view, was that it had decided its identity was sales enabler rather than profit center. “It’s no wonder this approach produced mediocre results,” he wrote. “Where would the motivation to perform emanate from?”

Rothman made a number of organizational adjustments, like centralizing all back-office operations. And he had to dance on a tightrope after finding that the $475 million in bad debt that the old HP financing arm had already written off was actually $250 million too optimistic. “My name was mud for a while at HP headquarters, as though this was my fault,” says Rothman. “Hey, don’t shoot the messenger.” But that’s just what HP did. The newly combined financing company was required to absorb a fiscal-year loss of $125 million, or the net income lost from the extra $250 million write-off.

But Rothman’s chief merger-related activity was traveling the world to, in effect, market the internal changes wrought by the deal to anxious, doubtful employees, many of whom did, in fact, lose their jobs. “We couldn’t completely avoid the musical-chairs aspects of combining two big business operations, but we didn’t blow up product lines and fire 1,000 employees,” he wrote.

Now nearing the end of his career, and despite having survived and even flourished in the wake of large mergers, Rothman has no romantic illusions that M&A deals tend to be risk-free, painless to execute, or even successful.

As noted in a 2011 Harvard Business Review article, study after study has shown that the failure rate of mergers and acquisitions is between 70% and 90%. “That’s even higher than the much-discussed divorce rate,” Rothman says in an interview with CFO.

One reason acquisitions fail, he observes, is that growth expectations and assumptions about “synergies” are overoptimistic. But the biggest reason, he says, is that companies expend far too little effort “blending two disparate cultures in a way that is sensitive to everybody’s needs but at the same time is very clear. That is really hard, and it takes a lot of time. The CEO is putting his reputation on the line with the deal, yet he then fails to pay attention to the most important thing.”

It’s a major challenge to get people who formerly competed against one another, and have been taught to dislike or even fear the other side, to work together productively.

What’s more, often the acquiring company pays stay bonuses to key people at the acquired one to prevent intellectual property from walking out the door. “Then you can have people from the acquired company making more money for doing same job, which doesn’t necessarily motivate people,” observes Rothman, who is donating all royalties from his book to Room to Read, a charity that promotes children’s literacy, with a particular focus on undeveloped and disadvantaged countries.

Companies all too often set growth targets, perceive that the only way to meet the targets is through M&A, and aren’t careful enough to only do deals that are a good fit, in Rothman’s view.

“When you’ve got all the information together on a potential deal, but the information is subject to too much interpretation, or there are certain behaviors on the other side, or for whatever reason you don’t feel right about it, you should walk away,” he counsels. “You can’t have deal fever.”