The link between integration, valuation and due diligence

The cash flows of the combined businesses will depend on how they are run. Integration planning therefore has a direct input into valuation and, as already mentioned, the due diligence phase should include critical testing and challenging of the estimated synergies. These are often misjudged. Figure 5.1 shows the relationship between integration, valuation and due diligence.

Post-acquisition planning should address the most important issues which impact on valuation. The most important of these are where the synergy benefits are going to come from and how (and when) they are going to be realised.

Private equity investors develop detailed business plans with their management teams, which are effectively integration plans, before a deal is completed. All acquirers should do the same by developing an objective explanation of how the deal contributes to the acquiring company’s strategy. This in turn will set the agenda for integration.

The main reasons for acquiring were shown in Table 2.1, which has been expanded into Table 5.1. As can be seen, there are only five.

FIGURE 5.1 The relationship between valuation, due diligence and the integration plan

TABLE 5.1 The strategic reasons for an acquisition

As shown in Table 5.1, being crystal-clear on the acquisition rationale and on what the acquisition is supposed to achieve – what are we buying and why – will help define the broad framework for integration. Use due diligence to help fill in the details, and specifically to help:

• Confirm the sources of the post-deal competitive advantage and identify how to capture them.
• Quantify market growth – extent and timing and how to capture it.
• Define how closely the acquiring company can integrate the target company into its existing operations.
• Identify major cultural, structural or legal factors which influence the speed and direction of integration.
• Identify the operational demands of integration:
  • Investment required to upgrade equipment and plant
  • Systems changes and upgrades
  • Property and facilities changes
  • Personnel changes
  • Changes to products, suppliers and customers.
• Provide a clear project plan for management, with associated tasks, resource requirements, timelines and milestones.

Table 5.1 is an ideal. Often there are operational and cultural barriers to integration which need to be identified.

Operational barriers to integration

Some significant operational barriers to integration are set out in Table 5.2.

Operational integration barriers can increase the risk and even become ‘deal-breakers’. It is a mistake to allow such operational barriers to pass largely unnoticed during negotiation, as they can become real problems later on.

Cultural barriers to integration

The culture of a company is the set of assumptions, beliefs and accepted rules of conduct that define the way things are done. These are never written down and most people in an organisation would be hard pressed to articulate just what the organisation’s culture is. However, these rules and shared beliefs are powerful. It is a mistake for an acquirer to assume that the target company will have anything like the same cultural dynamics as itself. Morrisons, a leading food retailer, blamed its post-acquisition performance dip on the culture clash with Safeway while Marks and Spencer took ten years to get to grips with Brooks Brothers’ culture. DaimlerChrysler provides another example of the problems that can arise from a culture clash among employees. The integration team invested much time and money trying to help employees understand the differences between American and German culture, but the firm’s real problems seemed to stem from differences in management perceptions and business practices. The firms championed different values, had different compensation structures, and ultimately, had very different philosophies about how to brand their products.

It is very important for acquirers to spend time on understanding the way in which the personnel within the target company behave – both individually and within the ‘culture’ of the business. Management can then decide how it would like to see the combined company’s culture develop and, in the meantime, adapt the way it manages the target. Table 5.3 summarises the main points to consider.

Information will have to be collected from various sources to understand what is important:

• Management interviews (if access is granted)
• Relevant experts if the acquisition is in a new country/sector
• Trade literature and website visits
• Ex-employees (through contacts and due diligence if possible)
• Customers (through contacts and due diligence if possible)
• Suppliers (through contacts and due diligence if possible)
• Mystery shopping (acting as a prospective customer and analysing responses).

It is also useful to remember that culture tends to reflect the business model, so it therefore makes sense to understand and reflect on differences between the two companies’ business models while assessing their cultures.

Cultural convergence is rarely achieved quickly and sometimes not at all. Moreover, acquired employees seem to have fewer problems with ‘they are very different from us’, than they have with ‘they are imposing their ways and did not listen to us’. Overemphasis on controlling newly acquired firms by imposing goals and decisions on them may lead to problems amongst the very group who may be instrumental in determining the acquisition’s ultimate success. Although people within an organisation learn to accept its working practices over time, we rarely have the luxury of several months or years with an acquisition. Changes need to be made quickly. This reinforces the need to concentrate only on essential changes and those which will have a significant impact in the short term.

Adjust integration to fit the cultural gap

If a target has a significantly different culture, this can substantially increase post-acquisition costs or hold back performance. The risk increases if the businesses are to be merged as opposed to operating as independent units.

The acquirer needs to assess the impact of the cultural divide and plan accordingly. Where there is a big cultural gap between the two organisations:

• The pace of many aspects of integration should be slowed down.
• The acquirer’s management may have to spend more time with the business.
• The level of integration may be revised down, at least for the first 6–12 months.
• The new parent should explain in detail why certain changes must be made and not just inflict them without consultation unless absolutely necessary.
• Company training levels may have to be enhanced.
• Various standardised operating procedures may need to be introduced and enforced.
• Additional financial resources may need to be budgeted for.

Operational and cultural constraints may mean choices have to be made about the way in which the target will be managed, ranging from allowing the target to have effective operating independence through partial integration to taking full control.

The acquirer should be clear about the type of parent it wants to be and the level of independence it will allow the acquired business. Table 5.4 shows the options.

TABLE 5.4 Level of integration options

For most acquisitions, the ideal is to achieve full integration, though the speed at which this is achieved may be influenced by particular circumstances. It took Reed International and Elsevier Science about five years to integrate properly into Reed Elsevier. Broadly, the less the target is integrated, the greater the level of risk. Risks include failure to achieve cost savings, and conflicts about strategic direction, investment and sales and marketing or other policies.

Thinking about the right arrangement cannot await closing. The integration team should use the information and time during the due diligence process to develop the appropriate integration approach and have in place the necessary action plans ready for execution on day one. Whilst taking control, acquirers should not forget that integration should be a two-way process. Acquirers are not perfect and acquired companies are not run by dummies. The best acquirers know that there may well be some tricks to learn from the business it is buying and that the integration policy and process must not be allowed to bury this value.

Agree the way forward with the sellers

Consensus among buyers and sellers on the merged company’s strategy and operating principles significantly contributes to post-acquisition performance by minimising destructive conflicts, political behaviours and confusion among employees about lines of authority.

A high level of consensus is possible to achieve even when the two sides have a low level of cultural fit. Target company employees will be ready to accept the management styles imposed by the acquirer if they see the deal as an opportunity to advance their careers.

Make people decisions early

As the buyer you will have convinced yourself that you can run the business better and will be itching to get on with it. The first concern of those who you are going to rely on to make all those changes is: what does this mean for me? They all know that acquisitions mean job losses so where do you think their logic takes them? And having got there, is their next instinct to work productively and serve customers with a smile? People like certainty. Even if there are to be mass redundancies and closures it is best to say so up front and then quickly get them out of the way. Do not procrastinate; there is no ‘right’ time to make this sort of announcement. With it done, at least everyone knows where they stand. As long as restructuring is handled with sensitivity people will respond much better than they will to creeping, piecemeal changes that only add to the anxiety.

Identify key talent

Key people or groups are those whose departure would have a significant detrimental effect on the organisation. People or groups can be considered ‘key’ for various reasons, but the business impact of losing them should be the factor that deems them essential. The impact that their departure would have might include, for example, the loss of a key client or customer, important innovation abilities, knowledge of a core product or service offering, or considerable project-management skills. Once the key talent has been identified, the factors that are important to retain these people must be understood and an action plan developed that covers both the macro-level (organisation-wide human resources practices) and micro-level (manager-to-employee) engagement factors.

For example, at the macro, organisation-wide level, management might conclude that key talent needs to be fully aware of, and included in, the core human resources practices of the merged company. At the micro-level management might think in terms of increases in base and/or bonus compensation, better job titles, bigger offices, bigger roles and/or responsibilities, assignment to high-profile projects, changes of location, etc.

Communicate openly

In essence, you need to communicate openly. There should be no secrets, no surprises, no hype and no empty promises. This includes being able to say, ‘we don’t know’ or ‘we haven’t decided yet’.

Whilst the acquirer may be pumping out a consistent message about how great the new world will be, this will by no means be what everyone will be thinking. Figure 5.2 outlines some stakeholders concerns.

This illustration shows that communication with stakeholders is complex. There must be a consistent core message. Underneath this, different messages are required for different audiences. Each one must be honest and accurate, but tailored to address the real concerns of real people.

Best practice in communication is to:

• Communicate early and often; avoid silence.
• Communicate in a coherent and consistent manner.
• Avoid contradictory messages; they destroy credibility and increase uncertainty.
• Appoint a single person or small team to act as the focal point for the communication.
• Develop specific messages to address the individual needs of each of the differing audiences.

FIGURE 5.2 Various stakeholders interpret the same core message according to their concerns

• Use the best communication tools, language and tone for each audience.
• Listen to feedback; establish a two-way communication process.
• Answer questions as honestly as possible – if you don’t know, say so.
• Be open about reasons for the acquisition and the likelihood of job losses.
• Challenge false rumours.

Remember that actions and non-verbal signals are very important and that a physical presence is the best way of confirming the written message.

Worst practice is for the message to get out in the wrong way. One British group forgot about time zones. It prepared a press release with a time of release embargo for the morning, but because it did not specify GMT in the UK, employees in Asia heard about the acquisition on the radio on the way in to work. They immediately got on the phone to colleagues elsewhere in the world and the communication team had to back-pedal its way out of a mess.

Should we appoint an integration manager?

Yes, you should. Like any other big project you need one person to be accountable for the project’s success otherwise there will be delay, false starts and confusion. Integration is a full-time job. It cannot be done part-time by, say, the buyer’s MD or the MD of the relevant subsidiary. These people have a business to run and besides that they will concentrate on the urgent day-to-day issues. Nor should it be left to some bright MBA unless the integration is small and highly-structured. An integration manager needs to be a well-respected all-rounder who understands the industry, who knows his or her way round the acquiring company and who has the confidence of its senior management. Other skills and attributes will include:

• Proven experience in project management
• Effective interpersonal skills
• Sensitivity to cultural differences
• Ability to facilitate project groups.

Ideally, the integration manager will be in the midstream of his or her career, with a broad experience while remaining receptive to new and evolving business practices. He or she must have the authority to make decisions, co-ordinate taskforces and set the pace.

Effective integration requires clarity of purpose, detailed target setting and detailed reviews. Smaller acquisitions and private equity transactions require less integration than larger complex mergers, but even the smallest ‘stand-alone’ transactions require a plan. The integration should be structured around sources of value. It is also necessary to articulate non-financial aims such as a single financial reporting system or a single sales force.

Role of the integration manager

The MD, not the integration manager, is accountable for the performance of the business. The integration manager acts like a consultant held accountable for the creation and delivery of the integration plan and reaching its milestones. It is all too easy for people in an organisation to get caught up in the glamour of integration, but management must not get distracted. At least 90 per cent of the organisation should be focused on the day-to-day business.

The integration team

Acquisition integration is like any other major project. It has a one-off objective, limited duration, financial or other limitations, complexity and potential risk, and requires an inter-disciplinary approach. The integration team should therefore include members with both project-management experience and operational skills. If the required experience or skills are not available, the acquirer should consider bringing in external resources such as consultants or interim managers. Key managers must be selected as early as possible. They will then make decisions on additional assistance required during acquisition integration. The integration team should consist of a balance of different people and skills. At least some team members should have previous acquisition and integration experience.

As the probability of making the acquisition increases, the support provided to the acquisition team should increase. It is best to maintain continuity by adding additional team members to an existing structure. The level of additional resource required depends on the complexity of the acquisition, its strategic importance and its size. Experience suggests that in larger acquisitions, individuals should be assigned in at least six areas:

• Personnel
• Sales and marketing
• Production/service delivery
• Logistics
• Information technology
• Finance.

Each of these areas will have specific and detailed tasks which should be broken down in detail, and then built into the overall master plan. If this all sounds a bit much, remember that resource requirements are frequently underestimated. Integration teams need to understand the value for which they are accountable.

If outsiders are needed, they can be expensive, but remember always that their cost is insignificant in the context of an acquisition. The trade-off of more effective and more rapid integration against the cost of adding a few additional internal or external members to the team is often significant. Trying to muddle through with existing resources is short-sighted and often counter-productive.

Many executives fail to appreciate the scale of the merger task. Imagine bringing together two organisations that ostensibly mirror each other in size and function: two finance, marketing and research and development departments, two sets of manufacturing or retail sites, differing information technology and international operations. The numbers can be enormous: the aborted GE/Honeywell merger involved over 500,000 employees worldwide. Add to that the extra complexity of different countries, cultures, time zones and languages, and it becomes easier to see why so many acquisitions fail.

In the acquisition wave of the late 1990s, most successful mega-acquirers used external consultants to assist with implementation, which was considered a unique skill and process. There were additionally at the time few companies with the in-house expertise to undertake large-scale implementation on their own. Moreover, many employers felt they had insufficient manpower. After completing acquisitions it became clear that, even with consultants, the implementation phase required a large staff. One French banking mega-merger had 50 post-acquisition working-groups each averaging ten employees. This equated to 500 executives working on implementation globally – even before external consultants were added in.

Increasingly, acquirers are bringing the implementation process in-house. Why create a significant internal resource for something that happens only occasionally? In the long term, it may cost less than hiring consultants, who can charge up to £15 million a month for mega-acquisitions. It also offers companies greater control over the process. Over time, a company’s internal M&A skills may become so well-honed that it becomes much more likely to make future deals succeed. In some cases, acquisition implementation can become a source of competitive advantage.

Potential acquirers can choose to maintain a separate implementation team, as does GE Capital, though this is relatively rare. The team remains a separate entity and is called upon to integrate several acquisitions as they arise. This is the most expensive option and requires several acquisitions or other projects to take place over a year to justify the cost. But the company can usually ensure acquisitions are integrated quickly and smoothly.

Other acquirers, such as Lafarge, the French cement producer, have a small but separate M&A unit consisting of only a few individuals. It routinely oversees the integration of acquisitions and supplements its ranks with fellow employees or external advisers who work on specific tasks. By rotating employees on and off projects, it spreads acquisition expertise throughout the company, rather than confining it to a few integration experts.

However the team is resourced, there should be enough skilled people on the ground from day one. Do not be tempted to add resources on an ad hoc basis. Once the team is in place, each member should prepare a detailed project plan for their specific area of operation. To do this they must be absolutely clear about what they need to do, and how their roles relate to the overall goals of the acquisition.

A properly structured and resourced induction plan therefore avoids throwing any new team members in at the deep end. They need to understand:

• The acquisition rationale and how it fits the overall company strategy
• The key drivers of success and failure of the acquisition
• Their specific role within the overall team and how this relates to the overall objective
• Who else is in the team and who to turn to for assistance
• Any bonuses available for on-target completion of the tasks.

Prioritise what needs to be done

The integration manager will have the overall responsibility for co-ordinating the development and fine-tuning of the project plan. This will involve:

• Liaising with the negotiation team on the investment requirements to achieve required objectives
• Briefing the due diligence team on the key risk components
• Briefing senior management on task definition and resource requirements
• Delegating individual elements of the project plan to specific integration team members.

Once the plan comes together, the integration manager has to decide what needs to be done in what order. As with most activities, 80 per cent of the wins will be generated by 20 per cent of the activities. Focusing on the projects which yield the highest financial impact in the shortest time has two benefits:

• It helps secure early wins. In contrast to the naive optimism of many top managers, the initial feeling on the part of both workforces is that it will not succeed. The only things that will get buy-in are well-communicated tangible wins to convince employees that there is a brighter future.
• It helps shorten the process by completing the most important projects first.

Traditionally the early effort focuses on reducing costs, but reducing costs often proves more difficult than first thought. What looks like a simple business of eliminating duplication and reducing unnecessary overhead always turns out to be a complex, long-term re-engineering job in which work processes and procedures are fundamentally reorganised, people are redeployed and additional investment in training is needed – oh, and everything has to be achieved with a demotivated workforce.

Depending on the extent of the integration, there is bound to be duplication and everyone internally will be aware of this. The best way forward is to deal with any such redundant effort then get on with capturing the longer-term, growth-orientated benefits. Do not get hung up on cost savings for their own sake: they are a one-off. Once they have been realised there is nothing left. Growth, on the other hand, continues forever.

Get the reporting right

At each stage of the development of the pre- and post-acquisition plan, managers must maintain information systems, including a detailed checklist, and ensure it is completed at each stage. Some managers may choose to use project management software for this purpose. Software can help to integrate cash flow and resource demands and conflicts into a coherent and integrated action plan. Developing a coherent project plan also provides a framework for assessing risk profiles.

Without quality data it is impossible to monitor the integration process. The acquired company quickly needs to start reporting in the standard format.

Overlap with the due diligence team

All the evidence suggests that the most effective integration managers are those that serve on the due diligence team.

It is vital to have a dedicated group focusing purely on integration; it must not be distracted by other operational requirements. This focus will enable the group to:

• Research the market and the company and fully understand the target.
• Ask the right questions of the due diligence providers.
• Consider the operational problems that should be resolved following the deal.
• Plan how to achieve the desired value-add.

By understanding the operational and market dynamics of the acquisition in detail, the team will be able to evaluate and value the target. This quality of understanding and insight also strengthens the hand of the negotiating team.

If the integration team can hit the ground running and win the support of the acquired company, it can then implement change rapidly and avoid the immediate erosion of value.

Remember, though, that the integration and bid teams should be balanced as they perform different roles and the integration manager has different priorities to the negotiating team. His or her role is conciliatory and about building trust and value. It is not adversarial, as that of the negotiating team can be, particularly when there is some tough deal-doing. Figure 5.3 illustrates these roles.

FIGURE 5.3 Roles performed in the bid and integration process

Additional staff from the target company may join the team post acquisition. This will depend on the initial assessment of the acquired company’s management teams and the personnel review, which is part of the week one activities (see later in this chapter). Acquisition planning should always be prepared for the worst case – that none or few of the target’s managers will be suitable for key integration roles in the early post-acquisition stages.

Get people to work together

The best way to overcome cultural problems is to get people working together to solve problems. Short-term projects that focus on achieving results quickly involving employees from both companies almost always serve to bridge the cultural gap. Employee involvement and participation empowers them and provides them with higher job satisfaction and commitment to the organisation. Employees who are involved in the acquisitions process will demonstrate higher levels of identification when compared with employees only indirectly involved. Get managers to communicate rather than using communications professionals because they will not just say the words but also engage in a dialogue.

Day-one communication

For the day-one announcement and explanation of the future, personal contact is best; this means individual or group meetings. These should be supported by useful documentation. Ideally this is a tailor-made presentation, which describes the acquirer and explains exactly what this will mean for the acquired company and particularly for its employees. In addition, the acquiring company should have sufficient copies of basic documents such as its:

• Company website address
• Company annual accounts
• Terms and conditions of the company’s pension scheme
• Standard operating procedures where relevant.

Acquired employees are often reassured once they are clear about future strategy, policies and procedures.

Be prepared for the obvious questions

The uncertainty surrounding an acquisition will manifest itself in ‘what about me’ questions such as:

• Will the combined company continue to employ me?
• Will I continue to work in the same place with the same colleagues?
• Is my workload about to increase?
• Will I have a new boss?
• Will I get the same level of current benefits?
• Will my potential future benefits be better or worse?
• Have my longer-term prospects for career development improved or got worse?
• Will my status change?
• Will my lifestyle change?

The questions and the emotions behind these questions will also change as the deal proceeds from its early days to full integration. The common different emotions are shown in Table 5.6.

If the acquirer does not act quickly and coherently, employees within both organisations will become increasingly unsettled. They will start to focus on their current situation and spend time doing things which are not much use, such as:

• Spreading rumours and listening to other people’s gossip
• Trying to find out about any changes and the latest news
• Looking for a new job.

Productivity declines and key employees leave. The pharmaceutical mergers of the 1990s saw the mass exodus of senior managers from many of the acquired companies. Remember that the true cost of replacing key employees is a significant proportion of their first year’s salary. This takes into account productivity loss during recruitment, recruitment cost and low productivity of the replacement during induction. Put simply: the acquirer must get to the key employees early, with the right message.

Senior management from the acquirer should be involved because the people in the acquired business need to see and believe that the new parent takes them seriously: ‘Well, the big boss did make the effort to come all the way from London to see us.’ Therefore, senior management within the parent should be part of the communication team, on site, on day one, even for minor acquisitions. Senior managers must be seen to be interested in the future of the new organisation.

As the day-to-day management of the acquisition has been delegated to the acquisition team, senior management can perform a vital role of ‘management by walking about’; meeting employees, customers and suppliers to demonstrate their level of commitment to the smooth development of the new combined organisation.

Financial control

It is essential that financial control passes from the acquired company to the parent at once. This ensures that:

• Potential liabilities are limited to those existing at the time of acquisition
• The company has time to verify financial management procedures in the acquired company and review security procedures
• The ownership of assets is immediately clarified.

Obviously much of the groundwork will have been covered during due diligence. With the right preparation and resources, harmonising financial controls should be relatively straightforward.

At the end of day one, the integration team should review progress against the day one action plan. Any additional actions, which become necessary during the next stages of the integration, can be agreed.