Managing IT challenges pre- and post-M&A
July 2018 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
July 2018 Issue
FW moderates a discussion on managing IT challenges pre- and post-M&A between Shant Peter Yeremian, Ben Gaster and Aaron Collier at KPMG.
FW: Could you provide an insight into some of the IT challenges that commonly arise in association with an M&A transaction? To what extent can they threaten to erode deal synergies and undermine value creation?
Yeremian: IT systems and programmes are inherently complex. They require investment and long lead times for implementation, configuration or change. These inherent complexities tend to be magnified during an M&A transaction, when a large amount of change often occurs and scrutiny is placed on IT investment decisions during valuation. Furthermore, IT tends to be the most costly, complex and time-consuming aspect of a transaction involving a carve-out from a seller or integration into an acquirer’s company. These cases involve a significant amount of IT change, as systems, infrastructure, data and people are lifted from the seller’s IT environment and then integrated or migrated to the buyer’s. Technology is an operational dependency in most companies and is increasingly a value driver of product and service offerings. However, the use of technology is inherently complex and costly, and it is therefore associated with risks, costs and delivery delays. As such, when buying or selling a business, technology can be a lever that either enhances or erodes value. IT is often thought of as a risk in M&A due to its inherent complexity, cost and dependencies. However, many buyers and sellers fall short of using technology to create value in deals. When considering the impact of technology within M&A, it can erode deal value if IT complexity serves to delay the realisation of synergy value. It can, however, also serve to accelerate transition timelines if properly assessed and planned.
Gaster: IT strategy is one of the common areas to address in most M&A transactions. One issue this causes is that other parts of the business become distracted by the IT programme and await its conclusion before taking action in other areas. Another viewpoint is to assume that the IT system on the other side is always better than what you have, which can result in inactivity during the critical period post-deal, which is when companies should commence the realisation of synergies.
Collier: Many executives lack comfort with IT and have at least one experience of IT integration ‘gone wrong’. The discomfort on the topic and potential disruption that an IT failure can cause to customers and business continuity is why many companies never properly integrate technology and often leave significant deal synergies on the table.
FW: In your experience, are IT aspects often an afterthought in M&A? Do many acquirers neglect this issue in the pre-deal, due diligence and post-deal planning phases?
Yeremian: Historically, IT has been an afterthought in M&A, and the relevance of IT to a successful transaction is still often underestimated. However, this has improved over the past 10-15 years, as the proliferation of corporate technology has brought IT into closer consideration when buying a business. The exponential growth and reliance on the internet and IT has transformed the way customers behave and the way companies operate. Companies heavily rely on their business systems to perform operationally, to sell their products or services, to engage with customers and suppliers and for future financial planning and forecasting. A company’s use of technology and data can be a significant competitive advantage. The proliferation of cloud-based services used by companies has transformed the way IT is used and delivered. However, with this has come new risks and exposures to the continuity of business operations and to a company’s revenue. Cyber threats have the potential to debilitate a company and interrupt or prevent trading altogether. They can also impact a company’s reputation in the market. These and the many other ways technology has been adopted have made IT much more of a dependency for businesses and therefore has contributed to its consideration when acquiring a business. Acquirers typically underestimate the impact and importance of IT within M&A transactions across the deal lifecycle. However, this is improving as IT becomes a bigger part of the operational and strategic importance of a company’s value.
Gaster: IT is not forgotten, however, it is often one of the areas that is left until a deal is almost negotiated before it is given much consideration. I would always recommend that parties at least have an outline plan in place for IT in advance of a deal.
Collier: Compared with even five years ago, IT is less of an afterthought as technology systems have become increasingly complex and a larger part of many company’s core strategy.
FW: What considerations should an acquirer make when evaluating both its own and the target company’s IT systems in the very early stages of a proposed transaction?
Yeremian: IT considerations in M&A vary, depending on the type of buyer and its intentions for the target, as well as the target company’s industry, level of maturity and current and future strategy. This implies a broad scope of IT considerations for acquirers to focus on and prioritise. It is important to consider IT in the context of these factors when acquiring a business. Acquirers should consider IT from both risk and value perspectives, as technology is increasingly a factor in both. Acquirers should seek to understand IT risks that present operational, financial or commercial exposures to the target, as well as the cost, resources, time and business disruption involved in mitigating these risks. This is important when considering any limitations to a target’s future growth or cost exposures that may have an impact on the acquirer’s purchase price for the target. From a value perspective, acquirers should also understand how IT is used to drive or support the target’s growth, and look for opportunities to refine or further deploy IT to help drive the top line though expanding sales, or the bottom line by driving efficiencies through automation or greater productivity. Of course, there are cases where IT is less of a priority in acquisitions due to a lesser degree of IT dependency or use within a company. In these cases, the considerations of IT during acquisitions typically focus on material and fundamental risks, such as the continuity of financial systems and reporting. More specifically, each acquirer will have different plans and priorities for the future of a target acquisition. For a corporate acquirer, the synergies of an acquisition may be a priority to drive future growth, so the speed and degree of IT and operational integration of the target may be an important priority. A financial buyer may have a defined investment thesis and limited duration in which to maximise earnings before interest, taxes, depreciation, and amortisation (EBITDA) through revenue growth and operational efficiencies. In this case, IT considerations may focus on support for strategic growth initiatives over a shorter lifetime of ownership. When looking at a target acquisition, acquirers should first understand how IT is currently used within the business in order to contextualise the relative risks and opportunities, and then use this context to focus their assessment of IT in line with their future plans.
Gaster: Evaluating IT systems should be on the agenda to at least understand whether there is an issue that could impact the value of the deal. The challenge with getting involved very early is that often IT people need to engage on both sides to really understand the transaction. Those with experience of transactions with multiple systems should be a useful source of intelligence to identify any major issues before the deal becomes wider knowledge.
Collier: In the very early stages of a deal, buyers have very little information, which makes it difficult to assess anything other than ‘deal breaker’ type issues that would destroy the economics of a deal. Assuming there are no ‘deal breakers’, it is important, at this stage, to formulate the right list of questions and data required to greater assess synergies and risks later in the deal process.
FW: In your opinion, should the IT department have a meaningful presence and impact throughout the deal process? What role does the chief technology officer (CTO) need to play?
Yeremian: In many cases, IT representation can add significant value to the deal process. In the initial assessment of a transaction, a strategic IT perspective is important to identify the key operational and IT dependencies of realising any assumed deal synergies, as these will inevitably depend on the timelines and costs of IT integration before larger operational synergies can be realised. It is often the case that the purchase price of a deal, and particularly the estimate and timing of synergy value, are made in isolation of IT input or the CTO. Without a practical IT lens on when synergies are likely to be realised through IT integration, the value of synergies can be significantly overestimated, and the time and cost required to realise synergies are often underestimated. This can affect the purchase price of an acquisition if synergies are overestimated in terms of total quantum or time to realisation. Furthermore, there may be potential IT risks worth considering in the early stages of considering the fit of an acquisition. These may relate to issues such as cyber security threats, protection of customer data, delivery of a digital strategy, expansion of online sales channels and geographic expansion. The role of the CTO has become increasingly important to the deal process. With the explosive growth of technology and the associated increase in operational and strategic dependencies on IT and data, the CTO has needed to evolve into both a strategist and a steward of IT. In line with this, during an acquisition the role of the CTO is best served by providing a level of operational and technical reality early on in the process to the future plans of an acquisition – system integrations, new system deployments and managing a new expanded cost base – in order to inform and shape the near-term integration and future growth plans. The CTO can also provide strategic insights on whether and how IT can be leveraged in the commercial realities of a new acquisition, for instance by considering new technical capabilities for online sales, insights from the use of customer, market or operational data, and for leveraging economies of scale in an acquisition to drive more competitive pricing with IT suppliers, among other areas.
Gaster: Everyone is different. We have seen some CIOs who are deal savvy and others who are completely thrown by the concept of assessing IT before they have good knowledge of the system.
Collier: The criticality of IT to overall corporate strategy and deal rationale should dictate the extent to which the CTO is involved throughout the deal process. For the most part, early involvement is important to assess the relative importance of IT to the transaction, both in terms of risks and upsides.
FW: What steps should acquirers take to avoid poor or inadequate integration of their target’s IT framework once the deal is closed?
Yeremian: The best mitigation for post-deal IT integration failure is early assessment, planning and engagement well before the deal is closed, as well as having strong governance as the integration progresses post deal and flexibility to adjust to complexities as they inevitably arise in implementation. There are a number of steps companies can take to avoid challenges in the IT integration of a target acquisition. The first step requires companies to conduct a phased IT due diligence. A pre-deal assessment of IT risks, mitigating actions and opportunities should start early and be conducted iteratively as information and access becomes available, in order to uncover any material IT issues requiring mitigation in the immediate term. This should also inform and shape the priorities for the IT integration strategy, for example systems worth keeping compared with those to be replaced or migrated. Acquirers should also develop an IT integration strategy in line with acquisition priorities. Early IT integration planning and engagement with the seller’s IT team, vendors and IT delivery providers is critical to preparing for a smooth transition and to be able to hit the ground running once the deal is closed. It is also important to define a target IT operating model in line with the operational needs of the business and synergy targets. This helps outline different target states that the IT environments may need to step between during and after transition, for example current state, during TSAs and end state. Acquirers should prepare for a smooth day one. In the period between the signing and the closing of the deal, a greater level of access and information is permitted, which allows for detailed planning for the overall IT integration and, critically, all the IT changes required for day one when ownership changes hands. Acquirers must understand the requirements of IT for the closing of the deal and take action as early as possible, either before or after signing, to deliver the IT changes necessary to ensure a smooth day one transition when the deal is closed. Acquirers must also ensure that the company is set up for success in the first 100 days post-close. Following day one, acquirers must have a detailed and prioritised integration plan and should bank early IT integration ‘quick wins’. Strong governance and IT business alignment is also required. It is critical that IT integration priorities are aligned with the wider operational integration and deal-value priorities. This will help to ensure that IT efforts remain focused on the success of the deal, rather than all possible changes for IT during the process. In order to achieve this, a strong IT and integration programme management office should be set up before the deal closes.
Gaster: Conceptually, the process should be simple. Acquirers should carry out a robust diligence process which aligns both IT operations and finance.
Collier: Most deals suffer from poor or inadequate implementation of IT. To avoid this, pre-close, IT integration needs to be established as a top priority in the investment thesis and buyers need to make commensurate investments in both time and resources to due diligence and understand the environment pre-close. They must also transition appropriately and provide adequate resources to make the necessary changes post-deal.
FW: To what extent are IT issues amplified in cross-border deals? How can acquirers overcome the additional obstacles?
Yeremian: Cross-border deals can be impacted by different regulatory standards for cyber and IT security, particularly those related to the protection of personal and payment data. If an acquirer in a location with certain data protection standards purchases a company in a country with stricter standards, there will be a need to evaluate which standard to apply across the board in the combined entity and for international clients. Furthermore, an additional layer of complexity may exist when deciding where to base the company’s core IT operations in order to form the IT integration strategy. Typically, one company’s back office IT operations are integrated into the others. However, with cross-border deals, while IT applications and infrastructure can be migrated, IT staff and suppliers are typically based locally. Moving these across borders usually requires hiring new staff and changing IT service providers, at least on a local level, even if the supplier is global. This can extend transition timelines during a deal, and therefore requires longer IT transitional services from a seller to a buyer. In order to overcome these obstacles, cross-border deals need to consider an IT transition and integration strategy that typically redefines overall IT architecture in terms of the combined company. By planning for a new IT operating model that accommodates the regulatory and operational realities of the combined IT environment, acquirers need to allocate a greater amount of time and cost to the planning and implementation phases of the integration.
Gaster: With connectivity today, distance becomes less of an issue. Instead, the structure of the deal has more of an impact. If a business is buying the shares, then provided that key people and licences are available, among other things, then the cross-border aspect of the deal should not be an issue specifically for IT. The location, travel and visas would be common to all areas, including IT, in a cross-border deal. Good due diligence should help with these issues.
Collier: As part of any cross-border deal, the legal and regulatory environment in both jurisdictions needs to be understood to properly anticipate issues with regulatory compliance, transfer of assets, and IT and data security risks, which may vary across different jurisdictions.
FW: What essential advice would you offer to both buyers and sellers on successfully managing IT during an M&A transaction?
Yeremian: Companies must understand the IT risks and opportunities early on. Sellers should understand how buyers may discount the value of the transaction due to real or perceived IT risks, such as cyber threats that expose future revenues, faulty disaster recovery plans, systems to be replaced to accommodate scalability, and so on. Buyers should understand the IT risks that are likely to expose revenues in the short to medium term, and incorporate the costs into their valuation model and mitigate these risks in the projected capital expenditure budgets. Parties should avoid the pitfall of using the change momentum during a deal to over-reach on the potential optimisation of the IT environment. Focus on the IT change that is needed to enable the transaction, and have a strategy where the transaction change is the first step in a mid- or long-term IT strategy to build an optimised IT environment.
Gaster: It is vital to have alignment based on facts and detailed planning that allows the integration lead to monitor and drive the project with the incumbent teams.
Collier: Invest upfront in understanding the relative importance of IT to your deal. Many operational synergies are hampered post-deal because the technological implications were not properly understood pre-deal.
Shant Yeremian is a KPMG director in Toronto’s deal advisory group and leads the technology M&A services practice across Canada, which advises clients on the impact and value of technology within M&A transactions, including buy/sell side M&A, leveraged buyouts, IPOs, divestments, and restructurings. Over his 17 year career, Mr Yeremian has worked across the globe, previously based in London and New York, as an M&A adviser, investment banker, technology consultant and principle investor. He can be contacted on +1 (647) 870 5883 or by email: firstname.lastname@example.org.
Ben Gaster leads the KPMG operations M&A Team in Vancouver and is focused on the West Coast market. Mr Gaster has over 15 years of experience advising companies and stakeholders in mainly deal situations. He has spent his career in professional practice in the UK and more recently in Canada. He also completed an extended secondment at Lloyds Bank (UK) and has led a number engagements working alongside client’s teams for extended periods. He can be contacted on +1 (778) 785 2919 or by email: email@example.com.
Aaron Collier is a director in operations M&A at KPMG LLP in Canada. He has more than 10 years of experience advising buyers of businesses on improving operational value post-close. He also frequently works with owners to maximise operational value prior to the sale of business. He has worked in London, UK, Toronto and is now based in Calgary, Canada. He can be contacted on +1 (647) 527 2496 or by email: firstname.lastname@example.org.
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