Don’t Overlook IT When Calculating The Value-Creation Potential of a Deal

More often than not, charting a path into the future starts with an accurate assessment of the current; you have to understand where you are before you determine how to get where you want to go. This is particularly true when it comes to M&A, where due diligence is the most important ingredient. Merging with, acquiring, or investing in a company requires the appropriate due diligence to determine the true deal value. Part of the diligence is assessing the target company’s IT assets. An extensive study by Robert Bruner, Dean of the University of Virginia’s Darden School, concluded that one third of all M&A deals destroyed value, one-third broke even, and one third created real economic value. Several common causes of failure were cited by the study, however, the top five reasons cited for failure all have IT implications, although not one of them mentions “IT”: * Vision versus strategy * Culture shock * Overpayment * Inadequate due diligence, and * Poor execution So how can IT contribute to M&A success or failure? Consider the following: A buyer has a vision and strategy to grow the target company. During implementation of those plans, it discovers that the target’s information systems can’t support the strategy execution. As a result, the acquirer determines that executing the strategy will require a major overhaul of the systems, and thus delay strategy implementation. Another common situation occurs when multiple firms are involved in a very competitive bid situation and the winner pays a higher price than the assigned value. The pricing models still showed promise of achieving a reasonable level of EBITDA, but then the management team begins assessing the IT functions and systems, at which time it becomes very clear that a large outlay of capital investment will be needed to provide the right information systems to operate the company. Since the buyer significantly overpaid, there is a negative impact on EBITDA for the next couple of years. Last, a buyer conducts due diligence without investigating the target’s IT. This oversight becomes significant when the buyer learns that the target’s systems are antiquated and have been customized over a lengthy period of time without appropriate levels of documentation. In effect, the target’s developers become as valuable as the systems themselves because they understood the systems, the business, and the business rules that govern the company. Unable to operate without the current resources, the buyer is forced to pay well above market rates to keep the developers while the target company undergoes an extremely expensive IT overhaul. One of the key aims of mergers and acquisitions is value creation. IT’s role in enhancing a company’s value makes due diligence a necessity. The cost and value of IT need to be thoroughly assessed if greater value is to be achieved. Noise or Wisdom? The assessment should focus on analyzing and evaluating the current environment in order to provide an in-depth viewpoint of where and how IT operates and its alignment between the business and technology. This is the value IT provides to the business. Drawing from PSC Group’s Content Progression Model, an information control tool, it’s important to understand whether the company operates with noise, wisdom, or somewhere in between. Does the company make non-fact-based decisions or does IT provide wisdom and knowledge to the company so it can make informed decisions? Is the appropriate technical infrastructure in place to create a knowledge-based environment or does IT need such a costly overhaul that it will impact a deal’s value? It is critical to have systems that allow the business to function and grow. Content Progression Model Therefore, even though IT is not listed as a sole attribute for failure, it certainly has an implication in each of the top reasons for deal failure. Assessing the quality and cost of the IT environment can speak volumes. Investors often make critical decisions without this key element as part of the process. They overlook the IT component for several reasons – often because they lack the expertise. In order to deliver IT as a value-based function, not just a cost center, companies must ensure that they probe the IT aspects of a deal with the same level of rigor they apply in assessing other parts of the business. This is where experts can help companies achieve an accurate, value-based IT model. Technology must be viewed as a business enabler that can provide a competitive advantage, allowing it to operate in a strategic, differentiated manner as opposed to a tactical, undifferentiated, reactive manner. The technical architecture should be flexible and scalable to handle additional acquisitions or transactional growth. To perform proper IT diligence, you have to answer critical questions, including: * Are the business systems sufficient to handle the operations? * If the business is scaled, can the current systems handle the transaction load? * Is the appropriate infrastructure – hardware, software, people, etc. – in place? * Are there key people who run the company’s systems, or have they developed or purchased products that are supported in the marketplace? The company must be able to operate with information, knowledge, or wisdom and not noise. The Bottom Line IT can be a key differentiator in the way companies manufacture, market, sell, and support products and services. Therefore, it’s important that companies validate the assets and alignment of the IT department to the business. The IT group needs to be viewed as an assisting asset rather than one that hinders the company. IT due diligence requires experience, expertise, and a structured assessment process that allows for an accurate, complete analysis of the target’s IT. Based on a company’s specific needs, the diligence should be tailored to deliver analysis that ranges from quick, issue-specific assessments to comprehensive M&A studies. This allows for identification of the target’s strengths and weaknesses. Doing this also enables evaluation of the IT organization and the determination of its current value to the business and, ultimately, to the deal. Taking a structured approach to conducting IT due diligence means the difference between knowing the true value of the deal and taking an unmitigated and unnecessary risk. The better the buyer understands the target’s IT, the better it can place a value on the business as a whole and its future potential. Sonny Origitano Leader of the Advisory Services Practice PSC Group (c) 2006 Mergers and Acquisitions Journal and SourceMedia, Inc. 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