Acquiring Minds

Last year may have been a low-water mark for mergers and acquisitions in Australia but 2003's M&A activity is expected to hot up. The M&A challenge for the CIO is to ensure that due, not dud, diligence is done with regard to information systems.

BHP's Information Technology team had been considering what might happen if the company merged with another business. How could it get its ship in order? How could it ease any transition process? It knocked at Deloitte's door. Ulysses Chioatto, then a partner with Deloitte, was asked to provide advice and guidance on a just-in-case basis.

"Within a couple of weeks there was an announcement of the Billiton merger and the IT team were totally caught unawares," says Chioatto, now a principal of consulting firm SSAMMs. "Here was the IT team, trying to do something about it - but they were not in the decision-making team. When you only tackle these issues post-event there is an overwhelming amount of money involved in integrating those systems."

If the financial pundits are correct, and the mergers and acquisitions caravan is rolling again, many CIOs will have to tackle the same sorts of issues as did BHP when it merged with Billiton, only hopefully they will brought into the loop a lot sooner.

According to a recent Bulletin magazine report there is already $15 billion worth of merger activity waiting in the wings. Mergers such as Burns Philp and Goodman Fielder, Tabcorp (or Unitab) and Jupiters are already well canvassed and the list of potentials is long, including AMP, Southcorp, WMC Resources, Ansell, Aristocrat Leisure and MIM. And lest we forget, Bulletin owner Kerry Packer has himself cashed up in recent months which might well presage a flurry of his own takeovers.

Sean Gregory is the partner in PricewaterhouseCoopers (PwC) who leads the post-deal services operations of the firm. "After the transaction is consummated I help with the integration and planning process and deliver the cost-saving synergies. IT is one critical enabler to that," Gregory says. And no matter how difficult merging IT systems might be, "you very rarely see a situation where the CIO in the deal will stop the deal happening", he adds.

"As to what a CIO can be doing to harmonise the systems [in advance of a merger] I've never ever seen that happen," Gregory says. "I've never seen an IT person make a decision based on making a company more attractive as a merger target. They focus on making the company more efficient or effective and I tend to think that's the way it should be.

"It is the role of the company's management to make the business attractive as a business, not as a takeover target. The CIO has a duty to deliver the technology to make that possible," he says.

However, once it is game-on as far as the merger is concerned, the CIO ought to play a much bigger role than he or she traditionally has, according to Gregory. At present, he believes, CIO and IT due diligence in general is not carried out to the extent it ought to be. In some sectors, such as telecommunications and finance, he believes the situation is better, with the high importance placed on IT due diligence during the M&A process reflecting these industries' dependence on information and communications systems. Other sectors, he says, need to lift their game in order to deliver the synergies and benefits anticipated from mergers.

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The last time PwC released a formal survey about how difficult it was to integrate merged businesses' information systems was in 2000, but Gregory believes the situation has not changed markedly. At the time 72 per cent of all respondents reported difficulty integrating their information systems. That compared with just 39 per cent in 1997, which suggests that the problem is magnifying not shrinking as information systems become more pervasive and important. And, as mergers and acquisitions become larger and global in nature, it will likely be further compounded.

"The number one integration issue is compatibility of IT systems," says Gregory. "Without being able to effectively integrate [IT] it's very hard to deliver all the other synergies."

One Australian company currently battling its way through the integration process is Insurance Australia Group (formerly NRMA), which has merged with a number of other insurance businesses. Although the company declined to be interviewed for this article as it is still completing the integration process, reports have emerged of the company axing a $60 million IT project and 70 IT jobs, and ending an IT management contract with IBM early at the cost of $10 million in compensation payments - all steps deemed necessary in order to allow the information systems to be meshed.

A business taking a completely different approach is the finance firm JP Morgan, which has developed an entirely new information systems platform following its purchase of BT Portfolio Services. The so-called Everest platform, which has cost around $20 million, is part of a global initiative by JP Morgan to develop an information infrastructure that will allow the firm to provide outsourced services to a range of financial clients internationally.

When it bought BT Portfolio Services JP Morgan knew that it would salvage little of the information systems. David Braga, originally part of BT and now a vice president of JP Morgan, was charged with preparing material to allow the firm to complete its IT due diligence. "I think that the IT value was of interest, but it was not the key component," Braga says.

Nevertheless, in the future IT due diligence will be far more important. The firm may have built Everest from scratch, but it is not a peak it will want to scale each time it merges or acquires a new business. So, for future mergers and acquisitions, "open platforms and standards are really important", says Braga. "An exercise like this is all about systems integration and finding ways of making systems talk together."

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It's Not Easy Being Merged

Merging IT systems is clearly costly and full of pitfalls, says Gregory, but even so, it has to be done in order to liberate the value from the merger. He's seen cases where the IT integration costs blew out to double or even three times what was expected; but he says once a merger is completed IT integration has to proceed almost regardless of cost. "That IT project is a one-off cost," he says, "the deal-makers assume that the savings will be an annual saving".

The extra spend, Gregory says, is rationalised using one of two arguments. "[First], if you don't get the IT integrated then you can't achieve the synergy. Or second, if you want to achieve the synergy by headcount reductions then you couldn't sustain that without the IT infrastructure to support that."

Although IT integration is unlikely to put the mockers on a merger, it can significantly affect the perceived value of the organisation to a buyer, even to the extent of deciding whether it is worth making a bid in the first place. In most M&As, Gregory says, "if you understood more about the IT systems then that could be used as a bargaining chip over the purchase price".

Paul Binsted is the vice chairman of investment banking at Salomon Smith Barney, a leading financial adviser on mergers and acquisitions. "Three years ago we acted for the Trust Bank of Tasmania," says Binsted. "We canvassed every bank in Australia to see if they'd buy it."

Interestingly, information technology itself was the reason that the bank was up for sale because there was an insufficient customer base over which to cost effectively spread the cost of technology. "They needed a larger customer base in order to defray the costs," Binsted says. "When we put the bank forward as a merger candidate one item in which there was very keen interest was the banking platform and how that might be integrated. It was only going to be economic if that was not a major expense."

The merger made sense for only some of the banks to which the Trust Bank was offered. "Some potential acquirers were not able to put forward such a good price because of the cost of merging the IT," Binsted says. Clearly it was necessary to conduct a thorough IT due diligence in order to make the M&A proposal financially sensible. And in these instances it was important that the CIOs of both sides were involved. Ultimately, the State Bank of NSW bought Trust Bank.

Due diligence is more than conducting an inventory of platforms, applications, licences and staff - it is about understanding the core competencies of each merging enterprise, the extent to which legacy systems are held together by prayers and promises, and the efficiency levels at which the current information systems run. It is one reason why Binsted is very wary of hostile takeovers, because without a deep level of IT due diligence there may be many nasty integration surprises ahead, which might undermine the envisaged value of the acquisition.

As well as selling Trust Bank, Binsted was the financial adviser on the more recent sale of AMP's GIO business to Suncorp-Metway. "For an insurance company the platform is its factory," he says. "When Suncorp purchased GIO, in working out where cost savings could be made, IT was critical. "There was an enormous effort involved in that and [Suncorp's] Carmel Gray was pivotal."

Although Binsted knows of Gray, Suncorp's general manager of IT, he never actually met her during the merger. He dealt with Peter Johnston, Suncorp's group executive operations and integration. Although in this case the deal seems to have gone smoothly and relatively few surprises were left uncovered by the due diligence process, the CIO was still one step back from the front-line merger managers.

However remote the CIO, at least in the financial services sector the need for IT due diligence is well understood. Chioatto, like Gregory, believes this is less so in other sectors. He says that last year when a Sydney-based utility initiated a takeover, it failed to conduct adequate due diligence and on completion of the merger found it was underlicensed for its software to the tune of around $500,000.

The fundamental problem, Chioatto says, is that CIOs are kept out of the loop pre-merger and then told to "fix the problems" once the merger is a done deal. Worse, the CIO also has to carry the can for the integration costing too much and sapping the value from the takeover. "In the last 24 months I've been involved in five transactions and each time I've been called in post-event, and every time the CIO says they haven't been in the loop," he says. "CIOs need to insist on a seat at the table. When you look at the services sector IT is core."

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The Call of Duty

Gray may not have had a seat at Salomon Smith Barney's table but her opinions cast a long shadow over it. She believes that CIOs have a duty to involve themselves keenly when a merger looms. "The quality of the IT in the target is very important. And by that I mean how robust and resilient the system is. The IT systems are core, so you need to understand the state of those systems and be asking through the due diligence process about the production environment," says Gray. "I'm not saying that they have to be at CMM [Capability Maturity Model] Level 3 or 4 or 5; but I want to understand it. If there is flaky IT, which is up and down, then that could well be contributing to customer attrition."

Gray acknowledges that due diligence, even in friendly takeovers, is "very difficult" to do. "Obviously you go through all the material in the data room, anything in the way of reports that helps you understand the IT situation. And you ask for, but you don't always get, presentations by the IT staff," she says.

In a hostile situation, getting that information would be even more challenging. This could be very significant. "If you went ahead with the wrong information then you could destroy a heck of a lot of the value of the merger," Gray says.

While she has never been involved in a hostile takeover, an event which she acknowledges would be "very difficult and quite risky", Gray believes it would be possible to glean some information about the company's IT shop from peers and competitors, or published data in some cases. Those efforts would perhaps establish what a company used in its IT shop, but it would be difficult to ascertain how well the technology was being used. In the end, the IT element of the due diligence process would have to be accepted as an assumed risk.

There are, however, some warning signs to help assess the risk in the more open environment of friendly mergers. Gray says that if during the due diligence process it became clear that the target was redeveloping core systems from the ground up, she would be wary of recommending the merger. More attractive from her point of view are companies with relatively standard technology platforms, both from the technology aspect and skills availability.

She would also want to see more than an IT "blueprint". She would want to see clear evidence that the blueprint for information systems was merging with the overall business model of the organisation, and that the IT team was meeting its service level requirements at an appropriate cost level.

Gray uses a check list when performing due diligence on potential targets, which she constantly refines. "In our case I see it as an important part of my role to be M&A ready, with a small 'A Team' working on it."

One of her tests to gauge how well Suncorp and a potential merger partner might mesh is what she calls the "strawman hypothesis", where she looks at the merged entity and determines the best underlying information architecture for the merged business. If that back-to-basics analysis determines that the current Suncorp information systems are still appropriate, then it greatly reduces the risk and increases the comfort factor associated with the plan.

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Liberation Day

Still, the greatest comfort of all is knowing that the value expected to be liberated by the merger will materialise and not be sucked up by the cost of the integration. "When I look at companies taking over one another, I need details over the time frame and how much money has to be spent integrating companies because they go to the core of whether the deal stacks up financially," Binsted says. "Ideally, you need systems that are adaptable and easy to communicate with, rather than arcane systems."

He believes that far more attention is now paid to IT due diligence than was the case in the past. "I've been doing M&As for 20 years. There are two areas of due diligence that did not receive much attention in the 1990s but where there is now extreme emphasis. One of those is IT and the other is environmental."

SIDEBAR: In Due Time

Avoiding the nasty surprises

One of the hurdles in performing accurate IT due diligence is the lack of an established value yardstick. Ulysses Chioatto, principal of consulting firm SSAMMs, says that between companies, there is no one standard method. "And how do you value the IT projects behind the IT systems?" he asks.

For CFOs involved in performing due diligence, the company balance sheet should provide most of the important value indicators. Not so for the CIO. "If you're going to merge the two organisations," says Chioatto, "then you need to consider the culture, the brand, the locations. And at the heart of that is the IT systems. You need to establish the value of the IT no matter how imperfectly."

There can still be nasty surprises he warns. "If you are doing your due diligence and they tell you that they have a state-of-the-art system and you get in there and they don't, then you may have to revalue the cost of the integration - and that's where it becomes problematic because IT projects often blow out."

Suncorp's IT general manager, Carmel Gray, says that as far as valuing the competency of the organisation she would ideally be looking for a CMM (Capability Maturity Model) Level 3 accreditation, which would ensure that good practices and services had been established. "You need a method of assessing what you have found and then how to bring that into discussions [on the merger] about price and risk," she says.

Getting into the discussions is another hurdle entirely. "There is a greater importance [placed on] technology; but I would question that in putting M&As together, deal-makers put that much effort in [to IT]," PricewaterhouseCoopers partner Sean Gregory says. "The deal team generally involves the investment banks, the CEO and CFO and usually the financial advisers. Then there are lesser roles for the COO and CIO. But as they [the deal team] are assuming that they'll get these value synergies, the CIO and COO should come in to help verify that."

The flip side to mergers and acquisitions is the corporate carve-out, which presents CIOs with a another set of challenges. "There have been a number of deals where companies have been part of a larger group and are sold off. Carve-out situations are the opposite of integration," Gregory says.

The issue facing the CIO is that as part of the carve-off is that they may lose a critical part of the technology. For example, in some businesses the information infrastructure may have been owned and operated by the core business, leaving the carved-out business with applications but not the wherewithal to host those applications.

"The carved-out business may have some of the information technology, but a lot of the infrastructure and staff may reside with the core business, and that could be an issue," Gregory says. Again it is up to the CIO to explore the costs and risks associated in order to ensure that the appropriate value is realised from the carve-out.