ACQUIRING MINDS WANT TO KNOW
New software and services help buyers assess the IT systems of potential takeover targets.
By John Edwards

Whenever managers at private-equity firm The Watermill Group identify a
likely takeover candidate, they look at the standard benchmarks. Those include a target’s earnings power and debt level, as well as intangibles like the competence of upper-level management. But in weighing a possible bid, the Lexington, Massachusetts-based firm goes beyond the usual suspects. Management also factors in the state of the target company’s IT system and its underlying data. “We need to know what kinds of systems the target company actually has,” says CFO Steve Kotler, “and how much it will cost to either separate or integrate those systems.”

These days, that’s crucial information. IT systems and databases are growing larger and more complex, playing an increasingly pivotal role in daily business activities. While factors like stock price and return on equity are relatively easy to quantify, judging the state of a company’s IT system can involve as much guesswork as judging the temperament of employees. “It’s a little like trying to estimate the value of rare artwork,” says Stephen Bruel, a securities and capital markets analyst at TowerGroup, a financial industry market research firm. “Only it’s far more complex.”

Indeed, the calculation can be so complex that many eager merger and acquisition suitors simply brush it aside. “IT systems are the last things managers focus on,” confirms Bruce Richardson, chief research officer at AMR Research, a Boston-based business technology market research firm. “Then suddenly they realize they have to deal with the IT end of things, too.”

That Due Diligence That You Do

Several technology vendors have rushed in to help eliminate this blind spot. India’s Patni Computer Systems, for one, markets services and tools that help a buyer quickly assess the condition of a company’s IT assets.

The technology would seem to be particularly suited to private-equity firms, which often lack in-house IT expertise yet need every conceivable piece of relevant information when negotiating a deal price. Certainly, the discovery of faulty IT systems or data in a potential acquisition can be a powerful bargaining chip. And given the nature of takeovers, buyout specialists need information fast. They can’t wait months to find out if a target’s data warehouses are poorly stocked or impossible to navigate. “A lot of this comes down to turnaround time—how quickly you can provide this analysis to the company in play,” says Bruel. Adds Richardson: “What you don’t want to do is make decisions based on information that’s 30 or 60 days old.”

To help Watermill examine the tech capabilities of a potential takeover target, Patni evaluates the target company’s entire IT infrastructure, applications, organizations, and processes. That includes servers and networks as well as the company’s applications portfolio, from enterprise resource planning to business intelligence deployments. Says Kotler: “They develop a baseline for IT, determining the organization’s operational and transactional aspects.”

So far the service has proved invaluable. Earlier this year, Watermill, along with Hicks Holdings, the buyout firm that recently purchased a 50 percent stake in the Liverpool Football Club, was looking to acquire Latrobe Specialty Steel. During that process, the two firms relied on Patni’s IT due diligence to provide a detailed breakdown of Latrobe’s computer systems and data. Eventually, Watermill and Hicks acquired the steelmaker from The Timken Co. for a reported US$215 million. Once the deal was done, Patni helped ensure a smooth transition of all IT infrastructure and applications—often an overlooked part of an acquisition. Down the road, Kotler says, Watermill and Hicks may hand off Latrobe’s IT infrastructure and support operations to Patni.

Other vendors market software tools designed to analyze a buyout target’s business data. Oco Inc.’s Mergers and Acquisitions Solution, for example, is billed as being able to identify, extract, organize, and report on critical business information. According to William Copacino, Oco’s CEO, the software allows a user to identify problem areas and drill down to the lowest transaction level to find out what’s causing the foul-ups.
Oco’s software-as-a-service offering can extract and report on almost any data from such diverse sources as customer relationship management systems, procurement, and human resources. “This is the stuff you need to know,” says AMR’s Richardson. “How much obsolete inventory is on the racks? How many employees do you have? What’s the exposure in crucial areas?”

Bum Steer

For the most part, vendors are pitching their IT asset analysis offerings at companies undertaking buyouts. But the same services can also be applied after the fact, to help a purchaser get a handle on an acquisition’s IT infrastructure. Often, buyers find themselves saddled with inadequate—or incompatible—technologies.

Managers at Designs Inc. know all about that scenario. Back in 2002, the company acquired Casual Male, operator of the U.S.’s largest chain of big and tall men’s clothing stores. As the retailer’s current CFO, Dennis Hernreich, recalls, “The Casual Male [IT] infrastructure was in disrepair—little investment had been made to it over the years.”

Of course, five years ago, tools weren’t readily available to alert Designs’s executives to the woeful state of Casual Male’s IT infrastructure. But by 2004, management at Designs (which has since adopted its takeover target’s better-known brand name) realized that it desperately needed to repair the company’s rapidly failing IT infrastructure. Pivotally, company executives lacked real-time visibility into operational functions like product sales, channel management, and vendor relationships.

The problem was compounded by the conflicting data sources and legacy systems used by the retailer’s store, Web, and catalog operations. Not surprisingly, the welter of networks hindered senior management’s ability to react quickly and make informed decisions. “How do you drive a car without a steering wheel?” asks Hernreich. “That’s the situation we were in.”

Ultimately, Casual Male signed on with Oco. Using the company’s hosted software, data from multiple systems was retrieved and integrated, then cleansed, warehoused, and analyzed. Within six weeks, Casual Male’s senior management had access to reports providing insight into an array of financial and operational metrics. “We’re now defining our inventory better and are better able to keep things in stock,” says Hernreich. “Gross margins have improved significantly over the past few years.”

For his part, Kotler is convinced that thorough tech due diligence is crucial to the long-term success of any acquisition. “If there are things that are technically bad, or the IT strategy is bad, the company is never going to function; it’s never going to report,” says the Watermill CFO. “It’s never going to give you information that will be meaningful.”

John Edwards is a frequent contributor to CFO in the u.s.

RUST BELT
By John Edwards

Sadly, the horrific collapse of the Interstate 35W bridge in Minneapolis in August did not surprise longtime critics of the U.S.’s transportation system. The truth is, civil engineers, trucking CEOs, and even media types have been carping about America’s rotting infrastructure for years.

Few officials have listened. Last year, state and federal agencies spent an estimated US$8.3 billion making repairs on corroded bridges—the financial equivalent of sticking a finger in a dike. Indeed, the American Society of Civil Engineers reckons it will cost close to US$100 billion annually (over the next five years) to maintain America’s highways and bridges.

Oxidation is an equal-opportunity destroyer, corroding public and private metal alike. Business assets like railcars, storage tanks, and outdoor equipment are not immune from rust. While numbers are hard to come by, the most recent study on the subject (released by the U.S. Federal Highway Administration in 2002) found that corrosion costs U.S. production companies and manufacturers more than US$17 billion a year. Utilities were even harder hit, with a nearly US$50 billion annual rust bill. That’s a substantial tab. What’s more, companies that delay repairs do so at their own risk.

Scientists say that rust can be held in check. One of the most common types of corrosion prevention, cathodic protection, was first used on ship hulls in the 1820s. Although the technology has evolved since then, the idea is essentially the same: use an electrical charge to alter the electrochemical potential of a metallic object, thus thwarting corrosion.

Still, some corporate executives pay scant attention to rust prevention. This has more to do with human nature than with lack of interest in ‘sacrificial anodes’. Oxidation of large, well-coated metal objects tends to be a gradual process, one that occurs over a span of 5 to 10 years. A business’s capital tends to go to more immediate needs—like buying new machinery or purchasing software. “We’re conditioned as automobile owners to take our car in and have the oil changed every 3,000 miles,” says Cliff Johnson, director of public affairs for the U.S. National Association of Corrosion Engineers. “But if we don’t have the time or money, we put it off. The same thing occurs with [corrosion] protection.”

Making the casing

The U.S. Congress is trying to get corporations to scrape the rust off such thinking. Legislation introduced in the House of Representatives in March would provide a tax offset for 50 percent of net expenditures on corrosion prevention. The credit would apply to depreciable property comprised primarily of metals susceptible to oxidation.

Even without a tax break, rust prevention can be a money-saver. Pioneer Natural Resources USA Inc., an independent oil-and-gas exploration and production company, has been systematically installing cathodic protection systems on production casings on its largest producing wells over the past five years. Without the corrosion prevention program, Pioneer estimates it would have had more than 70 corrosion-related well failures in 2002. That number would have risen, too, as the company’s 4,600 wells got older.

The cost of the corrosion? Fixing a corroded casing costs around US$100,000, which would have left Pioneer with roughly a US$7 million repair bill in 2002 alone. “That would consume much of our lease-operating-expense budget,” says Jim Uhelski, an energy manager at Pioneer. “And it would cause our production to be lost temporarily or permanently.” In contrast, the company says it is spending about US$3.5 million this year on corrosion prevention systems. Says Uhelski: “Now, I don’t have management asking me what we can do to stop the epidemic failure rate of casings.”

The payoff from rust prevention can be seen in more modest projects as well. At Blue Surf Condominiums in Daytona Beach, Florida, the condo’s governing board has hired contractors to repair corrosion and cracks on balconies and railings twice in the past 10 years or so. Now the cracks are reappearing.

Duncan Dowling, a construction lawyer who is president of the association, says the company could have saved nearly US$2.4 million by simply installing corrosion prevention systems in the first place. “We were treating the symptoms,” fumes Dowling, “and not the cause.”

Esther Shein writes frequently about business technology.