October 1, 2008

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When the Honeymoon is Over

Acquirees Face Challenges to Fit Their New Mold

Mark Dayton

October 1, 2008

Deals, deals, deals! In the corporate world, some of the headiest conversations center on upcoming or recently completed business acquisition deals. Corporate managers and media often gush about the size of the transaction, the strong synergy, the great strategic fit and substantial projected benefits to shareholders. Executives inside and outside of the deal speculate on how the newly merged companies will impact industry, life and the world. It’s smiles and optimism all around. However, much less discussion centers around the actual results deals produce after the fanfare has died down. According to a Boston Consulting Group analysis of more than 3,200 transactions, nearly 60 percent of acquisitions completed from 1992 to 2006 reduced shareholder returns. Officials at consulting firm Bain & Co. in Boston maintain there are few home runs for shareholders resulting from acquisitions. Closer to home, Clark Hinckley, executive vice president for Zions Bankcorp says, “My guess is that the vast majority [of acquisitions] don’t benefit shareholders.” That said, we decided to take a closer look inside some of Utah’s recent acquisitions for a post-deal assessment of what makes them work and what significant challenges can turn a well-intentioned combination into a drag on shareholder wealth. And since much of the post-deal information emanates from the acquiring firm, we decided to talk to acquirees for their perspective on the experience. Getting Past the Honeymoon Many acquisitions go through distinct phases as the new entities come together and learn to work effectively with each other. Josh Coates, founder and CEO of Mozy Networks, an online backup solution for home and small business users that was recently acquired by Boston behemoth EMC, says first there is a honeymoon period, then a cold, hard reality period and finally a maturity period. “When an acquisition happens, expectations are set,” says Coates. “The acquirer says, ‘This is what we bought, right?’ and the acquiree says, ‘This is who bought us, right?’ There is always disappointment on some side, and with a successful acquisition, a lot of learning has to take place. The trick is, can you both learn and not wreck the business?” According to Coates, Mozy has navigated both the honeymoon and cold, hard reality phases, and has moved into a mature relationship that works for both parties. “EMC has been thrilled. We made them look smart – the business growth is still a hockey stick – and we are still doing what we love and have tripled in size.” Other Utah acquirees describe important aspects of the phases, including completing a thorough, reality-based pre-honeymoon due diligence and business plan. “Too many deals focus on the dollars, co-marketing, customer bases, etc. and not enough on the new business plan – the goals, benchmarks and plans for the next six months or year,” says Drew Judkins, vice president of product management for UCN. Two of Judkin’s early-stage software companies were acquired by UCN, a leading hosted contact center technology provider based in Salt Lake City. “The success of an acquisition often hinges on the amount of due diligence you put in up front. Like a good mechanic, you have to look under the hood, understand the risks and tradeoffs, and how they may reduce value. Beyond that, you must be sure to create a reasonable plan that gets them to success.” Executive sponsorship within the acquiring company was almost universally cited as a crucial component of navigating the cold, hard reality stage of an acquisition. Seth Bailey’s company iTok was acquired by Lindon-based DirectPointe in December of 2007. As former CEO of iTok, Bailey emphasized how important having a good corporate sponsor was in quickly integrating his small company into the larger DirectPointe. “When coming into a corporate environment that was set in their ways, to have someone in a position of authority give their stamp of approval and paint a picture for the entire organization was absolutely essential,” says Bailey, who is now vice presi-dent of DirectPointe’s consumer division. “We probably couldn’t do that on our own because there wasn’t that established trust, but we had (DirectPointe CEO) Mike Proper’s blessing and got a lot of people excited. We integrated very quickly because of that; there wasn’t a lot of downtime.” Judkins illustrates the point this way: “You must have an internal champion, or you will fail. The CEO must appoint someone to own it – to say, ‘Give me a business plan and let’s execute on it.’” Related to this notion is the challenge of learning to navigate within the new organization, even with strong executive sponsorship. Judkins has encountered challenges in generating the same passion for his products in the acquiring company as existed prior to the acquisition. “You just have to realize that bigger organizations have other products and more siloed specialists who don’t see your product as the most important thing in their lives the way you and your entrepreneurial team did when you were on your own,” he says. “You learn that they can be good team players, and you can utilize their skills to your advantage – you just won’t get their passion.” Culture Cross Navigating cultural differences between the two organizations can have a major impact on results. According to Hinckley, “It’s talked about a lot, but I see a lot less action than I do talk. It is surprisingly important to how an acquisition fares.” When asked about how differing corporate cultures impact the success of an acquisition, Coates quickly points out that East Coast employees still wear ties (EMC is headquartered in Boston) while in the West, business atmospheres are often a bit more casual…which isn’t a major deal in acquisitions these days. What is important culturally is recognizing the difference between a large, Fortune 500 company and a small entrepreneurial group – particularly in how decisions are made and how the business is run. “At Mozy, we would get the decision makers in a room, work the white board, discuss, say ‘Let’s do it,’ and go do it. That would take all of an afternoon,” says Coates, noting that it doesn’t work that way in a large company with departments, sub-departments, committees and approval protocols. “One isn’t better or worse than the other, just different,” says Coates. “We have to realize that having EMC as a parent means we have a safety net and new international reach, which is fantastic. They’re trying to help us grow up. Right now we’re an adolescent – sometimes we need help and sometimes we just want the keys to the car.” Bailey noted similar challenges and advantages in the Direct Pointe acquisition. “It’s a little less flexible than being a small company. You’re doing things more by the book and less duct tape is used to get things done, which is difficult, but also good in the end,” Bailey says. While the change was a challenge for some, the combination with Direct Pointe brought counterbalancing advantages. “[The acquisition] allowed us to have some additional resources and focus on what’s important, which is business growth. The smaller things like payroll were off our plate and we could really focus on building the organization,” Bailey says. For both Mozy and iTok, the fact that the acquiring company allowed them significant autonomy dramatically eased the challenges of merging two disparate cultures. The other tricky aspect of merging cultures is recognizing that reporting relationships and span of control responsibilities will change following an acquisition. Judkins points out that prior to the acquisition, his organization had a very nimble, shared-responsibility type of environment where the CEO did QA one minute, debugged code the next and negotiated terms the next. In a larger organization, people tend to get siloed into smaller areas of responsibility by necessity. “I went from CEO to VP of a division, in charge of products and marketing,” says Judkins. “Even though the dollars are much bigger, the focus is smaller.” Coates likens it to a family situation. Relationships and responsibilities are crystal clear before the acquisition. Getting acquired is like getting married. “You have another family now, with a mother-in-law, sisters-in-law, brothers-in-law…you have to redefine your relationships,” he says. Not only does this affect who reports to whom and how decisions are made, it impacts how the overall business is directed. “The new parent not only has to determine who we report to now and how we develop things, but who should drive the boat – the guys in Utah or them? Who has their hand on the rudder?” Coates also points out that to be successful, you must be willing to deal with change and adapt. “It’s not business as usual – it’s change.” The picture is further complicated by large organizations that make multiple acquisitions in relatively short periods of time. “We were just getting used to our new nieces and nephews, and EMC acquired another company they wanted us to work with,” says Coates. “Just like that we had a new brother-in-law. It was a big surprise – but we’ve worked through that one as well.” Direct Focus The pace of change and myriad challenges involved with being acquired can be daunting, even to seasoned entrepreneurs. Things don’t always go smoothly with the new parent company as strategies, priorities, reporting relationships and responsibilities are sorted out, negotiated and realigned. At times, smaller acquirees may feel disadvantaged in the balance of working things through. However, these acquired companies point to one last key that may be the most important in a successfully integrated acquisition: focus on the business. Bailey points out that offloading many of the operations aspects of the business to the new parent allowed employees to focus on business at hand. In the year since the acquisition, iTok has tripled its business, which Bailey attributes to the acquisition with DirectPointe. Volume and sales growth, happier customers and better products delivered on time are results everyone understands. “At the end of the day, you can hold onto that safety harness – that’s why they bought you in the first place. It keeps them anchored,” says Coates. “As soon as you let go of the fundamentals of the business, your value is in question, you’ve lost your credibility.” And what’s the best way to maintain that credibility? “Keep the business up and to the right.” Formula For Success One Acquirer Tells How To Make an Acquisition a Winner Zions Bankcorp has completed a number of successful acquisitions over the past decade – all outside of the state of Utah. According to Clark Hinckley, executive vice president for Zions Bankcorp, successful acquisitions hinge on three fundamental principles: Economic Value Acquirers must look for sound economic reasons for an acquisition, Hinckley says. He points out that many companies follow a strategy of growing by acquisition, which almost never works for shareholders in the long run. “Doing acquisitions is not a business,” says Hinckley. As an example, Hinckley points to a large U.S. bank that grew through a large number of acquisitions. This bank actually came to view itself as an acquirer rather than a bank. As the negative results piled up, shareholders began to refer to the CEO as the “serial dilutor.” His successors spent many years unwinding this trail in an effort to restore shareholder value. Discipline Staying on track to deliver sound economic value boils down to financial discipline, says Hinckley. “Are you proposing this acquisition because you like to do acquisitions, or because it is really strategic? Does it create value for shareholders or for your ego?” This disciplined approach actually enables a company to critically analyze many different possible deals, sometimes yielding unexpected results. For example, in 1998 Zions acquired Sumitomo Bank in California, which, on the surface, was out of character for the bank at that time. However, Zions was able to negotiate a very low purchase price, allowing the organization to build Sumitomo into one of its most successful acquisitions. “When you do acquisitions, you must have a lot of discipline,” says Hinckley. “You’ve got to be able to reject those that may appear attractive but aren’t, and pursue those that might be out of the mold, but would be good for shareholders.” Culture Misaligned cultures cause some of the biggest headaches for acquirers and acquirees alike. The most important area of alignment: business philosophy. One of Zions’ smoothest acquisitions had a very similar approach to business, which was discovered through a partnership of several years prior to the acquisition. Other acquired banks who began with a mismatched view of the business environment took several years to integrate effectively.
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