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 Liverpool Football Club (see "Pitch Fever" in the Deals section of CFO magazine's June issue), 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 $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?"
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 nation'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.