- For Students
By Sean Epstein `04, Head of SAP Private Equity, EMEA and
Emmanuel Cassimatis, Head of Small & Mid Cap Private Equity, EMEA
Most everyone would agree that technology has a role in M&A or at the very least an impact on its success. In early September of this year, hundreds of General Partners (GPs) and Limited Partners (LPs) gathered at the annual Capital Creation event in Monaco. If there were a word cloud from these conversations the phrase “value creation” would have stood out the most.
Funds and their LPs are prioritizing this element of their investment thesis, or criteria for allocating funds. More than ever, they recognize that technology has come from being an enabler to being a source of competitive advantage. At a time where there is high liquidity, being able to create operational value through technology has become a key success factor, a door to efficient value creation. The hope would be that responsible directors, majority owners, and shareholders have stakes in, and should be armed with, the following questions:
1. How do I choose which technologies are required to support and execute our investment thesis? What investments need to be made, in the short and longer term, to implement those solutions quickly and with minimal disruption?
During due diligence and certainly soon after the deal closes, PE investors should have people on the ground analyzing if the current operational processes/technology can do what they need them to do. This analysis should focus first on the required processes based on investment thesis, for example – multi-currency/language capabilities for international expansion; spend visibility and optimized procure-to-pay processes for indirect spend reduction; e-commerce and multi-channel commerce capabilities for top line revenue growth and multiple expansion through business model changes. A majority of operationally active funds deploy resources, time and money to the core functions of Sales & Marketing, Finance & Procurement, and of course by industry where they “have to get it right” (manufacturing – plant maintenance, supply chain, logistics; technology – R&D; health care – regulatory & compliance). There is now clear evidence that Funds are hiring or contracting individuals that can connect the dots between short term changes required in certain key process and the technology needed to support that optimization.
2. How do should we think about transition services agreements costs, benefits, and alternatives? What is our contractual and operating transition exposure at separation? Are the licenses currently in use transferable, in compliance, and being used correctly, and if not, what should I do about it?
Day one separation of technology infrastructure, or integration of one or many core operational technology platforms requires a good deal of planning. Looking back at one of the largest divestitures at its time, HP’s carve out of Agilent, it cost hundred of of millions of dollars, tons of consulting resources, and huge upheaval in the business; many suggest it stunted both organizations growth for quite some time. When business merge or separate two things must happen to the existing systems.
First, they are supported for a period of time by the previous owner through a transition services agreement (TSA), at a significant mark up and with questionable levels of service.
Second, the buyer (NEWCO) sets up a parallel technology footprint that can enable all core process that were operating prior to day one; this is generally outsourced to consulting, implementation, and hosting companies.
TSAs can be expensive for what you are getting and may not always have the best level of quality and service. Buyers who decide to leverage the TSA offered should carefully determine the TSA duration and ability to tweak the timing without penalty. TSAs can provide a sense of security, limit disruption, and give everyone time to really understand the organization's needs.
As a rule of thumb its best to get off a seller provided TSA sooner rather than later. Most implementation firms can quickly assess your landscape and create a parallel one to migrate you to quickly; getting off a TSA in 3-6 months has significant cost savings. The advent of cloud based point solutions (HR, finance, supply chain, etc.) as well as enterprise wide solutions (like ERP), means that companies can move their applications to the cloud, while moving capital expense to operating expense. Many technology providers are offering customers compelling terms to swap existing on premise licenses for cloud-based licenses.
Another area that requires attention is ensuring that technology in use at NEWCO is in compliance. More than 30% of all Global 2000 companies are running software in some “out of compliance” manner (reselling without rights, sharing of seats, using new versions without having purchased upgrades, etc.) Some investors may choose to shy away from probing on this issue, and it is understandable why. But, if there is gross abuse and the company plans to acquire additional technology from those provides, it may be beneficial to proactively reach out and get a gauge on the issue. You will be more prepared, avoid surprises, and give yourself better leverage at the negotiating table.
3. How does technology integration impact strategic acquirers likelihood of purchasing the asset and its valuation? Where should I focus any technology investment towards the end of my hold period?
Where most people agree is that lessening integration effort will positively impact the attractiveness of the company to strategic buyers and therefore its valuation. Each industry, region, and size of company will change the buyer’s value placed on the ease of integration. For example, companies like Valero or Cemex, have placed significant value in getting new companies up and running quickly, as have the major bio-techs and pharmas. Most serial acquirers have very specific criteria during due diligence focused on IT integration costs, resources and timing. This is where investors are wise to work with leading players in technology and advisory services to get a voyeuristic view into what these potential buyers are doing with technology currently and what they plan to do in the future. Simplifying the potential investments down to line of business processes that provide competitive advantage is a nice way of prioritizing any investments in technology during the latter part of the hold period. Another approach would be to focus on core, somewhat commodity processes, like billing, shipping, hiring, pricing, etc. Lastly, this is where the cloud really changes the game. Focus on quick to deploy cloud-based solutions that can be metered and scaled so you can buy only what you need before exit and the buyer can scale up as much as they need. As an example your ability to manage outsourced/contract labor or efficiently monitor travel and expense compliance, maybe an ongoing issue, most of these issues can fixed rapidly in the cloud.
Technology has become a key component to realize investors’ investment thesis. The investment world is in a constant race towards value creation. The weight of the typical EBITDA/multiple/debt levers changes, but so do the ways in which these levers are actioned. The question is no longer do I invest in technology, it is how do I best use technology to truly create value.