by irmgard heinz, jens niebuhr and justin pettit › 2008 › 10 › heinz... · 2008-10-31 ·...

By Irmgard Heinz, Jens Niebuhr and Justin Pettit

20 financial executive I October 2008 www.finandalexecutives.org

is, there's a chief financial officer thinking about<i deal he or she is involved in. For somethinglluil ivpresents juist one responsibility on a longlist, thf lole of deal maker can certainly accountfor a disproportionate share of mind.

Tht're's a reason for this: mergers and acqui-sitions are often tbe most significant capitalinvestment a company makes in the course of ayear. Acquisitions represent a huge opportunity— and also a huge risk. A bad deal can perma-nently damage the reputation of an executiveteam and its CFO.

Not every deal operates by the same rules,and no one strategy fits every company. Thtîre aremany different ways to succeed at M&A. Yet, forall the differences in how companies approachM&A, CFOs typically play three basic and essen-tial merger roles:

Merger Strategist. In this capacity, the CFOensures that the merger plan meets larger cor-porate objectives. The CFO's role isn't limitedto ensuring the deal's financial soundness; italso extends to shaping the strategy. What isthe best target? How can the company mitigatewhat could go wrong?

Indeed, one of the strategic decisions CFOsneed to help make is what sort of '¡deals their companies shouldpursue, Traditional deal-makingis only one tool in most compa-nies' growth kits — and "not nec-essarily the one that gets themost use," says Peter Kellogg,the CFO of Merck & Co. Inc.Nowadays, many companiespursue partnerships that involvelicensing and joint development,manufacturing and marketinginitiatives. "We seek to find awin-win approach that is finan-cially logical," Kellogg says.

Synergy Manager. Synergiescan take several forms, from thecost savings achieved by consoli-dating operations, to increasedsales through new capabilities, |But whatever the type of synergy, !CFOs play a key role in creating 'the post-merger integration plan and Identify-ing the people who can execute it. They alsoimplement program-management systems toensure synergy capture.

Business Integrator. Here die CFO identifiesthe changes related to personnel, processes andorganizational structure that will best bring outa deal's value. While CFOs play a hands-on role

in bringing the finance organizations of two pre-viously separate entities together, there is often arole in integrating businesses and departmentsoutside of Finance.

For example, the CFO's organization willdefine the performance metrics and establishthe goals that must be achieved to justify thedeal's purchase price. These goals may also betied to the incentive<ompensation system, put-ting the CFO at the heart of incentive design.

Furthermore, monitoring progress throughflash reports and monthly reporting of perform-ance against goals, and other key performanceindicators, are all important parts of a success-ful integration that the CFO must drive.

Finally, to achieve these goals, many CFOslead synergy-oriented education and trainingprograms, or "business literacy" workshops.These programs communicate the performancegoals and identify the key value drivers withineach team's line of sight, and how their actionscan help the organization achieve its goals.

In fulfilling these time-tested roles and suc-ceeding at M&A, winning CFOs act in certain,recurring ways. Here are six rules that CFOsshould follow to ensure that one plus one canequal more than two:

MERGERS AND

ACQUISITIONS

REPRESENT

A HUGE

OPPORTUNITY

AND RISK.

DESPITE THE

DIFFERENT WAYS

TO APPROACH

M&A, CFOsTYPICALLY PLAY

THREE ESSENTIAL

DEAL-MAKING

ROLES.

1: Shape the strategic intentof the merger.Any deal must support the com-panies' long-term, value-creationstrategies. Doing a deal mainlyfor a short-term reason (such as tomeet a forecasted number) is amistake.

Deals can be done to addscale, position a company in apromising geographic market,expand a product line, acquiretalent or gain better control of thesupply chain. Sometimes, dealsare done simply to add new capa-bilities. This is true of Johnson &Johnson, which has completedmore than 70 deals in the lastdecade, and UnitedHealth Group,which has done almost U)0 deals,many of them small. "A lot of

them were done to piece together capabiiities,"says UnitedHealth CFO G. Mike Mikan,

Whatever the strategic intent of a deal, theCFO needs to help shape and communicate it.In particular, tbe CFO must have the resolve notto be swayed by the market's initial response.For example, during bear markets, fundamen-tally sound deals can get an unwarranted

OwH<

www.financialexecutives.org October 2008 financial executive 21

thumbs-down from wary investors.As one of the deal's key strategistsar\d its clear-eyed analyst, the CFOshould not be dissuaded either byunrealistic optimism or by ground-less pessimism.

2: Sense your opportunities andprepare to capture them.We have all heard it: "Company Xacted opportunistically in an M&Asetting; " Ihe implication being that aprofitable deal emerged unexpectedlyand that the buyer or seller pouncedon it. Extreme time pressure height-ens M&A risks, especially the risks ofpaying too much and giving shortshrift to essential internal processes.

Preparation increases the likelihoodof a company getting in early on anattractive deal and wresting momen-tum from rival bidders. Some compa-nies have a central group that regular-ly scans the market to identify poten-tial targets. Other companies employ"regional scouts" whose job is to stayabreast of interesting M&A opportuni-ties in their respective markets.

Advance preparation can alsohelp in the financing of a deal. Afterbeing appointed CFO at globaltelecommunications company Tele-fonica S.A. in 2002, Santiago Fernán-dez-Valbuena spent long hours court-ing commercial banks to establishopen pipelines to capital. Thatgroundwork paid off in 2005 whenFernandez-Valbuena secured thefinancing for the company's $32 bil-lion bid for mobile and broadbandservice provider 02 over the courseof a weekend.

3: Never overpay.Among the many mistakes that com-panies can make in M&A, none is asirreversible as overpaying. There isno recovering from an acquisitionthat doesn't earn its cost of capital orends up burdened with a debt loadthat it can't service. "If you can'tbuild the case for how you're goingto make money, you shouldn't goafter a certain target," says KurtBock, the CFO of global chemicalscompany BASF.

Leading CFOs determine the value

of potential targets in several ways.They triangulate value through multi-ple analytic methods, as well as sub-jecting critical assumptions and otherrisk factors to a comprehensive sensi-tivity analysis. Some companiesdeploy a centralized M&A depart-ment whose job is to view the eco-nomics of a deal more dispassionately.

Winning CFOs also lower the riskof paying too much through creativedeal structures. Some companies rec-ommend structuring riskier deals sothat a portion of the payout is contin-gent on the target's achieving keymilestones. That helps to mitigate therisk of overpayment, align interestsand bridge the gap between thefuture expectations of buyers andsellers. Deal structure is also oftendesigned to incorporate other ele-ments of risk management, such asthe form of consideration or the useof collars on stock deals.

4: Cash Jn your synergies.Once a deal is done, investors judgeCFOs on their ability to deliver onpromises and achieve synergies.There is generally little questionabout what is expected; CFOs createthese expectations themselves, bytalking to the equity markets — oftenin considerable detail — about thedeal's economic rationale.

In today's demanding businessenvironment, there is no time forblurry plans, timid decision-makingor ambiguous communication. Itdoesn't bode well for the CFO whohas not already created a detailedimplementation plan and convincedthe business units of its urgency.

To meet these demands, CFOsneed a dedicated financial controlcapability that enables them to keeptrack of critical events, measure thesize and robustness of identified syn-ergies and create an unbiased andcomprehensive picture of a deal'sresults. Integration plans shouldinclude a clear timeline of milestonesand hold specific managers account-able for achieving them.

When the deal closed, financial syn-ergies that were once theoretical dis-cussions should be embedded in budg-

ets and nonfinancial synergies shouldbe tracked as integral parts of synergyscorecards. CFOs should also see to itthat everyone critical to make the planwork has some skin in the game.

Finally, if a deal's synergies aren'tachieved, it often falls to the CFO toexplain why. This is another task thatshouldn't be put off if credibilitywith the capital markets is to bemaintained, in these cases, CFOsshould communicate as quickly andclearly as possible the root causes ofthe problem, the corrective actionbeing taken and revised estimates forthe deal's economics.

5: Buiid trust in future success.Much of the acquired value of a dealhinges on existing staff. People main-tain operations, own trusted clientrelationships and develop marketinsight. And yet in almost everyacquisition, key staff members andmanagers react with concern to newsof the transaction and wonder whatit will mean for their futures. Manyworkers lose focus; some considerleaving and others do leave.

CFOs can help mitigate this risk ina number of ways. One is to resolveStaff uncertainty as expeditiously aspossible. This means making fast-track decisions about organizationalstructure, staff and governance aswell as decision rights. With certainacquisitions, it may mean dealingforthrightly with labor issues. Theaim is always the same: to cut shortinternal speculation and re-engagepeople in the firm's business asquickly as possible.

Making post-merger managementappointments on the basis of meritcan be a powerful retention tool. Keystaff members usually take stock ofthe acquiring company's disciplineand objectivity before decidingwhether to stay. Aditya Mitta!, theCFO of Mittal, remembers from theArcelorMittal merger: "We operate asa meritocracy, on an honest, transpar-ent and fair basis."

6: Don't compromise on financialcontrol and compliance.CFOs ultimately must lead and

22 financial executive I October 2008 www.financialexecutives.org

reshape the finance function itself.This can be a huge challenge becausethe reporting processes, informationsystems and control tools of theacquired company often differsharply from the buyer's. And time isshort as the new company generallyhas to meet deadlines for its upcom-ing quarterly financial.

Leading CFOs break the finance-integration into three phases: fulfillexternal reporting requirements; estab-lish a set of common financial prac-tices; and transform the entire financefunction into a world-class operation,while consolidating operations.

In the first phase, the treasury andcorporate finance functions in thenewly merged firm must be immedi-ately operational, even though orga-nizational decisions that will definethe new external reporting structureare still pending.

During the second phase, CFOsidentify the control capabilities thefinance department will need, shifttheir attention to planning and per-formance management and deter-mine the financial processes, systemsand tools the business units will use.

After the basic finance operationsare established, CFOs can work onthe long-term changes that will maketheir finance departments more effec-tive and efficient. This is the thirdphase and it entails instituting globalstandards for structures, processesand tools to simplify financial controland compliance issues. Throughoutthis transformation, CFOs ensure thatoverarching quality and compliancestandards are met.

This article is based on a recent study of

leading CFOs on mergers and accjuisilions

conducted by Boot & Co. The studij results

are published in the strategy+business read-

er THE C F O AS DEAL MAKER —

THOUGHT LEADERS ON M & A SUCCESS.

FEI members can access a free doïimload athttp://wwn'.strategy-business.com/cfo2reader. The authors are all partners withBooz & Co., IRMGARD HEINZ (irmgard.

heinz@booz.com) in Munich, JENS

NIEBUHR ijens.niebuhr@booz.com) in Dus-

seldorf and JUSTIN PETTIT (justin.pettit©

hooz.com) in New York.

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