IT Plays Linchpin Role In High-Stake M&As

A handful of companies understand what far too many don't--that IT's ability to integrate, and in some cases adopt, an acquired company's IT systems and operations can determine whether a merger flourishes or flounders.

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When Cogent Communications eyes a company to acquire, it goes into battle mode. Two miles north of the Pentagon, across the Potomac in Washington, Cogent sets up what it calls the War Room, where it marshals eight top executives to evaluate the target company. Among those on the due diligence squad: the IS director and IT infrastructure manager.

Cogent, a midsize Internet service provider, understands what far too many companies don't--that its ability to integrate and in some cases adopt an acquired company's IT systems and operations can determine whether a merger flourishes or flounders. For one thing, unanticipated IT integration costs can offset merger savings. And imagine the business lost when orders vanish, accounts payable go uncollected, and customer information goes AWOL because the acquiring company gave short shrift to the IT challenge ahead.

When Wells Fargo acquired rival First Interstate a decade ago, it created an IT misalignment of "epic proportions," recalls John Boochever, director of the North American IT practice at management consulting firm Mercer Oliver Wyman. In its rush to cut costs, Wells Fargo closed too many First Interstate branches and ATMs, costing the bank $100 million as First Interstate customers pulled upwards of 20% of their deposits. At the time, CEO Paul Hazen called the merger "a sorry experience for far too many of our customers."

Whitehead strong-armed Microsoft Photo by Bob Barkany/Getty Images

At a minimum, an M&A due diligence team must dissect the target company's IT budget to learn how much money is spent on infrastructure, maintenance, and innovation. "One of the main justifications for acquisitions is innovation, so if you can't get the maintenance and infrastructure costs down as a result of the acquisition, there is no way in the world your innovation budget is going to go up," says Solstice Software VP Chris Benedetto, who was on Hewlett-Packard's IT assessment team when it acquired Compaq several years ago.

When Logicalis, an IT integration and consulting company, first started scrutinizing a value-added reseller last year, it was impressed in early talks with the VAR's claim that its CRM system efficiently produced sales leads and matched reps with customers. But due diligence revealed that the system wasn't a fit with Logicalis' Salesforce.com applications. "It wasn't the only reason we didn't do the deal, but it was a key factor," chief operating officer Terry Flood says. "Not only were we not going to get the value we thought we might, but we could end up dumping a lot of money on something that's not going to scale for us."

Flood, who has helped guide five acquisitions over the past two years, during which time Logicalis' annual revenue has more than doubled to $450 million, says it's possible to discover hidden truths about a company in the premerger IT due diligence. Is a target company inflating its value by cutting back on IT maintenance spending? Have the company's IT investments been strategic, or just tactical fixes that reveal short-term management thinking? "IT is an area where you have a subjective opportunity to stand back and say, 'OK, what do they really think about their company?'" he says.

Mega M&As

M&A activity in the United States fell to 7,736 deals last year from its peak of 11,179 in 1999, but the average value has soared, to $385.6 million in the first five months of 2006, up 21% from 2005, according to capital markets software maker Dealogic. So much is at stake.

In general, an M&A due diligence team should include managers responsible for IT infrastructure and application development, including the CIO or a top deputy. It's time-consuming work. Logicalis' CIO spends about two weeks at each of the target companies' sites to assess infrastructure, applications, personnel, and culture. Cogent, which has grown rapidly in recent years by acquiring distressed competitors, temporarily relieves team members from their day-to-day responsibilities.