Given that integration costs and plans in a M&A are initially formulated with limited information, it is not uncommon that the initial estimates for both time and costs may prove to be incorrect. In this extract taken from the Geneva Papers, Mr Adam Hodes of MetLife, Inc explains how certain best practices can be developed to limit the gap and improve the quality of even early stage estimates.
Global acquisitions have been a critical component for growth of multinational insurance companies. The structure of transactions can take many forms, but a key objective is to ultimately leverage capabilities and expertise to maximise the value of the acquired entity.
The success of most transactions depends on some level of consolidation of operations. As a result, success depends on having a good view on the cost and timing of operational integration. From a M&A execution perspective, a solid estimate is critical for both a preliminary bid and a final bid.
By the nature of the M&A process, the limitations on information and the circle of people involved create challenges to developing a good integration cost estimate. It is critical for the corporate development team to have the best information available, as the integration cost estimate could be the difference between advancing in the process or being excluded.
While no two acquisition processes are alike, there are some things to be aware of. The mere recognition of information gaps can itself improve the valuation process.
From the perspective of transaction execution, it is critical to estimate the amount of integration expenses as well as the timing. Having a good estimate at “Day 1” following the closing is not helpful, as the overall transaction valuation needs to be determined and agreed upon much earlier.
The initial bid sets the stage for the flow of future negotiations. There are several unique issues which affect the ability to develop a solid estimate.
In a perfect world with unlimited access to information and people and time, developing a fully scoped-out and costed integration plan would be straightforward. However, in a competitive sale process, none of these ideal conditions exist.
First, information during the diligence stage, while broad, does not generally include the level of detail sufficient to fully develop an integration plan. Second, given the desire for confidentiality by both buyer and seller, the number of people involved is limited and so the individual that will be responsible for integration may not be fully involved. Finally, a project management leader, who is often not a subject matter expert, may be reluctant to commit without the input of his or her larger team.
Developing integration cost estimates
However, certain best practices can be developed to limit the gap and improve the quality of even early stage estimates.
The first element is the imperative need to understand the integration strategy and objectives. By understanding the integration strategy, it is easier to evaluate the scope of the initial integration plan—ie full operational integration or only selected functions. It is then important to work with the functional partners to develop the discrete buckets and an estimated cost.
The second key element to ensure more effective integration is ownership and accountability. It is important to have the right people involved—not just the titular leaders of an affected area. This leads to much better engagement with business partners. It is then important to work with the owners so they understand the need for increasing specificity over time, but that initial high level estimates are necessary.
The third element is to draw upon prior experiences. The estimated cost can be rooted in specific information provided, prior integration experiences or industry benchmarks. Having a template of a range of costs based on prior deals is often a useful tool to ensure all areas are addressed. By having a template of integration items and an associated cost, a more productive conversation can result. If a representative from a certain functional area is not involved, a preliminary cost can still be incorporated versus omitting the item or deferring it to a later stage.
Multi-jurisdictional transactions
A conventional wisdom for M&A transactions is that scale is better.
However, in certain situations, mere scale may not create synergies in the same proportion. This is often the case for regulated entities. The requirements for distinct regulatory approvals and limitations on intercompany services need to be considered.
Relating to the approval process, there is a high likelihood that not all regulators will approve their parts of the deal on the same timetable. Structuring for this potential can be quite complicated, as the buyer and seller’s objectives are in obvious conflict. Further, it is not always assured that the new company can operate to fully leverage enterprise capabilities. It is important to work with both local business teams as well as advisers to develop a full view of the viability of a fully integrated model and the time frame to achieve.
Thinking about unanticipated changes
Insurance or other transactions that require regulatory approvals, not just for the initial change of control, but also for intercompany agreements, new products or employee changes, tend to take longer to get to the desired integration state.
Often the focus is how the current state of the target can be integrated with the current state of the acquirer. The issue is that such states change over time. For example, if the acquirer is considering a future change in a basic technology such as email, then factoring in the cost for the target to get to the current state would be insufficient.
Further, with the passage of time, external parties may require changes that affect the entire enterprise. Therefore, it is important to have a good view of the overall approval and integration process under consideration if an additional buffer for currently unknown changes should be added.
Transitional services agreements
A cousin of the integration plan is transitional services arrangements (TSAs).
The timing for integration will determine if certain services need to be provided by the seller. This tends to be an area of complicated discussions, as the scope of services, cost and timing all need to be negotiated, generally on a service-by-service basis.
By having a clearer picture of the ability to internalise or transition to the acquirer’s functions, the TSA negotiations can be more or less critical. TSAs, by their nature, have embedded optionality whereby the buyer is seeking access for lower cost and for more time, and the seller is seeking to avoid being a low-cost outsourcer.
As with the integration plan generally, TSA discussions can benefit from an historical review of experiences. If the acquirer’s integration plans tend to be well estimated, the time frame for a TSA can be narrowed. If not, then the time frame will need to be more open-ended.
Post-mortem review
Given that integration costs and plans initially are formulated with limited information, it is not uncommon that the initial estimates for both time and costs may be proving incorrect.
Active acquirers can improve the process of consolidation and integration by incorporating a systematic post-transaction review process. Actual costs should be tracked and compared to the initial estimates.
Mis-estimates can result from several factors: incomplete information, deficiencies in the diligence process, unanticipated events. It can be difficult to get to the root of the problem and the sponsoring business may be reticent about being evaluated.
However, it can be very beneficial to identify the source so the process or approach can be corrected or an additional element can be evaluated the next time around. In many cases, the mere identification of an issue will result in a different level of focus by the team during the next diligence process. It is easier to conduct a post-mortem assessment if it is clear to the business partners that such a process is done in all cases and a particular deal is not being singled out.
Summary
Integration expenses are often under-analysed in the context of a significant acquisition but can be the difference between meeting and not meeting a targeted return.
Successful companies address these issues early on in an acquisition process and focus on identifying key areas of risk and timing. To be successful, all deal team members need to understand the importance of getting integration costs right with limited information.
Finally, the M&A leaders and deal sponsors will often need to incorporate a buffer to ensure there are no major surprises as more information is made available.
Mr Adam Hodes is Executive Vice President and Global Head of Mergers & Acquisitions at MetLife, Inc.