Some assembly required (Corporate Dealmaker)

Some assembly required

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The target company looked ideal. It had the expertise and the geographical location that United Parcel Service Inc. needed. Due diligence showed it to be a solid business with strong numbers.

But close examination also spotlighted a potential problem: a CEO with a major ego. And in the end, that was enough to kill the deal for the shipping giant, whose close-knit culture is nearly as famous as its fleet of brown trucks. "In a lot of ways, our culture does not reward individualistic behavior," says David Mounts, then co-head of M&A at the Atlanta-based company. "If the company we are looking at has a single star, or someone who believes their importance is higher than the overall value of the organization, we have found that those companies are not good fits for us."

UPS has walked away from dozens of deals in the last five years, Mounts estimates. But it has also completed about 20 acquisitions. Most of them have since been combined into a new business unit that made its formal debut in a 2002 reorganization: UPS Supply Chain Solutions. That division, where the 40-year-old Mounts is now chief financial officer, was pieced together to create a high-growth engine inside the nearly 100-year-old company.

Supply Chain Solutions is moving UPS from its traditional strength delivering small packages into relationships handling sophisticated inventory and fulfillment management for big corporate customers. It's a transition from a brawny business to a brainy, value-added one. Delivering value for shareholders, an objective at UPS since the company's 1999 initial public offering, made the strategy desirable. Tough competition from the likes of FedEx Corp. and Deutsche Post World Net AG made it urgent.

So acquisitions, rather than organic growth, were the obvious solution. But that course presented its own challenges. UPS needed to add the skills and knowledge of people working in a score of mostly small companies in locations from France to San Francisco, including small border towns in Montana and New Mexico, and it needed to weave them into one seamless operating unit. Given its massive size and preference for doing things its own way, UPS found it had to pay careful attention to the people it was adding to its fold, and devise some simple rules for successfully integrating what it was buying.

UPS has invested about $2 billion in recent years to buy and operate the companies that now make up SCS. That's modest for a company that had $31 billion in 2002 revenue. But for Mounts and for Robert Stoffel, the operations executive who directed the integration of SCS and is now president of the unit, price was not paramount. The two men were more focused on finding the cultural compatibilities that would enable SCS to rapidly improve upon the $2 billion in revenue it posted last year.

For much of its history, UPS has stuck to handling items that comfortably fit on the back of its trucks. The business is highly profitable but was already quite mature by the time it went public, and even the coming of Internet merchants and the package shipping opportunities they created aren't enough to keep the company growing at a rate acceptable to Wall Street.

Supply Chain Solutions, on the other hand, is competing in an area where the growth seems boundless. With supply-chain wizards such as Wal-Mart Stores Inc. and Dell Computer Corp. showing the way, companies worldwide want the profits and competitiveness that come with leading-edge logistics. But supply-chain management is difficult, and UPS is confident that an ever-growing number of them will prefer to let UPS - with its experts, advanced IT systems and abundant warehouse space - do it for them. "No matter how good you are at solving those problems," Mounts argues, "you can get better economies of scale by leveraging UPS' systems."

UPS' first step into the logistics business came in 1995, when it purchased express courier service SonicAir. But Mounts and the deal team did not really throttle up the acquisition engine until 1999, when it began purchasing 17 businesses within a three-year span.

The preferred practice at UPS, as at most other big acquirers, is for a business unit to sponsor every deal the company contemplates. The supply-chain initiative, however, was all about creating a new business unit. So the sponsors were a corporate management oversight committee as well as a strategy group that was charged with querying potential customers about their logistical needs and concerns. As targets were found, Stoffel moved into a prominent role heading up acquisition integration.

In UPS' model, the deal team is responsible for providing investment banking-type services for the business unit, supplying an objective analysis of potential targets and the ramifications of a deal. (On larger deals, the company uses outside investment bankers as well.) The deal team's reports are also given to UPS' board of directors, providing the board with a more objective view of a potential acquisition than it might get from the main proponent of a deal.

The actual target identification and negotiations are handled by the dealmakers, and not the sponsor. However, UPS keeps representatives from the sponsor groups on hand to provide assistance to the deal team throughout the process. And if the two sides appear to be moving toward a transaction, the sponsoring unit starts laying the groundwork for the all-important integration process even before a final merger agreement is signed, by formulating organization charts for the acquired company. Thus, while Mounts was finalizing the terms on the companies that went into SCS, Stoffel was gearing up for integration.

The SCS targets ranged in size, with the largest a $450 million purchase of freight forwarder and logistics firm Fritz Co. of San Francisco in 2001. Other targets - such as a handful of customs house brokers at key border towns such as El Paso, Nogales, Ariz., and Buffalo, N.Y. - were much smaller. All but one of the targets were private.

Each deal added a different kind of expertise. Fritz is a specialist in managing large freight businesses, the sometimes tedious process of shipping large items such as heavy machinery from manufacturing plants in Asia to distribution points in the U.S. Fritz extended UPS' know-how in arranging for deep-sea transport and other modes not native to UPS' original business, and gave the company control of 400 facilities in more than 100 countries.

UPS also bought companies for their knowledge of specific industries. It acquired Livingston Health Care of Oakville, Ontario, in 2000, after years of turning down inquiries from medical-device and pharmaceutical companies looking for logistical help. Before the deal, Mounts says, UPS was daunted by the thicket of regulations it would have to master to handle the business. "We were not comfortable that we understood the many compliance issues involved," Mounts said. "When we bought Livingston, we acquired their expertise in the field, and have expanded it beyond the U.S. to our entire Americas region." Mounts says UPS has more than doubled Livingston's revenue since the acquisition by using the target's industry knowledge to court new healthcare customers.

Other UPS acquisitions have likewise blossomed, according to Mark Davis, an analyst with FTN Midwest Research in Cleveland. "They are very good at buying small companies with very specific capabilities and growing those businesses by integrating them into the larger operation," says Davis. "They have been very successful in instilling the positives of the UPS culture into the smaller company, and then finding ways to grow the business from the base they have bought."

UPS begins instilling its culture in a target before the deal is complete, when the sponsor unit starts drawing up the flow charts describing how an acquired target will operate. During the late stages of due diligence, UPS executives will begin communicating with the employees of the target, giving them a chance to understand how their roles might change after the deal is completed. UPS also likes to get an early start on discussing benefits and communications channels inside the company.

The goal, according to Mounts, is to be able to clarify the roles of the people to be acquired as soon as possible - thereby relieving some of the natural anxiety that goes along with being acquired. "The most important things to get sorted out are the organizational decisions, so people know what team they are on and what they should be doing," Mounts says. "Mergers are always uncomfortable for people, but having your organizational charts lined out before you close on a company keeps employees out of that dangerous uncertainty phase where they don't know what to expect."

Of course, UPS has made some mistakes - and learned some lessons. Mounts says that the company learned during a previous expansion campaign - a late 1980s push to grow its package delivery business worldwide - that there should be limits to the assimilation process. Back then, Mounts explains, the company pushed too hard to get the new employees to do things the UPS way. "We came in very strongly with the attitude that we were going to show them how to do things," he says. "In a lot of countries, our model eventually had to be tweaked, and a lot of the things we ended up tweaking, the local managers we had acquired had been saying from the beginning."

In some cases, UPS has chosen to partner instead of purchase an asset. Mounts says that his company's preference is to control the operations, and so it is therefore usually a buyer. However, in trying to extend Supply Chain's reach globally, UPS has encountered barriers that have made joint ventures and partnerships a better decision. Until recently, for example, outside companies were prohibited from owning more than 50% of a joint venture in the important market of China. Other emerging markets carry political and economic risks that at times have made UPS think twice before investing money to enter.

In total, the business that Mounts has helped create now controls more than 25 million square feet of warehouse space in 120 countries. (UPS' package shipping business, meanwhile, controls its own warehouse space.) The acquisition campaign has given SCS locations within two hours of nearly 90% of all U.S. businesses, allowing it to preposition parts or manage deliveries for customers nearly anywhere they need an item shipped. The business has attracted customers such as Cisco Systems Inc., DaimlerChrysler AG and Honeywell International Inc., all of which have signed contracts to let SCS manage at least some of their logistics and shipping.

Semiconductor production equipment maker Tokyo Electron America Inc. hired UPS to help it speed deliveries of time-sensitive replacement parts to its U.S. customers. TEA previously shipped replacements from its 82,000-part inventory from its Austin, Texas, base, forcing customers to wait and costing them millions of dollars in lost productivity. SCS took control of inventory management from TEA and stocked many of the key parts at its field warehouses located within driving range of the company's semiconductor fabrication customers. Now a needed replacement part can be delivered the same day it is ordered, a big competitive advantage for TEA.

Jeff Jonas, logistics manager for Tokyo Electron America, says the breadth of services that UPS has built would be too costly for his company to duplicate. "When it came down to it, logistics did not have a lot of value-add for us," Jonas says. "If we wanted to get into the warehousing and distribution business to the level that UPS can offer, it would be quite an expensive endeavor."

After eight years at the helm of UPS' dealmaking, Mounts is now happy in his operational role as the chief financial officer at Supply Chain Solutions. He likes the chance to nurture what he helped create. "Deal management is adrenaline peak-and-valley sort of work," he says. "When you are in the middle of doing a really good deal, it is extremely satisfying, but when the deal is over, it is over for you. The value of being on the operations side is to be able to be involved with something that is developing, which will become one of the strengths and pillars that make UPS what it is."

Of course, UPS continues to be on the lookout for acquisitions, both inside and outside of the Supply Chain business. The company has more than $3 billion in cash on its balance sheet, Mounts says, and is evaluating different opportunities all the time. But any negotiating in the near future will be led by Rich Mitchell, who used to share leadership of the deal team with Mounts and now heads it up by himself. - Lou Whiteman

Also, a look at the companies UPS bought to build its Supply Chain Solutions unit:

Adding know-how and presence, deal by deal A look at the companies UPS bought to build its Supply Chain Solutions unit
Year	Companies bought
1995	SonicAir Scottsdale, Ariz.-based same-day delivery service with 68 warehouses provided the foundation from which UPS grew its logistics business. UPS at the time billed it as the largest acquisition in its corporate history, but didn't reveal terms.
1999	Rollins Logistics Inc. This Wilmington, Del.-based former subsidiary of Rollins Truck Leasing Corp. provided UPS with more than 100 additional logistics customers. Finon Sofecome Formerly a unit of French holding company Qualis, Finon provides service parts and supply chain management services. The company added 45 locations, primarily in France, to UPS, allowing the company to expand its business stocking critical parts for technical repairs.
2000	Burnham's North American Service Parts unit UPS acquired infrastructure from Burnham that, when combined with its existing facility, created the nation's most extensive critical parts delivery network, with the capability to deliver to 88% of all U.S. businesses within two hours. Computer Logistics Solutions Australia-based CLS grew UPS's service parts logistics to 13 Asian countries, including India, Japan, South Korea and China. Comlasa A companion acquisition to CLS, Miami-based Comlasa provides computer-related on-site field service, repair depots and parts inventory management in addition to logistics. The company's 550 employs worked in 37 countries in Latin America and the Caribbean, serving as a leading service provider to the airline and travel agency industries in the region as well as hardware and software support services for multinational corporations and government agencies. Livingston Inc. & Livingston Healthcare Services The purchase of Livingston gave UPS a coast-to-coast network of distribution facilities in Canada, and served as the company's entry into the highly-specialized healthcare field. The company also added a number of state-of-the-art distribution centers in the U.S. designed for the special needs of health care logistics.
2001	Polysys Electronic Systems A.G. Swiss logistics provider Polysys broadened UPS's reach in Europe, adding experience in the technology, telecom and pharmaceutical markets. Polysys provided its customers with order and warehouse management, transportation management services, after sales support and spare parts repair. UNI-DATA AG The German firm specialized in providing logistics to the European high-tech industry, including services such as installation and repair, spare parts and warranty management and urgent delivfery services. UNI-DATA added a well-developed distribution network throughout Germany and, through its international facilities, brought to 60 the number of countries served by UPS's logistics operation. Fritz Companies Inc. The $450 million deal for San Francisco-based Fritz added 400 facilities in more than 120 countries to UPS' logistics operations, greatly expanding the company's reach. Fritz also allowed UPS to dive head first into offering heavy freight transport via any mode of transport, as well as freight forwarding and customs brokerage services. Fulfillment Systems International (Buffalo, NY) Trans-Border Customs Service (Champlain, N.Y.) H.A. & J.L. Wood, Inc. (Pembina, N.D.) W.Y. Moberly Inc. (Sweetgrass, Mont.) Border Brokerage Co. (Blaine, Wash.) William F. Joffroy Inc. (Nogales, Ariz.) Miles Group Inc. (El Paso, Texas) UPS announced these seven deals for customs house brokers and international freight forwarders on the day the Fritz deal closed and the Supply Chain Solutions business unit was announced. Thsee small companies help businesses move cargo across some of the busiest checkpoints on the U.S. border. First International Bancorp Inc. UPS expanded its capacities to include structured trade finance and commercial lending through its $78 million stock deal for Hartford, Conn.-based First International.
Source: UPS