What's
the right role for corporate directors to play in the acquisition
process? Robert Fusaro, vice president of mergers and acquisitions at
Praxair Inc., a $6.6 billion industrial gas company in Danbury, Conn.,
shows how one acquisitive company answers that question with an
anecdote about a boardroom debate in the fall of 2003.
Praxair was preparing a bid for a large German competitor, Messer
Griesheim GmbH. When Fusaro and other executives explained the pricing
rationale to the board, there were questions. "They probed on whether
the price was too liberal, or alternately whether it was too
conservative," Fusaro says. "They wanted to understand the rationale."
The management team assured the directors it had named a price that was
consistent with a good rate of return - which, as it turned out, wasn't
nearly enough to win the auction. Last summer, though, came a chance to
purchase assets that Messer's new parent was required to divest. Again
the board engaged in a pricing discussion, and this time Praxair
prevailed, picking up key pipelines in Germany for what Fusaro calls a
"very good price" of $650 million.
The governance reforms of the Sarbanes-Oxley Act in 2002 certainly
got boards looking more closely at acquisitions. But board members
themselves admit there's need for continued improvement when it comes
to deal oversight. Only one in five directors rated themselves "highly
effective" in their oversight of M&A in a 2003 survey of 595
directors conducted by the National Association of Corporate Directors.
Even without SOX, which of course had more to do with accounting
scandals than botched acquisitions, the many honest but disastrous
deals of the bubble years naturally focused the attention of
shareholders, regulators and directors themselves on their
responsibility to get a better handle on M&A.
Still, getting a handle on just what boards are doing differently,
and how and when practices have changed, isn't easy - not surprising
given the diversity of size, cultures and industries you find just
within the Fortune 1,000. Conversations with corporate dealmakers,
directors and governance specialists show a range of practices,
including board-level M&A committees and tighter monitoring of
integration. Praxair's board, for one, has at times gotten more
involved in pricing strategy and recently added two more independent
directors with financial backgrounds. Meanwhile, some experts caution
against directors becoming too hands-on. "They should not be involved
in negotiating or creating a transaction - their job is to review it
dispassionately," says Charles Elson, who heads the John L. Weinberg
Center for Corporate Governance at the University of Delaware.
Certainly, the climate change is real. "In general, everyone's a bit
more vigilant and eager to find out how [an acquisition] would fit into
the strategic direction," confirms Barbara Franklin, a former U.S.
Secretary of Commerce and a director at Dow Chemical Co., and Aetna
Inc. And SOX has clearly introduced a strong cautionary note. Directors
are far more attuned to the serious financial risk for a company in
buying a business with hidden accounting problems or a lack of official
financial checks and balances. "No one wants to buy a Sarbanes-Oxley
problem child any more than they want to buy a toxic waste dump," says
Pat Daugherty, a former Securities and Exchange Commission counsel and
partner at law firm Foley & Lardner LLP in Detroit.
But some governance experts say that SOX has only accelerated trends
in M&A oversight that were under way well before the law's passage
nearly three years ago. Directors are asking more questions today in
part because they can. In general, in the past five years, boards have
gotten smaller (the average is 11 members) and more independent,
according to 2004 proxy research of S&P 500 boards by executive
recruiter Spencer Stuart. Both factors foster more open discussion.
(Praxair's 10-member board has only one insider, CEO Dennis Reilley.)
The major stock exchanges have helped in the push for more outside
directors while requiring more financial experience on boards,
especially on audit committees. The competition for board members is
keen; directors are serving on fewer boards nowadays. But when they do
sign on, "they ask lots of questions, because they are senior managers
at their own companies," says Bob Korzeniewski, executive vice
president of strategic development at VeriSign Inc., the $1.2 billion
provider of digital commerce and communication services in Mountain
View, Calif. "They all have M&A experience, and we have lively
discussions because of that." With communications offerings - all added
through acquisitions - now accounting for more then half of VeriSign's
sales, the board recruited more industry talent. Len Lauer, president
and COO of Sprint Corp., became a VeriSign director in February 2004.
As the current acquisition cycle accelerates, more and more
companies will need to think about how their executives and boards are
interacting to make deals successful, as opposed to just getting them
done. "You want to make sure that the decision-making process is
proper," Franklin says, "and that you're being informed of the right
things at the right time and that it's all documented." True, some
board members say the changes afoot are simply an affirmation of
practices they already had in place. "I feel thoroughly informed and
always have," says Gary MacDougal, an independent director on the board
of United Parcel Service of America Inc. But clearly, the spotlight on
corporate governance issues of all kinds has created or accelerated
several trends in the way companies manage the acquisition process.
Among them:
Vetting prospects with the board early on. VeriSign's Korzeniewski
says he presents even rough concepts to board members, often six months
in advance of a deal. Sometimes those ideas are less mature than the
ones he would previously have brought to the board. "But in today's
environment, you do it," Korzeniewski says. "When in doubt, overinform,
overeducate, overdebate, so the board knows everything management
knows." He says that communicating with directors often and early
becomes even more important in a period of board turnover. At VeriSign,
five of the nine directors joined in the past five years. During that
time, the board approved more than 20 acquisitions, including three
major ones in the past 12 months.
Recently, VeriSign became perhaps the latest company to adopt a
mechanism that's popular among technology companies that count
dealmaking as an integral part of their strategy: a board-level M&A
committee. In VeriSign's case, the subgroup of directors will be led by
chairman and CEO Stratton Sclavos. Famously acquisitive Cisco Systems
Inc. has long had a powerful acquisitions committee on its board, which
among other advantages enables Cisco to move quickly on sizable deals
without the need to convene the whole board. EMC Corp., the $8.2
billion information storage and management company in Hopkinton, Mass.,
has had a deal committee on its board since 1995. And optical
communications equipment provider JDS Uniphase Corp. created its
version, called the corporate development committee, about three years
ago.
At JDS the impetus for the committee came from Kevin Kennedy, a
Cisco veteran, who joined the board as an outside director in 2001 and
then became CEO in 2003. JDS was known for its aggressive,
multibillion-dollar deals in the bubble years; today, after multiple
divestures, it's a $636 million-in-revenue company struggling to
achieve profitability - and bring a new discipline to the acquisition
process. JDS general counsel Chris Dewees says the corporate
development committee, where four of the five directors are
independent, serves as a "filter and approval mechanism," on
significant M&A transactions, with the power to put through small
deals. More important, though, is the committee's work helping the
board to ensure that all targets align with the company's strategic
intent. So far the deals that have met that criterion have been modest
in size: the $65 million acquisition of Lightwave Electronics Corp. in
April; the August 2004 purchase of Advanced Digital Optics Inc. for $12
million; and the $60 million purchase of E2O Communications Inc. in May
2004.
At EMC, the committee includes half the board: CEO Joseph
Tucci, chairman Michael Ruettgers and three outside directors. "We have
regular access to a very savvy sounding board," says Michael Cody, vice
president of corporate development. In his eight years at EMC, Cody has
managed about 40 deals with the help of the M&A committee. He meets
with the committee every six to eight weeks, he says, to talk about the
pipeline, valuations, integration wrinkles and the overall strategy.
"You want to use their expertise judiciously. I might look at 200 to do
10 to 15 deals," he says. "I don't talk to anyone about all 200." The
supreme rule he lives by: "Don't surprise the board with a big deal and
no time to review it."
The committee construct doesn't work for everyone. "I have seen the
other directors resent creation of a special committee as effectively
cutting them out of the review process," says Karl R. Barnickol, a
governance expert and securities lawyer at St. Louis-based Blackwell
Sanders Peper Martin LLP. But JDS Uniphase and EMC swear by theirs. In
both cases, not only does the committee help monitor deals early on, it
also helps inform the rest of the board as deals progress. At JDS, the
committee fosters more dialogue between the board and management. Says
Dewees, "It's a joining at the hip as you go through the negotiation
and approval process."
More disclosure before a vote. "Not so long ago, a common boardroom
attitude was, 'If it's a good strategy decision, then I don't need to
know the details,'" says Marc Shaffer, head of the M&A transactions
services group at Crowe Chizek and Co. LLC, an Indianapolis-based
public accounting and consulting firm. Shaffer often accompanies
management teams in their board presentations and notes a big change in
recent years. What used to be a 30-minute "agenda item" before taking a
formal vote, he says, has turned into a 90-minute discussion that
includes due diligence details and the integration plan.
EMC's Cody says he typically meets with board members several times
even before final negotiations take place. "The board is really asking
a lot of questions," he says. That means that Cody and his team have to
have everything ready sooner - due diligence planning, valuation
analysis, integration plan and first-year operating plan. Directors are
very interested in the results of due diligence, says Phil Richter, a
partner at New York's Fried, Frank, Harris, Shriver & Jacobson LLP,
who represented Dow Jones & Company Inc. in the acquisition of
MarketWatch Inc. Directors are asking tougher questions. "And they are
being encouraged by counsel to ask more questions," Richter reports.
SOX compliance remains a key concern. Under the act, acquirers must
be ready to publicly certify the target company's financials as soon as
the closing is complete. They may have as long as a year to comply with
the more onerous Section 404 internal controls certification.
Crowe Chizek's Shaffer says he sees closings delayed until the
beginning of a new quarter so that the acquirer has more time to
confirm that the target's internal financial reporting systems are
producing reliable data before the next 10-Q is due. Praxair's Fusaro
says the gas producer looks at many small private companies that are
not SOX compliant at the time. "So the question is, Can we get them
ready?" Still, he says the burden of Sarbanes-Oxley hasn't drastically
changed his job or slowed Praxair's dealflow.
All acquisitions involve risk; the diligence process protects the
company and helps the board establish a risk baseline, says Dewees, the
JDS general counsel. "There's a self-preservation aspect to it too," he
says. The director's involvement can help prove that they exercised
their fiduciary duty. "They can always say, 'Look, here are 18 e-mails
and multiple meetings and the whole due diligence package,'" says
Dewees.
How big a deal must be to require a board vote has a lot to do with
the size of the acquirer. At giant Cisco, a $500 million deal might not
require a vote. At Praxair, anything over $5 million, or virtually
every deal, requires board approval. The VeriSign board approves nearly
all deals as well. Says Korzeniewski, "Nothing gets a pass any more."
More eyes on integration. Unlike during the M&A boom of the late
1990s, boards are taking extra pains to critique integration plans,
with an eye toward how deals will be viewed by shareholders and stock
analysts.
"Integration wasn't our forte before," Dewees says of JDS. "Before,
we would acquire a company and leave them alone without a lot of
reporting structure." That's all changed, though, in the 18 months
since Kennedy took the helm. "We do an excruciating level of
integration planning," Dewees says. The board closely inspects the
integration plan from first draft (after a nonbinding letter of intent
is signed) to completion before closing. According to Dewees, a lot of
forethought goes into whether the acquisition should be fully
integrated, partially integrated or left to "incubate" on its own for a
time. When the company bought Lightwave in April, it executed a reverse
integration, whereby a JDS unit was merged into the existing Lightwave
operation. "It was very thought out," Dewees says, "not like before."
Boards, not to mention Wall Street analysts, are pushing for
more-specific post-deal milestones. Acquisitive companies agree they
still have a long way to go in this area but are making strides. When
VeriSign acquired LightSurf Technologies Inc. earlier this year, for
example, it predicted at least $30 million in incremental revenue for
2005. "We're trying to get as transparent as we can," Korzeniewski says.
But seasoned directors such as Franklin say boards won't stop asking
the next question. "Has the performance stacked up as promised?" she
says.
Of course, no amount of transparency or board-level M&A
expertise changes the fact that deals are inherently unpredictable -
for worse and, sometimes, for better. In April 2003, despite months of
board involvement and a largely completed operational review on each
side, EMC's attempt to acquire Legato Systems Inc., a storage
management software company, reached an impasse, mainly over valuation
issues. More than a month passed before the talks were revived, but in
the end EMC got its company for $1.3 billion. It also gained a valuable
new director from the Legato board - David Strohm, a general partner
with venture capital firm Greylock Partners. Today Strohm sits on EMC's
M&A committee. - Susan Greco
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