27 Jul 2021
Merging and acquiring the right opportunities
Sharon Klyne |
Australian companies have significant appetite for merger and acquisition activity amid high cash balances and low interest rates.
21 Oct 2021
Uncovering the hidden costs of M&A
Technology is a hidden cost in mergers and acquisitions (M&A) and it's bringing down the value of some of the biggest transactions in the market.
This trend has become more prevalent in the last two years and is increasing along with the scale, reliance and value of IT systems within an organisation’s infrastructure.
“Several US-based investors are buying Australian fintechs that can be commercialised through established global networks.”
Dealmakers need to obtain a full, early understanding of how IT can impact deals and the additional risks and costs that may emerge and add significant management cost for organisations.
Without proper planning and due diligence, the acquirer could buy a service that looks great on paper but will cost a lot to fix or replace the moment it falls over. However, with careful planning, this risk can be managed.
Increasing importance of technology in financial services
Like many industries, financial services has had a heightened focus on technology and digitisation over the last 18 months. Customers are more reliant and more comfortable with digital transactions, largely accelerated by the pandemic. The industry has also seen the introduction of Open Banking and client experiences being centred around online rather than face-to-face sales.
As a result, there is increasing interest from overseas investors in Australian fintech. For example, several United States-based investors are buying Australian fintechs that can be commercialised through established global networks. This is typified by Square's acquisition of AfterPay in 2020.
In addition, domestic players - including ASX listed companies - are acquiring existing technology businesses in order to enhance their online offering. The Square-Afterpay merger, the tech-nimble Judo and the move by other ASX 100 companies to recoup their fintech capital expenditure through third-party commercialisation all represent significant challenges to the established Australian banks - which account for 80 per cent of the Australian deposit and loan market.
And, as banks and other financial services institutions continue to streamline in the wake of the Royal Commission into Banking and Financial Services, we are seeing demerging and divesting non-core businesses to fund more investment in fintech and to meet the challenges of the new entrants head on.
This is driving a very active venture capital fintech market in Australia and valuation multiples continue to rise. Venture capital exits present an opportunity for buyers to acquire someone else's technology to boost their IT platforms. This bypasses the slow burn of internal technology development which often requires significant capital expenditure commitments but carries the risk of delays and uncertain functionality and user experience.
For organisations where technology is their central product, IT considerations are front of mind during any transaction. This is particularly the case if the target is technology or software-based and outsources any of its core capabilities.
However, for those financial services organisations that use technology to enable what they do, IT is often not prioritised during their transactions. It's here where costs can blow up.
Uncovering the hidden IT costs in M&A
Buyers need to properly understand their target's IT systems before their deal is finalised. Key questions include:
- Can the target's systems (such as payroll and enterprise resource planning software) integrate with the buyer's own systems?
- Are there other, unknown, systems the buyer will be taking on?
- How does the target use its data? If customer data is part of the target's value, how can the buyer integrate that into their own systems?
How reliable are the target's systems? What support do they have for when things go wrong?
If the target's main product or service is their software, it is especially important to consider intellectual property issues, including:
- Whether any open source software has been used in creating the product;
- Chain of IP ownership; and
- Whether any IT vendors or third-party contractors were involved in the product or software's creation.
In addition, considering the government's evolving risk and regulatory requirements, organisations need to take into account the target’s compliance with relevant APRA outsourcing, data and cybersecurity obligations.
Buyers need to bring a greater sense of IT knowledge and an understanding of what can go wrong in these situations to understand the genuine cost associated with a merger or acquisition. Some of this information will be elusive. For buyers, it is critical to ask the right questions – and to keep asking until they are satisfied with the response.
Issues to consider when demerging IT systems
For organisations looking to demerge or divest certain parts of their business, it's easy for costs to blowout if they aren't managed carefully. It is important for dealmakers to consider that while they are naturally looking for cooperation between the parties, cutting the business in half doesn’t mean it costs half as much to run.
When organisations sell off part of their business, one of the most difficult factors is separating the 'sold' entity and its associated enabling technology from the original entity's IT systems. This applies equally across all elements of technology requirements – from customer-facing services to back-end processing.
Typically, organisations underestimate the time and cost involved in breaking up the systems they have in place. For example, customer data and privacy are critical considerations for customer-facing businesses. Before selling, organisations need to consider how to deal with co-joined data and how to separate it while still complying with Australia's privacy legislation. Ownership of intellectual property is important here as well.
If not managed carefully, supplier costs can also present a significant expense. Many agreements with IT vendors are based on quantity and economies of scale. When an organisation separates part of its business, they are going to substantially reduce the volumes that go through their technology systems. Whatever agreements they have in place with suppliers may be impacted and suppliers may legitimately start charging them a lot more.
Conversely, when demergers are handled well, the process offers an opportunity to shed legacy technology and rationalise infrastructure and software to fit the new business.
Considering IT throughout a deal's lifecycle
IT needs to be considered at every stage in a deal's lifecycle including pre-deal planning, pre-deal assessment, due diligence, transition and post-deal operations. For financial services organisations, digitisation has amplified and accelerated since the global pandemic started. This activity won't stop and the pace won't slow down.
As technology becomes more significant in every organisation, the costs associated with ignoring it in M&A transactions become greater and the risks more significant.
Con Boulougouris is Partner for M&A and Simon Lewis is Partner for Technology Consulting at MinterEllison
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
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