Holiday Time - M&A Time

I'm enjoying my first Christmas in at least 4 years in which I'm not neck deep in a deal. To judge by the spate of recently-announced transactions, I'm in the minority this year.

I spent nearly all of December 2001 in New York, working on a deal that we walked from abruptly as wireless valuations cratered rapidly in early January 2002. The following December saw a similar scene, only this time a much bigger deal that never made it out of Seattle before having the plug pulled. So much of this work is spent on things that never come to fruition . . .

December 2003 marked the beginning of the process of selling AT&T Wireless. I remember having a particularly acrimonious call with my counterpart at one of the bidders a day or two before Christmas, and then taking out some frustration by felling several trees that had been damaged in an ice storm the night before (the short-handled axe is an underappreciated tool). By last December, I was living a different kind of frustration, dealing with Cingular and its parents as we tried to divest several hundred million dollars of assets to comply with the DOJ's consent decree on the merger.

What is it about the holidays that brings out such a frenzy of deal-making? Does the winter's waning daylight, forcing us indoors, cause the kind of corporate conjugation New Yorkers would associate with blackouts? Or is it just the draw of doing holiday shopping in Midtown Manhattan?

Google - AOL

Google's much-hyped investment in AOL illustrates the value of keeping deals as simple as possible. There can be a great deal of pressure, particularly in large organizations, to structure deals in a way that mitigates the most risk and pleases the most constituencies. That's fine in some cases, but not in a competitive bidding situation, and particularly not in a case like this, where the stakes were so high for Microsoft's opponent. Google NEEDED to keep AOL close, and Microsoft should have pulled out the stops to prevent this from happening.

Sure, valuation had a lot to do with it, but AOL certainly could have gotten the same price from Microsoft. However, while Google's deal is a straightforward minority investment with some ancillary commercial deals, Microsoft apparently insisted on structuring its investment as a joint venture.

If you're AOL, would you rather deal with an investor or a JV partner (with all the attendant minority rights, exit and management issues)? Couple that with Google's greater willingness to push the envelope on promoting AOL's ads, and this was probably an easy decision for AOL even if the parties were even on valuation.

More J&J - Guidant

Good in-depth article via Wharton on use of MAC clauses. It will be amusing to watch this one play out now that Boston Scientific has lobbed a bid in near J&J's original price. Does J&J really believe Guidant's issues cripple it as an asset, or did J&J seize an opportunity to try and get a better price?

The article also alludes to the complicated decision-making process a seller has to go through in evaluating multiple offers. Price is important, but not everything. In a stock deal, the seller has to decide which buyer will do better integrating and realizing the synergies of the deal, thus creating more shareholder value in the new company. Guidant will also obviously be concerned about certainty of getting to closing at the agreed-upon price, given their experience with J&J (my guess is that a Guidant - BSX deal will have a VERY specific MAC clause). In other situations, sellers have to be concerned about closing happening at all. Foreign buyers, companies with activist shareholders, and large buyers who by the merger create industry concentration all may find themselves needing to offer a premium price to win the deal.

Negotiation - Listening

I am modestly surprised at how consistently I still run across people in love with the sound of their own voice, who don’t pay enough attention to what others in the room are saying. For me, I’d guess that in a typical two-person business negotiation I do no more than 30-35% of the talking. I really prefer to listen, ask follow-up questions and keep the other side talking. I find this tremendously helpful in what I do, yet I still feel like listening is underappreciated as a negotiating tool.

I find two primary benefits to listening during a negotiation, but they can require different ways to focus the listening. The first is the easy one – listening to the other side’s point of view allows you to craft more creative solutions to their business problem that also work for you (the cliché “win-win” outcome), or more articulate and forceful arguments about why their positions are wrong or won’t work. Understanding what is really driving the people on the other side of the table is tremendously helpful. I don't mean understanding their negotiating positions - those are always right out in the open. I'm talking about the reasons why they are taking those positions, which often can only be gotten to via active listening and follow-up questions. Perhaps the other side has already received BOD approval to do the deal at a certain price, but will need to go back through the approval process to change the terms. Maybe the CEO got burned investing in his brother-in-law’s car dealership 20 years ago, and now the company insists on overreaching apportionment of liability. There's no end to the factors that can drive the positions we take in negotiation, but by actively listening (not just nodding your head robotically while mentally rehearsing your witty rejoinder) and asking probing questions, you can ferret these issues out and work on the solution to the real problem at hand.

The second benefit to listening, which can be harder to focus on because it seems inefficient, is what I call the “day in court” phenomenon. Some negotiators just need to be heard. It can be their egos, a need to be able to return to their senior management and truthfully report that they explained all of their positions to a receptive audience (an audience which still, incidentally, said “no”), or just a need to vent. But it can be hard to fight the urge to cut someone off. You’ll find yourself in a negotiation, and you know precisely what the other guy is going to say. You’re a smart fellow with lots of good uses for his time, so you cut in mid-sentence and say “no.” No question there are times, particularly in lengthy M&A negotiations, when you need to do this. But if it is your primary style you will come across as insufferably arrogant. That doesn’t make it easy to do business. Unless the other side has no leverage whatsover (and sometimes even then), bullying only makes them dig in. On important issues – even when I know without a doubt that I am going to reject the argument that is being spun to me – I will hear the person out, and perhaps even ask a follow-up question or two. It shows respect and indicates a consideration of the opposing point of view. The person I'm negotiating with can then accede to my point without feeling like they are knuckling under - and believe me, considerations of ego and face-saving are alive and well in American business negotiations. Furthermore, I have consistently found that opponents will treat my positions with greater deference if they feel I have fully considered theirs in reaching my conclusion.

J&J - Guidant Back On

Also not surprisingly, J&J and Guidant negotiated a new price - a $4B discount off the original price. Nice work by J&J. It's unusual enough for a buyer to invoke the MAC clause, but this discount - nearly 20% off the original price - is huge, and is likely well in excess of the drop in Guidant's value caused by post-signing events.

Guidant's MAC

Nor surprisingly, Guidant sued Johnson & Johnson today over the latter's backing out of its $26B acquisition. While there is never a good time for a business to have the wheels fall off, there are few that compare in terms of sheer bad timing to the period between signing and closing the sale of your company. Since signing the deal, Guidant has faced product recalls, Spitzer-ization, and an SEC investigation. J&J decided to invoke the Material Adverse Change provision in the agreement and declare the deal off. Of course, they'd be happy to put it back on - at a lower price.

I can really feel for Guidant, having spent most of 2004 working to close the acquisition of my company. I know that Guidant's senior management must have been living and dying by that MAC clause, wondering if the next shoe to fall would put their buyer over the top. This is why negotiating the MAC clause is so important for a seller. It's hard enough for a buyer to walk on a vague MAC clause, but if you are able to negotiate in some specific concepts - either storm clouds you are aware of or just big risks unique to your industry or operations - you will sleep a lot better at night. When we sold AT&T Wireless, we had a couple of really ugly issues hit our business in the midst of running our auction. With telecom mergers taking 9 months or more to close, we tried to push as much of the risk of those problems continuing onto the buyers. We also wanted to make it clear that the issues had been disclosed, the buyers knew about them, and they went ahead with the purchase anyway. Our one-paragraph MAC clause was the most bitterly-fought provision in the whole merger agreement, but it was well worth it.

As a seller, you care about nothing so much as certainty of closing. Every deal has specific issues that can impact whether you get to closing - regulatory approvals, shareholder votes, etc. - but the MAC clause is a constant, and something that deserves a great deal of attention when negotiating every deal. Of course, as a buyer you need to be equally aware of attempts to push too much into the MAC clause. Although the bar to invoking a MAC is very high to begin with, there's no point in boxing yourself in if it can be avoided - or unless you get sufficient price concessions.

Selling the Deal

Seth Levine’s post on why entrepreneurs shouldn’t view their initial meeting with a VC as a one-shot deal rang particularly true for me yesterday when I met with a company I’ve been trying to do a deal with for 6 months. So much of corporate development is creating relationships with likely targets, whether they be large companies with businesses or assets that may need to be spun off, or small ventures that could be rolled up one day. And when you make a call to pitch a particular deal idea, it’s highly likely that you’ll get some manner of “no”. Like an entrepreneur, the kind of “no” you get – and what you do with it – depends entirely on the relationships you can establish. The guys I met with yesterday have told me no several times, as have I to their counter-proposals, but we’ve continued to talk – amicably – about what could be done to meet both of our needs. The outcome of all this dialogue is that we have finally reached a deal that works.

Circumstances change, and a deal structure that doesn’t make sense to a seller today may make a world of sense in three months. Sure, I sometimes feel like the persistant salesperson. But by leaving the door open, by being proactive and calling just to check in, I greatly increase the chance of being in front of the deal when it finally makes sense. And it's not just timing and luck - those calls and dialogue build the trust and information exchange that can create a deal where it otherwise would not ever happen.

Portland's Wireless Pipe Dream

I attended a presentation in Portland, Oregon this week on the City of Portland’s “Unwired Portland” initiative to bring WiMax/Wi-Fi to the city. Although Portland has wisely shied away from the prospect of owning and operating a system themselves, they’re still dreaming. The city wants a commercial enterprise to build a network that:

• Provides free access for all to a “walled garden” of city-related sites
• Provides low-cost access to the disadvantaged
• Provides high QOS service for public safety and other city uses
• Is lower cost to all end users than existing broadband options
• Is offered at wholesale cost to the city
• Is provided on an open access basis so any ISP can resell the service

There was lots of discussion about the wonders of wireless, bridging the digital divide and all the great things that could be done (wireless meter reading; on-site building permits, etc) with wireless, but little acknowledgement of the real obstacles to making this work. The hardware to build networks may be getting cheaper, but the cost of operating those networks and providing customer service is rising. Implicit in the City’s proposal is an assumption that existing commercial services generate such excess profits that operators will be clamoring to build and operate this, despite the multiple ways the City’s requirements drive margins down and costs up. That's not the case. While someone may step up to provide some of this initially (and even Google's much-touted proposal for San Francisco wouldn't come close to providing what Portland wants), I predict that there will never be a wireless service in Portland resembling the “wish list” above.

It’s a shame the City can’t scale back its plans and focus on something workable. Solve the City’s needs by buying service from commercial operators. Verizon offers EV-DO in Portland, and Cingular will be there with HSDPA within six months. Better yet, buy from Clearwire once we launch service there! As for the digital divide issue, are there really a lot of disadvantaged citizens out there, toting laptops but stymied from joining the rest of us on the internet by the lack of a free broadband wireless connection? Besides, Portland, like many cities, is full of free Wi-Fi hotspots. The Personal Telco project in Portland has set up free sites all over the place – in cafes, streets, parks, etc. Publicize those to the disadvantaged, set a few new ones up in easy-to-access places – in short, do the easy, quick things rather than the grand, overarching scheme.

More on Working Capital

Questions about inventory and liabilities in working capital – a buyer’s level of concern about these matters will depend a lot on what kind of business is being purchased. In the case of inventory, I would usually have a physical audit done even where inventory is relatively nominal. It’s easy and cheap to do. I wouldn’t do it pre-closing, since there will be a closing statement of working capital that includes inventory levels. You can reconcile to that statement via a post-closing physical audit done as part of the working capital adjustment process. If the inventory records don’t reconcile the seller has to true up.

If inventory is a bigger part of the deal, unique, or of indeterminate quality, you’d want to physically review it as part of diligence. You might go so far as to get specific reps to address any particular inventory concerns. Typically, however, you’ll simply verify that inventory is present pre-close, take the closing statement, and then true up post-closing. In the corporate world, this work will most likely be done by your accounting team, so be sure to stay on their good side.

Liabilities are also pretty easy. You’re going to do a full diligence on your target, much of which will relate to accounting. It won’t take much digging to find understated or omitted payables. If you do find them, you’d want to consider walking – it’s a bit of a red flag . . . Lagging payables that come through post-signing should flow right into any working capital adjustment process.

Otherwise, you account for post-closing unknowns – whether unreported liabilities or litigation – via the reps and warranties and your indemnity rights (asset deals) and price (stock deals). That raises a subject for a later post – why thorough diligence is far more important in stock deals than it is in asset deals.

Working Capital

Brad Feld is running a very informative series on Letters of Intent; the latest post covers price and structure. Brad's comments on working capital shouldn't be taken lightly just because in his example they only account for $1 million in a $150 million deal - working capital is an area where it's very easy for the parties to talk past each other and end up with a very ugly dispute during negotiation of the definitives or even post-closing. It's also an area where you'll want to make sure your accounting professionals are at your side as you draft the LOI and the working capital provisions in the agreement.

While not a major issue in early stage companies, receivables can be a big point of contention in mature company deals, as they can represent several percentage points on the value of a deal. For example, a company selling for $100 million could easily have $4 million in receivables. Absent an explicit discussion of working capital (and many deals get to the point of drafting definitives without ever going through an LOI), the buyer may well assume that the $4 million receivable is an asset included in the purchase price, while the seller assumes it is on top of the purchase price as a working capital adjustment. This is not a negotiation you want to be having after you've already agreed on price.

As the buyer you might even consider detailing in the LOI the treatment of aged receiveables in the working capital adjustment. While you may pay full value for current receivables, you'll probably pay next to nothing (or nothing) for receiveables more than 90-120 days old, and a sliding scale in between. This will be a negotiation of its own, as it directly impacts purchase price. A lot will depend on where you are in diligence, whether the business is similar to your core business, and what your own internal rules are on creating reserves for receivables.

Game Theory Nobel

The 2005 Nobel prize for economics went to a couple of long-time stivers in the field of game theory, Thomas Schelling and Robert Aumann. One central finding of game theory is that cooperation and giving up short term gains leads to greater long-term advantage. This finding is styled as counter-intuitive, but I suspect that to most who spend a lot of time negotiating it seems pretty obvious.

While there are situations that call for a take-no-prisoners, zero-sum style of negotiating, the vast majority of cases call for a more nuanced approach. Game theory experiments show that working cooperatively toward a mutually-acceptable solution, and even sometimes giving up points in the margins, ultimately leads to the best outcomes. How much more compelling is this conclusion in business, where most negotiations involve trading partners who you will deal with again and again?

Ig Nobel-ists

I love the Ig Nobel prizes, awarded every year at Harvard by the Annals of Improbable Research for deserving works that meet this simple but expansive criteria: "Achievements that cannot or should not be reproduced."

See here for the complete list of 2005 winners, highlights of which include: Medicine - "Neuticles" replacement gear for fixed dogs, Literature - Nigerian e-mail scams, and Chemistry - a scientific study determining, once and for all, whether humans swim faster in water or in syrup (no, I'm not going to spoil the surprise by telling).

H.R. - actively harmful?

Great interview in Business Week Online with Marcus Buckingham. Despite the provocative title, Buckingham makes some great points about the need for managers and organizations to focus on developing their peoples' strengths rather than curing weaknesses.

Dealing with Google

Love this post from Chris Sacca with advice on how to pitch business proposals to Google. With the attention Google gets, I'm sure Chris needed to vent about the volume of crap he sees every day!

Two points resonate for me, particularly in the world of larger deals where you have to keep working together after messing up like this: Don't go over the head of the person you're dealing with (unless you ABSOLUTELY have to), and don't think that threats are going to get you taken more seriously.

At best, these tactics will sour the relationship with the person you need to be your advocate in the company. Your deal may proceed, but in a hobbled state where it is hard to get anything done based on rapport with your counterpart. And trust me - that person will be looking for an opportunity to have their vengeance . . .

M&A as E.R.

I was having drinks with a good friend and former corp dev colleague who is disgruntled with managerial expectations that he put in "face time" in the office. It's probably not a big deal, but it seems like dissatisfaction that should be easily cured. I've always told my direct reports that I consider them professionals - I don't care what hours they spend in the office, as long as they get their work done in a high-quality fashion. Sometimes that means a lot of time in the office anyway, but usually if you give a good employee that kind of flexibility you will get very good results.

In any event, after a few more drinks we concluded that a corp dev department could go one step further than my approach: Treat the group similar to the way emergency room doctors work:

Like an ER, corp dev staff are expected to work as hard and as long as necessary when a trauma case/big deal presents.

Like ER docs, corp dev staff can expect to be "on call" for emergencies.

Unlike many ER docs and surgeons, corp dev staff in most companies are also expected to work regular office hours.

Now, there are certainly those who relish their hours in the workplace and enjoy the company of their co-workers. And, of course, those who lead the organization can't expect to escape a good deal of office time. But what about those talented analysts who want more flexibility and work-life balance? They're already committed to being there for any emergency; why not free them up the rest of the time if they want it?

Ground rules would include always being accessible by wireless phone and e-mail, keeping on top of industry reading and being in the office whenever deal work demanded it. There could be months where this wouldn't look any different than regular work, but corp dev work is notoriously cyclical. I'm also not sure it would work at a smaller, high-growth company like mine. But in a larger, mature company, having an explicit policy that staff could be "on call" and away from the office when deal work doesn't demand it could create a great deal of good will and staff loyalty.

Other People's Deals

Like many, I don't have any hesitation in questioning (judging?) the wisdom of other people's deals (see, e.g., my comments on Skype). However, as I was reminded the other day, it's a temptation too easy to fall into when you're managing other corporate development professionals.

When you look at someone else's deals on paper, the less-than-ideal terms glare back at you. You want to pick it apart, point out the problems and limitations, but you've got to take into consideration the compromise and negotiation that got the deal where it is. By all means, you don't settle for less than the best deal you can get in the time available. But I know that when I was starting out I didn't like getting second-guessed on terms I'd considered and settled on, and I'm going to work harder to do the same when I'm peering over someone else's shoulder.

Altruism

Brief post from Heather's "Marketing and Finance at Microsoft" blog about the value of altruism ("the more you give, the more you get"). This struck a chord, as it echoes a debate I've had with colleagues over the years - what role does altruism play in doing corp dev work? My view is that altruism can be a powerful factor in both business and career success.

By "altruism" in this sense I mean doing things that you technically don't have to that benefit others. While I don't think there's any debate about the value of doing this internally in your company (you should absolutely help out your colleagues), the controversy arises over being altruistic with your trading partners - who are often your competitors. At AT&T Wireless, I dealt with other wireless carriers, large and small. At Clearwire, the cast of trading partners is even larger. At a certain level of abstraction, these trading partners are all competitors, and the instinct can be to do nothing that advantages one's competitors.

I think this attitude is tremendously short-sighted. While you are obviously not going to transfer material shareholder value to your competitors, there are opportunities every day to do things for your trading partners that cost your company little or nothing. For example, in wireless there are always requests to coordinate frequencies at the edges of licenses, do minor frequency swaps, or even just expedite a request for information. While these "favors" may theoretically benefit your competitor, they are firmly in the margins - things that make life easier for your counterparts on the other side; little wins they can establish internally. It's a quid without the pro quo, but it pays off in a major way over time as you establish relationships with your trading partners.

Besides establishing trust and greatly increasing the chances that you will be graced with return altruism when you need it, you get something that can prove even more valuable: A reputation as someone who is practical-minded and can reliably get things done. That can easily be the deciding factor in getting huge deals done down the road. Case in point: Several years ago I did a large deal to acquire cellular operations. Another large carrier was also bidding for these assets. I learned after the fact that the seller had gone with our offer - despite it having a value 5-10% lower than the other carrier - because of our good relations.

Why should good relations matter? We're in a cold-blooded business; shouldn't it just be about the money? Well, in a way it is. If you have good relations with your trading partners and a reputation for reliability, your proposals will be valued more highly than those of your competitors because of the perceived greater likelihood that the deal will actually get done. A lot can happen between initial proposal and closing a deal. If you are perceived as difficult, slow or unreliable, your offers will be discounted accordingly. Altruism (along with being cordial and keeping your word) is a great way to make yourself - and your company - someone your trading partners look forward to dealing with.

Over-Skyped

EBay's acquisition of Skype for up to $4.1 billion is a great illustration of my point on build vs. buy. How much would it cost eBay to build its own P2P voice platform? (hint: WAAAAAAYY less than $4.1B). Meg Whitman's comments are telling - in referring to Skype's tremendous user growth (for a free service) and name recognition, it seems EBay is afraid of losing out on the first-mover advantage or missing out on what could be a tremendous brand. But EBay's got such an embedded - and loyal - base they could roll out a home-grown solution out very quickly. And while Skype's got a bunch of (non-paying) users and flavor-of-the-month hype, they face deep-pocketed competitors and a rapidly-changing technological and regulatory environment. Smells like a bad case of deal fever over at EBay.

On Not Keeping Your Head Down

Interesting article from Wharton Business School on gaining competitive advantage by working "performatively" with colleagues (and yes, "performatively" is a word deserving of summary execution). The idea is sound, however, and probably even more meaningful when applied to one's individual workplace success: Benefits abound when you tap the knowledge of your colleagues. Furthermore, in any healthy organization the vast majority of workers "get it" and freely engage in this dialogue with no expectation of "payback."

That seems like a very basic observation, but in many corporate cultures - and for many smart people - interacting with others and asking for help is anathema. I've seen so many people who focus just on getting their heads down and doing the work. What suffers is not only their enjoyment of work, but also their ability to leverage the input of colleagues. Maybe you can avoid drafting a lengthy document from scratch. Perhaps someone else has great tips for dealing with a party you are about to face in negotiations.

Even more importantly, in corporate development you are a bit of an outsider to work that makes the company go. You aren't writing code, manufacturing products or designing networks. However, to do your job at the highest level you need to know as much as possible about how the business works. The more you know, the more informed your recommendations and decisions will be - you'll build better models, negotiate better deals and avoid costly mistakes. The only way to do this is by communicating with your colleagues throughout the business and at every level of the organization.

Katrina

I don't know what I can add to the discussion on Katrina in what has been a pretty business-oriented blog to date. I'm willing to wait to assign blame (although blame most assuredly will assigned) or conclude that the looting and other bad behavior was a widespread as depicted.

That said, there's no question that it was a horrible human tragedy on par with what we're used to seeing in the Third World. What's so shocking is the fact that our response to it seemed, for nearly a week, to also be on par with what we'd see from a Third World government.

The media incessently talks about the need to focus on the living, but look at the repeated details of bodies floating in the flood water, or left lying on sidewalks. Inherent in these repeated details? The horror that our organized and clinical culture could break down to the point where corpses are left in the street for a week. It's hard to imagine a more vivid image of how civic order collapsed in New Orleans. It took a foreign paper (The Independent) to do it, but I finally saw a piece today deal with this issue directly. It's worth a read.