Monday, December 23, 2013

Software mergers and acquisition

The company that I have been working for the past seven years has been acquired by a bigger competitor in the same industry. In modern US insurance industry it is common. In fact we have been sold and resold three times in the last five years.

The modern capitalistic system particularly in the west grows on mergers and acquisitions. Gone are the days where industries became more productive, produced more and because of that, added more resources and serviced more clients, and as a consequence made more profit. When this happens, they invest the profit in more machines, man power and take it to the next level.  They diversify into related fields and expand businesses around them. They grow from scratch to huge conglomerates.

The modern capitalism - the way it is practiced in the west now., has brought in a new phenomenon in the past decade or so. You do not grow by being more productive but instead you acquire smaller (multiple) businesses with often borrowed capital and show up a bigger revenue estimate and a fatter balance sheet. This way the path to becoming a bigger company is sooner and easier rather than a painful way of growing up from start. This has resulted in successful companies. They acquire and brand it as though it was yours. You build on the legacy. It is always the end users (client) who benefits from it. Overtime the acquired company name and brand become oblivious and only the buyer is known. Not many people remember wa-mu, Wachovia these days. Do they? They were easily recognizable until the 2008 economic crisis. People had their money in them actually. It takes few moments to recognize their past now.

Why is this trend so prevalent. Western industries have moved from manufacturing to service sector in the past 20 to 30 years. A normal progression of a manufacturing company is long often cumber some. It involved huge capital, high-end machinery, factory, labor, time, and a lot of years to make it successful. Most often the people who started the business end up running them for a life time. We see this setup in growing economies like in Asia. I have seen it in India where the entrepreneurs run their business as part of life. Most often they start it in their late 20s and 30s and end up running it through their life time. It gets carried over to their siblings who end up running it in the same fashion. Lot family owned businesses follow this model.

Acquiring a manufacturing firm is lot riskier. it often involves lot of capital. Service sector industry is so abstract.

One of the primary reason for mergers and acquisitions to be so common is the easy monitory policy of the US Fed. Big business often with a good track record can borrow millions of dollars from the bank and buy out competition rather than competing with it. This consolidate business. Eliminates competition in a way and ultimately results in fewer options for end users.  The money that is supposed to create new jobs often end up cutting jobs. There are harmful effects of easy credit policy.

**** Companies get bought for more than market price.
**** Ridiculously low interest rate skews market demand / supply.
**** Badly informed decisions by upper management.
**** More optimism for success there by masking failures.
**** Stock market highly priced based on bad facts.
**** Unproductive labor employment. Eventually huge layoffs when reality catches in.
**** Poor cost benefit.

Unlike manufacturing, the service oriented companies tend to be acquired or merged with others relatively with ease. The aim of the merger is to consolidate business and be more a major player. The field is reduced to lesser players. It does not add any new value.

With respect to acquisition that happened in Aplifi:

> Cost of acquisitions is higher than market price.
> Merger hopes for a more weakened competitor rather than strength of "Merged Company".
> Promise on new products that is yet to be developed from scratch. No one knows what this should look like and there are more probability of failure.
> Process and resources are in conflict and needs a careful management strategy to put things in place.
> Right now in my opinion the morale is at an all time low with unclear directions or road map. Unless there are radical changes., it is just a lost cause.

One thing that is always overlooked is there is huge money changing hands at these times of mergers. Often it's done with secrecy and only the top tier knows about it all. They sit together, deliberate it and decide. There is too much hype on the compensation claims, partnerships, bonus packages, relieving terms - the fundamental value (software products with resources to develop and maintain) is often overlooked. End of the day it's the "nuts and bolts" that matters. Enhancing the nuts and bolts is the ONLY thing that decides performance of the firms.

The current deal hugely lacks clarity on these.

One of the problems in merging service sector businesses is - we don't know if it's a good buy for a long-long time. The cause of failure can be easily blamed on a trivial change that happened post buy out. It wouldn't be a ideal for the top management to admit it was a bad deal to start with.
During mergers they shut down software products in favor of a better product that the bigger partner has. So what happens to the productive work that went into developing it in first place. Of course it was priced and sold off. But there is no continued value proposition of labor. This trims employment rather than create new employment. This would be unfair. The hidden truth could be the product that is being shut down could have had a better future prospect. It is lost opportunity. It would have been better to exist than to be sold on a fire sale.

Acquiring a company only to shut down later is true loss of productivity and a major mismanagement for the leadership. Multiple smaller companies benefit the real economy more than the few bigger ones. Some companies are found and operated by an entrepreneur. They reach a point there is a buyer for their company and the entrepreneur sells it for a fee. The cause could be that he is getting old or is unable to run the business or he thinks it makes sense for someone else to run the firm which could make it more profitable. This is a clean sale. Founder has interest in the well being of the firm and it's future. Many people find it more profitable and they initiate businesses with the sole aim of selling it to someone else. There is nothing wrong about it. Soon the trend carries over to people who are loaded with cash. They buy a business from a single owner and take it to the next level. These people are called investors. They do it because they are lumped with cash. And once they feel it's good for resale, they just flip it over. It's value addition to a commodity. Is this good for business always? But unlike the founder, the investor does not care about the future of the company. He just happens to be the holder for a brief period of time. In  a service oriented company it is very hard to measure the value proportion during these mergers. lot of emphasis is given to the revenue growth. We hear talks on how to make the company from a $10 million company to say, $50 million company. Lot of massaging of the financials take place to sell it to the biggest guy. One of the primary consequence of this is a reduced work force and less benefits. Income is exaggerated for the purpose of accounting and the expenses are cut drastically to give an impression of less cost. Sometimes you wonder if these really work at the ground level. irrespective of the huge numbers as I said before the nuts and bolts that govern the basic success is what matters.

Only the future can say how good Aplifi sale would work out. I will definitely want to know about it say 2-3 years from now.

If you don't mind living life in "whatever way you want" then you can lead a life like that. Some things bother you, and you go along with that. But if you decide to live a life with some self imposed conditionality then you might have to take some personal decisions that you know is right but would involve losing something personally.
Unfortunately you have to do those, not because it's different but because it is right. In a distant future, one day in my life I would turn back to look at this very moment and have a sense of satisfaction of the behavior. And that is where you gained.

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