Author Robert Zimmer, SeatonHill Partners
In my lengthy career, I have had an array of experiences with business acquisitions, both public and private. I could tell many stories about successes and what went right, but sometimes the best examples come from the ones that did not go so well. In the CFO world, we use every experience as a learning opportunity, sharing the knowledge we gain to help others. This is one such story and a great example of what NOT to do when acquiring a business.
Once upon a time, A NASDAQ, small cap manufacturer/distributor of aftermarket automotive parts was experiencing financial stress due to offshore supply chain interruptions, the movement to direct sourcing by their major retail customers, and a general consolidation trend in the aftermarket automotive parts market. The company also had two manufacturing operations making disc brake pads and drum brake lining/re-manufactured drum brake shoes.
In a land far away (sort of), there was a large multi-national manufacturer was divesting an SBU. This business was approximately the same revenue size offering numerous synergistic opportunities, expanded product-line offerings, and additional markets for the companies’ manufactured products. In addition, the target has a robust ERP system which would be an upgrade to the buyers IT platform.
It was love at first sight. Both organizations sold to the same markets, although geographic concentration varies with the company larger in the Midwest and East Cost and the target West Coast based. Each company had their own brands which competed in their respective market areas. The company’s overlapped in three product lines; brake drums and rotors, brake pads / shoes and brake cylinders. The target had new product line offerings, including re-manufactured brake calipers, chassis, and front-end parts.
The combined business was projected to be over $150,000,000 in annual revenues, offering six product lines, providing additional distribution channels for the company’s manufactured products, and enhancing geographical distribution to allow for further brand penetration. In addition, the purchase price was very attractive, offering over 100% leverage on the acquired assets, primarily inventory.
This made the acquisition very attractive as the company was under financial duress. The belief was that by integrating the operations, significant cost reductions could be achieved. Plus, additional market opportunities would be available for the company’s manufactured products and the new product offerings to the Company’s existing customers would further increase revenues.
The strategic challenge to a successful acquisition revolved around the successful completion of numerous tactical objectives including:
• The consolidation of six distribution facilities into three
- The relocation of rotor manufacturing from CA to IL
• The consolidation of overlapping part numbers
• The development of consolidated price lists and rollout of new customer contracts
• The integration of sales & customer service functions
• The successful integration of the Company’s ERP platforms
Due to the high leveraged debt associated with this transaction, the seller’s insistence on a short administrative service agreement period, and the financial distress the acquirer was experiencing prior to the acquisition; the tactical objectives needed to be completed on an expedited basis These tactical challenges, although not insurmountable individually, proved exceedingly difficult as both financial and human resources were significantly stretched, and adequate planning in terms of cost and human resource requirements was not performed.
The net result was that IF the transaction could be completed, including integration of the businesses facilitated on time and within budget, and with available resources, a 9th inning, game winning, grand slam home run would be achieved. Unfortunately, the batter struck out and the fairy tale crumbled.
So, why was didn’t they live “happily ever after”?
Let’s look at the market overview:
During this period of the early 2000’s, the aftermarket was in a state of change. The typical 3-4 level supply chain was being consolidated. Historically the aftermarket automotive parts supply chain was as follows:
1. Manufacturer be OEM or Aftermarket manufacturer; to 2. Wholesales or Distributor; to
3. Retailer or Jobber; to
4. Repair Shop or Consumer.
Additionally, as the ultimate customer demands instantaneous product availability, inventories carried at each level of the supply chain was traditionally bloated. Finally, autos were containing more and more digital and electronic components, which precluded the average garage mechanic from servicing their own vehicle, and non-factory repair facilities were beginning to close as they became uncompetitive due to the expense of modern diagnostic tools.
Let’s look at the tactical objectives and results:
Consolidation of duplicate distribution centers
The buyer and the target had distribution facilities in the Chicago, Los Angeles and New York/New Jersey metropolitan areas with main distribution and administrative offices in Chicago (buyer) and Los Angeles (target).
The distribution centers were successfully merged BUT parts were maintained in separate locations pending the consolidation of the part numbers and pricing.
Consolidation of manufacturing operations
The target has machining operating in its Los Angeles facility which needed to be relocated and consolidated into the Chicago operations.
The consolidation of the machining operations was achieved, although at a significant cost overrun. The Chicago location needed infrastructure upgrades to both the structural and electrical systems which were unplanned, and, due to the age of the acquired equipment, significant costs were incurred to bring the equipmentto current operational standards.
Consolidation of product numbering system
Each business had its own unique part numbering system which required the cross reference to each company’s’ legacy part numbering system, as well as was crossed referencing to customers item number.
This objective was totally mis-handled. Significant infighting amidst the players resulting from the absence of a strong leader resulted in this objective never being fully completed. The result of which not only caused confusion in fulfilling orders, but also resulted in the consolidation of inventories never to be fully realized. Strike 1!
Consolidation of price lists and new customer contracts
The aftermarket automotive parts industry is very fragmented, although during the period leading up to this transaction a transformation was beginning to develop. Historically, pricing is based upon “discounts off List Price” and varied by Customer and Geographic location. In fact, the same customer may have pricing different based upon the geographic location where the sale took place.
These price lists are frequently connected with “stock return agreements”, whereby customers are allowed to return a percentage of the prior year’s sales without regard to when the parts were initially acquired. Remember, the demand for instantaneous product availability required excessive inventories to be maintained at each point in the supply chain. This resulted in retailers holding parts that were become obsolete due to the passage to time.
Think about parts for a 1975 Chevy. Even though the vehicle was 25-years old, parts were readily available within 1 to 2 days. Retailers maintained large inventory levels knowing that these parts could be returned to their current distributor supplier at any time under the “stock return agreements”. In addition, as consolidation of Retailers continued, this excess inventory was being pushed back on the distributors at an increasing level.
The combined company overlapped not only part offerings, but also in its national based and geographical based customers, i.e., both companies sold to the same customer base, although in different geographic areas.
To reduce the risk of customers “cherry-picking” pricing and using the stock return programs, it was imperative that pricing lists be consolidated, discounts be rationalized across the customer base, and new parameters be established regarding stock returns.
Unfortunately, this objective was not achieved. As with the consolidation of the part numbering system, a consistent and uniform product pricing strategy was NOT implemented. Customers did “cherry pick” product and forced stock returns and adjustments back on the company. The company did not have the resources in personnel or systems capacity to develop and implement strategies to combat these customer actions. Strike 2!
Consolidation of Sales, Marketing and Administrative Functions
Given the short window allowed under the “ASA”, an expedited consolidation of the sales, marketing, and administrative functions was required. This proved to be problematic. The company was NOT allowed to enter into employee agreements with key target employees prior to the closing, and after closing it was learned that these same key employees were under a stay-bonus contract agreement. These conditions placed the company in a disadvantageous position as it related to employee retention.
The result is that these key employees stayed through the closing and were employees of the new company after close but were under no contractual obligation to assist with consolidation. As a result, local knowledge of the customer base, marketing programs, and customer relationships were lost. Strike 3!
Merger of the IT systems
As noted above a key strategic advantage the merger would provide an upgrade to the company’s ERP system. The upgraded ERP system was JD Edwards, and the movement of the hardware and servers to Chicago was performed efficiently and under budget. The company was initially added to the system as a separate entity and as of January 1 following the merger, the company operated as one entity.
Unfortunately, as the part numbering system, part locator system and pricing files were never consolidated in the system needed to maintain independent accounts receivable and inventory files. The effort required to maintain two separate data bases for both accounts receivable and inventory required significant financial and administrative efforts. You’re out!
Lessons Learned (aka, what NOT to do)
The company filed for bankruptcy protection in May 2005, 15 months after the closing, and the bank foreclosed on the collateral in June, ceasing operations. In retrospect, the initial merger scenario, although appearing sound on paper, was not achievable in the long run.
The company’s initial weak financial position, followed by the inability to achieve the tactical objectives, served to be too much to overcome. In retrospect the following conditions were not fully acknowledged causing the merger to fail.
- The ability to rally together a geographically diverse work force absent a strong leader was underestimated.
2. The lack of detailed due diligence into the cost and ability to move a production facility was understated.
3. The inability to consolidate pricing and inventory item referencing should have been designed and ready for implementation at closing. Not having an immediate rollout at closing provided a window for customers to take advantage of the disorganization of the merger process.
The financial and human capital required to complete to integration of the organizations was insufficient, the detailed timelines and process steps were not fully thought out, and the ability to bring a diverse work force together and “lock-in” key employees was not achieved. A classic example that thorough due diligence and detailed integration planning is imperative to a successful merger and integration (and a happy ending).
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About the Author: Robert Zimmer (Partner with SeatonHill) is a CFO and change-agent who achieves positive financial results through operational focus and a hands-on, participative management style. He has thirty years of management expertise in manufacturing, distribution, automotive, consumer products, printing & packaging, and healthcare/senior-care/ social services. With vast C-level experience in middle-market companies, privately held organizations, private equity/venture capital financing not-for-profit and NASDAQ listed companies, Bob has a unique perspective when it comes to acquiring a business.
