ITT: Present at the Creation

ITT Corp. is making its final endgame move in dismantling the historic behemoth that Harold Geneen built in the 1960s and '70s. It will separate its remaining major businesses into three specialized companies serving the industrial products, water treatment, and military equipment industries.

Renowned investment advisor Felix Rohatyn was present at the creation of the corporate empire that Hal Geneen built upon his joining ITT in 1959. He was a close counselor to Geneen and banker on the multitudinous deals that were to come. In fact, Rohatyn brought to Geneen the very first deal that started it all — a small company in California called Jennings Radio Manufacturing, which made vacuum switches and other products for the telecom industry.

Rohatyn recounts that first step in the launch of the ITT conglomerate in his memoir Dealings: A Political and Financial Life [Simon & Schuster, 2010]. It was a deal that came with a certain amount of boardroom drama and had crucial implications for the future of the company, as Rohatyn describes:

Here was an acquisition, I suggested, that made sense for ITT. Not only did it fit into Geneen's plan to build an economic core of American technological concerns, but Jennings was also a company with potential: its engineers were exploring new and profitable areas.

Geneen was intrigued. He ordered his staff to run the numbers and to investigate the science. Very quickly, they agreed: purchasing Jennings Radio made sense. It was a deal with a promising upside. And the $20 million price — a pittance for ITT— was reasonable.

It would be Geneen's first acquisition as CEO, and the first deal we had made together. But my excitement was abruptly dashed. When Hal proposed the purchase to his board of directors, he reported to me with a feisty bewilderment, they were reluctant. The board did not want ITT to make the deal.

Geneen realized at once that more was at stake than simply the acquisition of a small San Jose technology concern. The board was attempting to undermine his control — and all his large plans for the future growth of ITT. With a calm resolve, he gave the board members an ultimatum: either the deal is made, or I will resign.

The board capitulated. With the acquisition of Jennings Radio, the principle was established in the company that what Harold Geneen wanted, he would get. Hal was soon off and running on one of the largest acquisition sprees in American corporate history. And I was running with him.

Now that the Geneen empire is drawing its final curtain, how interesting to see how that first act set the stage for what was to come.

Dealmaking: Feeling the Love

This could be an "uh oh" moment. The Financial Times reports today that M&A deal making is hitting the $83 billion level already this year — the busiest start for deal activity in a decade. According to the FT, "U.S. companies are estimated to have $1 trillion in cash on their balance sheets and are expected to come under increasing pressure to put those funds to work or return money to shareholders."

Well, we know where this is headed. Managements are generally loathe to return monies to the owners, and doing deals is ever so much more fun and dynamic. That is where the "uh oh" comes in. And where a good board needs to come in.

Let me turn to Robert Denham (pictured) to amplify.

Bob Denham, as you may recall, parachuted into Salomon Inc. with Warren Buffett to help stabilize the investment firm following its 1991 Treasury auction scandal. He had been a partner in the law firm of Munger, Tolles & Olson, where he had worked for 20 years advising clients on strategic and financial issues, and to which he returned after resolving all the legal and regulatory issues that threatened to destroy Salomon and negotiating the sale of the investment firm to Travelers Corp. for almost $10 billion. When the dust cleared on all that travail, he recorded a set of thoughtful observations on corporate governance for a Directors & Boards article that we titled, "What Should We Expect from a Board?"

When it comes to M&A, here is what, unfortunately, shareholders can often expect:

The board can play a valuable role in connection with proposed acquisitions. Ego, animal spirits, and badly structured compensation systems all conspire to encourage CEOs to love acquisitions even when shareholders should hate them. Vastly more money is wasted on bad acquisitions than on overpaid CEOs.

For a board to be effective here, however, it has to have its own sense of the value of things — the value of their company and the target. While a good investment banker will seek to privately discourage management from a bad transaction or from paying too much, the board is unlikely ever to get a sense of this. If the transaction is being presented to the board, any good management will have found an investment banker to endorse it. There is really no substitute for the board making its own judgments about value, and that is something that many boards are ill-equipped and ill-prepared to do.

With M&A signings already so robust, and with all that cash sloshing around on balance sheets, shareholders can be forgiven for looking ahead trepidatiously at a banner year of "uh oh" moments in dubious dealmaking.

Deal Trouble

Maybe it is a good thing for the shareholders of Prudential PLC to be rebelling against management's desire to acquire AIG's Asian life insurance unit, as reported in today's Wall Street Journal. The price tag is a big gulp — $35.5 billion on offer.

In the midst of proxy voting season right now, shareholder bile levels are running high about levels of compensation. But getting back to the Prudential deal, it is worth being reminded, as a wise hand once said, "Vastly more money is wasted on bad acquisitions than on overpaid CEOs."

That sensible note comes from Robert Denham, in an article he wrote for Directors & Boards 10 years ago. Denham parachuted into Salomon Inc. with Warren Buffett to help stabilize the investment firm following its 1991 Treasury auction scandal that threatened to destroy the firm. He returned to his partnership at the Munger, Tolles & Olsen law firm in Los Angeles after negotiating the sale of Salomon to Travelers Corp. for almost $10 billion.

I resurfaced some of Denham's wisdom on cautious dealmaking for the latest Boardroom Briefing, a series of special reports Directors & Boards produces four times a year. Click here to access a copy of it.

Another bit of Denham's deal wisdom seems particularly worthy of mention. I don't know that this applies to the Prudential situation, but shareholders of the U.K. insurer (which is not related to the U.S. insurer of the same name) may rightly be fearful that it does:

"The board can play a valuable role in connection with proposed acquisitions. Ego, animal spirits, and badly structured compensation systems all conspire to encourage CEOs to love acquisitions even when shareholders should hate them."

Pru's shareholders seem to hate this AIG deal — at least at the proposed price. The board should take a page out of the Denham playbook and proceed cautiously.

Smith International as Buyer and Seller

That's a big deal — Schlumberger's acquisition of Smith International for $11 billion, announced on Feb. 21. It would be the largest acquisition in the U.S. so far this year, according to the Wall Street Journal's report on the transaction.

Smith International is a company that came to the attention of Directors & Boards almost 30 years ago. In 1981, Warren Bennis, then and still a guru on leadership and governance, visited with Jerry Neely, then the CEO of Smith, for a conversation on "Keeping the Entrepreneurial Spirit Alive," as we titled the resulting Q&A article. Bennis found much to admire in Neely's management practices and in Neely himself as a personable CEO, and we shared their informative exchange with the journal's readers.

You always read horror stories of companies botching up acquisitions because they want to make wholesale changes with their new purchases — which causes the sellers, the very people that made the company a worthy purchase, to bail out. Well, that seems to have been something Neely was quite keenly aware of and determined not to do as he grew Smith. Listen in to this exchange between Neely and Bennis:

Neely: Interestingly enough, in most of the companies that we acquired, the presidents or the owners stayed on until they retired. We tell them, "Look, you are selling your company, but we want to preserve your entrepreneurial spirit. However, in order to grow, we think that certain things have to be done. Can you live with that?" And if he can't, we don't want him or his company.

Bennis: You wouldn't just say to him, "Look, you're through, and we're going to put our personnel in there."

Neely: We have done that twice and failed miserably both times. I don't think that you can buy a company that feels right, or that appeals to you, then change all of the structure and hope to run it better yourself. A lot of people like to think they are turnaround specialists. I guess there are those people, but I haven't really seen any of them. I look with a jaundiced eye at people who say they can turn a company around. So, as a result, we try to keep people on board.

As the M&A market heats up, which it is, as this deal for Smith demonstrates, this seems like awfully good advice that holds up after all these years. Perhaps today's management team at Smith will benefit from this enlightened approach, presuming that this policy is embedded in Schlumberger's M&A strategy.

Jerry Neely, who started with Smith in 1966 as a plant manager, retired as chairman at the end of 1988 and stayed on the Smith board until 2007. He continues to serve as an advisory director of the oil tool manufacturer, and is also on the advisory board of Arenda Capital Management, among other board affiliations. [Illustration of Neely that appeared in the 1981 Directors & Boards article]

Bruce Wasserstein: 'Let's Just Think About That'

So sudden — the death of investment banker Bruce Wasserstein yesterday at the age 0f 61. Tributes to his colossal impact on M&A dealmaking have been made in the Wall Street Journal, New York Times, Financial Times, and other publications.

Directors & Boards visited with Wasserstein in 1999, when he sat for a cover-story interview with our lead columnist Hoffer Kaback. Over the course of nine pages of sharply conducted Q&A, Wasserstein gave a peek into his playbook for getting a deal done.

Of all the tips and tactics discussed, there was one practice of his that he talked about that is ideally suited for helping boards in all their decision making, not just with M&A.

When the conversation turned to his admiration for one of his Harvard Law School professors, Lon Fuller, Wasserstein said this:

"I admired him both in an ethical sense and for the way he was able to shave an intellectual problem, if you want to put it that way, and look at it from many different points of view. A prism of fact, if you would. And I guess I was attracted to that way of thinking.

"He had an expression, 'Well, let's think about that.' Someone would come up with the obvious answer and he'd say, 'Well, is that right? Let's think about that.' And that's what I try to do with the people around here. You get a young, bright guy who says, 'We're going to do this to solve that.' Maybe he's right. I don't know. 'Well, let's just think about that.' I find that taking that little extra time to think about something is helpful when everyone's in a big rush."

Powerful advice for boards. In the heat of the action, when management is raring to go down a particular path, how much better a decision will be made if one or more of the directors bats back with a "Well, let's just think about that"?

Rule No. 1 in M&A

A transaction that started Labor Day weekend just got to a flash point: The U.K.'s M&A regulator has given Kraft Foods six weeks (till Nov. 9) to make a binding offer to buy Cadbury PLC — a "put up or shut up" demand — or Kraft will have to walk away for six months. Cadbury's board has rejected Kraft's initial advance, a $16.7 billion combined cash and stock bid.

Ah — there's the rub. Cash and stock. Maybe Kraft needs to revert to Rule 1 in M&A to get this deal done. And what is that rule? I turn to one of my past authors, D. George Harris (pictured), who stated it with simple elegance:

"Rule No. 1 in the takeover game: If someone makes an all-cash, any-and-all-shares tender offer, and they've got any kind of a reputation to back it up, you know that company is going to be sold to someone. The question becomes: To whom, and what degree of control will you have in that determination."

Harris had intimate familiarity with this rule. He lost his company to a hostile acquirer. He was head of chemicals company SCM Corp. when it was bid on by Hanson Trust PLC in the takeover mania of the mid-1980s. He wrote a detailed case study for Directors & Boards of the attack, defense, and ultimate surrender to the voracious British conglomerate.

I titled the article, " 'This Can't Be Happening': The Takeover of SCM." That title was inspired by another of Harris' hardbitten lessons, which Cadbury's board and management might heed. Warned Harris: "One of the things defenders have to contend with — a wish, really — is that 'this can't be happening to us.' As a director of such a company, I think you have to make sure management knows: It can happen, and it is, and if you want to do anything about it, you'd better get a move on."

Post-SCM, Harris went on to a distinguished next phase of his life as an investor in and owner of chemical companies. I was saddened to learn as I was writing this that he died in 2007. Let's see if his "Rule No. 1" lives on in how the Cadbury transaction concludes.

An M&A Tale from the Drake Hotel

Today's news about PepsiCo concluding a long-running offer to buy out two of its bottlers for almost $8 billion caps a nifty little run of recent M&A action. Add in Sprint Nextel Corp. acquiring Virgin Mobile USA, Bristol-Myers Squibb buying Medarex, and IBM nabbing SPSS Inc., and we have some impressive green shoots presaging a pickup in deals activity. These deals are nicely timed to tie in with the just-released "Mergers & Acquisitions 2009" Boardroom Briefing — the quarterly single-topic special reports issued by Directors & Boards.

Back to the PepsiCo deal. According to this report in the Wall Street Journal, after months at the negotiating table it took the CEO of PepsiCo inviting a director of Pepsi Bottling Group to her home, where they hashed out the final price, to make the deal happen. "Real deals are struck between people, not institutions," notes the WSJ. Rightly so.

I had that observation told to me personally 25 years ago from one of the most savvy dealmakers I ever met. "The most important facet of any transaction is to establish a personal relationship between the seller and the buyer — not as companies, but as individuals," said a fellow named William Fishman. When I met him in the early 1980s Fishman had built, over the course of the previous four decades as a serial acquirer, a multibillion-dollar company called ARA Services — now known as Aramark Corp. "Until the seller has faith and believes the buyer," Fishman added, "the transaction is a very cold and probably unsuccessful one." This is a story he told me to powerfully illustrate this fundamental law of M&A:

"I well remember one transaction where I had worked the better part of three years on acquiring a company in Chicago that we desired very much, and I wasn't getting anywhere. The company was a competitor, so there was a natural amount of skepticism and hostility between us.

"But one day I just happened to take this fellow whose business we were trying to acquire to a restaurant in the Drake Hotel in Chicago. The waiter came up — I knew the waiter, I had been there often — and my guest looked at the waiter and, in the middle of his sentence, broke out in tears weeping. Well, it turned out that the waiter had waited on my guest's father back on the West Side of Chicago, and had always taken good care of his father — who had just recently died.

"This fellow had a tough, hard shell, but he wasn't hard inside. When I understood what he was crying about, that's when he and I began to relate. Those are the kinds of things that get into an acquisition that finance people don't always understand."

End of Bill Fishman's story. But it seems to be the start of a new chapter in PepsiCo's growth for CEO Indra Nooyi. Yes, there are financial, legal, strategic, and tactical dimensions to getting a deal done. But ... never forget the human element. Click here to get access to a copy of our Boardroom Briefing "M&A 2009" report.