Marriage counselling: the risks of software vendor mergers

Marry in haste, repent at leisure – or so the saying goes. But in the case of marriages between risk software firms, the clients can also end up repenting.

“Buyers and users of risk technology need to be aware of mergers and acquisitions (M&As),” says Peyman Mestchian, managing partner at London-based Chartis Research, a research and advisory firm covering the risk technology market. “Whether the deal is strategic or opportunistic, post-acquisition execution is not always done well. In some cases, it takes up to three years for acquired products to be integrated. In our research, we pick up quite a lot of dissatisfaction among end-users in terms of the impact on the service, support and maintenance they receive after mergers and acquisitions.”

In one recent case, a risk technology company was taken over and then more or less disappeared from the market for a year, he says. In that time it lost market share, and customers were left in the dark about what was happening to the products they were using, much to their frustration. All the focus was on the financial transaction and not on the customers’ need for new technology to meet regulations or other market challenges, says Mestchian.

In another instance, a company that had regularly invested up to 30% of its earnings in research and development (R&D) when it was privately owned had its R&D budget cut back when it was acquired by a listed company concerned about shareholder reaction to its quarterly reports. “That’s not good news for end-users in an area where innovation is necessary in order to succeed,” says Mestchian.

Others confirm this view. The head of electronic trading at a European bank who has also worked for software companies on both the acquiring and acquired sides of transactions, says it’s a case of ‘user beware’ when it comes to technology M&As.

Our market is still in the process of transition from point solutions to more of an integrated platform approach to managing risk, so we will see a continuation of M&A activity

If so, there’s been plenty for risk software users to be wary of in recent years, as a surge in M&A activity has hit the sector. In September 2008, Moody’s Corporation – parent company of rating agency Moody’s Investors Service – paid €132.5 million for Brussels-based risk technology specialist Fermat, adding the firm to its analytics division. Enterprise software supplier SAP bought risk data management firm Sybase in May 2010 in a $5.8 billion deal. In March this year, Misys completed its acquisition of rival Sophis, and risk tech supplier Wolters Kluwer acquired reporting and risk specialist FRSGlobal – adding UK regulatory reporting firm Spring Programs to the mix in April. There is probably more to come – the risk business at Thomson Reuters was up for sale as Risk went to press, for example.

Complex derivatives trading is relatively new, as is the discipline of enterprise risk management, with both growing in fits and starts, as new ideas, products and challenges emerge. The evolution of risk technology suppliers has mirrored that growth, with individual firms often focusing on a single piece of the puzzle – how to price a certain class of product, or tackle a specific risk type – at least initially.

However, as the cost and complexity of technology has risen, and as the need for integrated enterprise-wide risk management has become more urgent, there has been a corresponding drive for more consolidated technology platforms. Banks want a trading system that can cover all asset classes and a risk engine that can aggregate all risk factors. One way for technology suppliers to be able to offer such a solution – and often the quickest – is for them to acquire the missing pieces of a more holistic offering and integrate them into their platform.

“Risk technology is a fragmented market, and any fragmented market is ripe for consolidation. Our market is still in the process of transition from point solutions to more of an integrated platform approach to managing risk, so we will see a continuation of M&A activity,” says the head of risk solutions at one US software firm that has been an active acquirer.

Philippe Chambadal, chief executive of post-trade processing services provider SmartStream, sees it the same way: “A big bank can have 800 or more vendors. The cost of maintaining them all is huge, so there is a big drive for vendors to consolidate across asset classes and risk factors,” he says.

Chartis Research’s Mestchian predicts most small to medium-size risk technology vendors will merge or be acquired over the next three to four years. In light of that, banks would be wise to do some scenario analysis to mitigate their technology supplier risk – possibly leaving doors open with alternative suppliers should the post-M&A integration of their current supplier not be successful, he says.

Of course, it is not always a hasty marriage, and customers of the acquired firm can end up better off. Italy’s Banco Popolare has been a user of Sophis’ Risque system for five years in the front office and for market risk management, and Michele Bonollo, head of risk management services at Società Gestione Servizi, the bank’s operational services delivery subsidiary, says he welcomed the news of the Misys deal because of the broader range of software applications the combined company would offer. The bank had already had a positive experience of risk technology M&A as a user of Fermat software shortly after that company was acquired by Moody’s, he adds.

The most immediate benefit the bank is gaining from the Misys-Sophis deal is an incremental risk charge (IRC) application the company is developing with its now-combined resources – the IRC, designed to capture credit risk exposure in trading positions, is one of the new trading book capital measures being introduced at the end of this year as part of Basel 2.5. To get Italy’s central bank to approve Banco Popolare’s internal market risk model, it has to have IRC capability, says Bonollo.

The bank has been working with Misys-Sophis on the design of an IRC module, and expects delivery of the first version in August. Only a larger organisation with the kind of resources the combined Misys-Sophis has access to would have been able to tackle such a complex task in such a short amount of time, Bonollo argues.

Users should not expect these benefits to drop into their laps, however. The message from those with experience of risk technology M&A, no matter which side they have been on, is that end-users should not be passive observers. Instead, they need to get involved and challenge their suppliers. “It’s really important to talk to the chief technology strategist at the acquiring vendor to understand what its strategy is,” says Chartis Research’s Mestchian. “Users should ask: why are you acquiring this company? How will it add value to me as a customer? What is the road map for the integration of the new company and its technology?”

Ed Ho, Misys’ head of treasury and capital markets, also urges users to be proactive: “The key is to ensure users have the commitment of the senior management of the acquiring company on the direction of the combined firm and its products, and that it matches the users’ own strategic direction. If it doesn’t, they have a problem. But the sooner they know, the better off they will be, because they can then plan and manage the consequences.” Furthermore, end-users should review their contracts as part of their risk mitigation procedures. “Users should understand their rights and the obligations of the vendor in the case of an acquisition,” he says.

This is a two-way street, of course, and acquiring companies usually attempt to canvass opinions from their customers prior to a deal, says SmartStream’s Chambadal. But this process may not be as full as customers might like – losing a deal is usually a race to the finish for the supplier, which will typically have around three months to close the acquisition, including all the legal, accounting, and financial aspects, he says. “There are a lot of moving parts to a deal and the future is often not one of those parts.”

Nevertheless, if an acquisition or merger is to be successful, companies undertaking M&A activities need to communicate clearly and openly with end-users, as well as investors and industry analysts where relevant, says Misys’ Ho: “There needs to be clear communication and transparency into what’s going on so that everyone is comfortable. A critical part of any successful acquisition is making sure your end-users remains satisfied,” he says.

John Filby, president of the risk management division of Wisconsin-based financial technology supplier Fiserv, one of the largest and most acquisitive financial technology companies, agrees: “You’ve got to communicate very clearly both with the employees of the target company and with its clients about what they can expect. You’ve got to give them a clear sense of the road map of the product being acquired and of the benefits the acquisition will bring to them,” he says.

Where things do go wrong, it can be the result of a cultural mismatch between companies, says Fiserv’s Filby – although he notes that cultures don’t necessarily have to be identical as long as there is some commonality of corporate values. “Companies tend to focus on different things – some might focus on cost management, others on bleeding-edge innovation, or quality of solutions and services. Fiserv is an innovative company yet above all else we are focused on quality of delivery, and we would want to make sure any target company we look at is also focused on that,” he says.

A major reason a lot of M&A deals end up less than successful is mismanagement of the people risk, says SmartStream’s Chambadal: “It’s very difficult to acquire a company successfully. If you don’t do it right, the entrepreneurial people who don’t like working for a large company leave, and you are left with a product that doesn’t grow and never gets integrated with the acquirer’s main product line.”

To ensure success, the acquiring company has to work with the management of the target company and come up with a plan they can buy into. “You have to identify who the key people in the target company are. Clients can help – the key people tend to be very visible to the clients. Then you have to make these key people part of the future of the company. You can’t just tell them they are now employee number 1,001 and say ‘Here’s your corporate ID’,” says Chambadal.

Ownership

One way to make people in the target company part of the future is to give them real responsibilities and a stake in the business they are being absorbed into, says Amir Orad, president and chief executive of Actimize, a New York-based supplier of financial crime, risk and compliance software. Eighteen months ago, Actimize acquired anti-money laundering technology specialist Fortent and gave management positions to some of the acquired firm’s key people. “We brought in a strong set of people and gave them ownership of pieces of the business in the acquiring company as part of the process. If you don’t trust people and give them freedom and responsibility, they end up not being interested or excited any more,” he says.

An alternative approach is to leave the acquired entity and its people alone and let them carry on running their business as before, but with added financial and other support from the parent company. Actimize knows what this is like, following its acquisition by Israel-based Nice Systems in 2007. “Four years later, as promised, Actimize is still running as a separate business in terms of brand, technology, and so on. That ensures the team and the energy that existed in the company is still intact rather than it being swallowed and digested by someone else,” says Orad.

If integrating people is a challenge in mergers and acquisitions, so is integration of products. Sometimes, this is because potential for the integration has been hyped to secure the deal. “There is usually someone who champions the business case for a deal and often they exaggerate the benefits and underestimate the process and time it will take to integrate the new company and its products,” says Chartis Research’s Mestchian.

Despite all the potential pitfalls, a successful merger or acquisition can address users’ growing need for more consolidated cross-asset, cross-risk factor platforms, he says. Risk software companies know from their own experience how long it takes to design, build and test complex new technologies, so look to buy new capabilities where they can. “The move towards one-stop shops for enterprise risk management is positive for end-users,” he says.