Here are other background factors any buyer of a professional services firm must consider.
- One of the biggest carrots to motivate people in a tough, non-corporate work world is the promise of someday becoming an equity partner. Partners own the company and split the year’s income up amongst the partner group. The payouts can be huge and it’s why these people travelled so much, worked such long hours, etc. It's all working towards getting the big payoff. Partners are ACTIVE owners of the company and don’t like to share income with PASSIVE owners who don’t bust their butts selling and delivering new work. As a result, PASSIVE ownership in partnerships is not a common or desirable thing.
- Should an external firm try to buy a partnership, they’ll face a number of issues with the partners. First, the existing owners of the firm would receive a big payout of cash or stock in the new firm. They’ll take the firm’s equity back. This massive payout might well trigger a flood of departures of top income producing executives once they've been paid and/or the lock up period has expired. The acquirer must offer a stock option plan to retain the talent or else it will buy a company with a crippled revenue generation capability. It's not quite the same in today's Accenture but it ain't far off.
- When the existing owners are cashed out, the firm’s capital is now supplied by the acquirer who must receive an adequate return on the capital employed to finance this transaction.
- Short-term, stock options might stop the hemorrhaging of top talent from the services firm but it will not satisfy younger staff. They’ll doubtlessly detect a reduction in future compensation and question why they should remain with a firm that will no longer offer the kind of compensation partners used to make. Now, why isn’t that compensation available anymore? If an outside entity just dropped a ton of cash to buy a service firm, it will need to get its return on capital employed to make the investment. That ROI every year comes out of the service firm’s earnings before there’s ever anything distributed to top service firm executives or employees. In the past, the top executives got all of the income for themselves. Now, they get the leftovers.
- When Accenture went public, it sold some stock to passive owners. That stock sale generated additional capital for the firm and helped it grow. As a result, Accenture must pay dividends to these passive shareholders. To counteract some of this dilutive effect, Accenture offers stock options to its top executives (they’re now active shareholders not partners). Accenture buys back its stock and uses its treasury shares to boost its stock price and provide shares to its executives.
As to the Oracle/Accenture story, if Oracle had attempted this deal, it would face the issues Howlett described plus these:
- Oracle shareholders would expect an ROI of equal or better than it currently generates via its software/hardware businesses. How it could do so would be a challenge given the differences in the two firms’ operating margins and the carrying costs associated with debt financing. Assuming Oracle could get the very best financing terms possible, it would pay approximately 5% or more interest on the $80 billion plus it would likely need to buy Accenture. That’s a debt servicing cost of $4 billion annually. That’s just the servicing cost alone and covering that nut every year would put a strain on the income producing capability of the joint business.
- Retiring that debt would also require additional monies. Oracle would want to reduce this if it ever wanted to do other deals in the future and while its overall cash generating capability is impressive, it already has plenty of commitments with which to concern itself.
- Could Oracle finance this deal with Accenture’s cash and other non-cash (e.g., equity) means? Yes. That could reduce the size of the financing required. But, generating more equity/stock triggers additional dilution for existing Oracle shareholders and makes the deal less attractive for them.
- Debt servicing costs are important as those monies are not available as bonuses or dividends to top executives. That could trigger departures of the key money makers from Accenture and that would deflect from the attractiveness of a potential deal. Accenture executives are a smart lot. If they suspected this, they would take their talents elsewhere in the expectation of getting a better annual payout. Remember, Accenture employees and executives are just people like the rest of us and they’ll act in their self-interest.
- How would this deal become accretive? Accentire might generate great earnings for a while but losses of key partners or executives would diminish the value of the deal – possibly quickly.
Bottom line: Service firms are people-based businesses and attention to the human assets is required for a successful acquisition. Product firms are all about scale and physical assets. Oracle knows about the latter and Accenture the former. How you merge one with the other is a major change management, compensation and leadership challenge.
Would this have been one deal Oracle would like to make? Like Howlett, I doubted it when I heard the news last week and I think, to Oracle’s credit, it knew this deal was too big and too risky even for them. And, that’s an interesting thought about a company that has bought gobs of firms – many quite large.