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The Ultimate-Kronos merger - a marriage of equals

Brian Sommer Profile picture for user brianssommer February 21, 2020
Summary:
Two large HR/HCM players, Ultimate and Kronos, are to join in corporate matrimony. It's a story of common private equity owners, a $22 billion valuation and a big global opportunity - here’s our take

Composite Kronos and Ultimate logos with miniature couple on wedding cake © Amy Walters - shutterstock

Thursday morning, we got the news that Lowell, MA -based Kronos was merging with Weston, FL -based Ultimate Software. Both firms are well-established, substantial HR/HCM solution providers.

In M&A terms, this deal is pretty close to a ‘merger of equals’ given the similarity of:

  • revenues ($1.5B for Kronos and $1.4B USD for Ultimate)
  • headcount (each firm has approximately 6,000 employees)
  • ownership (each firm is owned by the same Private Equity-led consortium of investors)
  • global presence (each firm has a very strong U.S. & Canadian presence with varying degrees of support for non-North American locales)
  • both companies have solid employee cultures as recognized by Fortune, Glassdoor, and others
  • both firms have multiple product lines
  • both firms sell to many of the same kinds of target customers
  • both firms have a mix of legacy products and new cloud solutions

There are also notable differences between the two firms, too. Kronos’ time clock business is just one of them. The big questions on this deal are likely:

  • How will the combined firms be more global in their reach, development efforts and product functionality?
  • Who will fill the key leadership roles in the combined firm?
  • How will the combined product lines get rationalized from a go-to-market perspective?
  • What’s next for Kronos/Ultimate? An IPO?

Deal details

The deal specifics include:

  • this is an all-stock deal
  • the deal is expected to close by the end of next month (March 2020)
  • both firms are privately held
  • both firms owned by Hellman & Friedman, Blackstone, GIC, Canada Pension Plan Investments and JMI Equity
  • combined, the two firms have approximately 22,000 direct customers (Kronos also has 24,000 customers via its SaaShr reseller network

Quick analysis

Hellman and JMI Equity bought Kronos in 2007 for $1.8 billion. The company did a recapitalization that allowed in other investors in 2014. At that time, The Street reported:

Inclusive of Thursday's deal valuation and an expected $450 million special dividend paid by Kronos to its investors, Hellman & Friedman and JMI Equity have made over five times their initial equity investment. After Kronos's new equity investment and its expected special dividend, the company is expected to have over $2.7 billion in debt and an equity value of around $1.8 billion. Blackstone and GIC will hold about 42% stake in the company, while Hellman & Friedman and JMI Equity will control Kronos's remaining equity.

Kronos has been a great investment for Hellman and JMI with a 5x ROI. I wrote an update on the company and its product line after an analyst day last summer. What’s more impressive is that Kronos made these earnings, grew its business markedly, launched a cloud product line and covered its debt service costs during this timeframe. The 5x ROI is a return that PE firms love (and in just seven years, too) and this likely explains why the same equity investors made a similar deal last year to acquire Kronos rival Ultimate Software.

Why are PE firms keen on HR/HCM firms? PE firms like payroll and HCM firms as they have loyal, sticky customers, throw off lots of free cash flow and generate healthy margins. It’s the Willie Sutton rule in action — Why did he rob banks? Because that’s where the money is.

Ultimate was taken private this time last year. According to Forbes:

In February, Ultimate Software was sold to Hellman & Friedman for $11 billion, or $331.50 a share. During its two-decade run on public markets, Ultimate rose 33-fold and grew into a company with well over $1 billion in annual revenues and adjusted profits of beyond $250 million.

Ultimate and Kronos continued to operate as separate entities in 2019 even though they had the same owners. I even spoke with Kronos CEO Aron Ain about this at a Kronos Analyst briefing in 2019. It appeared that the idea of working closer with Ultimate had come up but at that time, they were not doing so. Actually, Kronos executives were clearly planning to battle with Ultimate on any deals where the two firms were competing.

In February 2019, I pondered how or if the two firms would work together now that they had common ownership. In a piece I did on the Ultimate transaction, I wrote:

Before we get to JMI, let’s explore the Kronos angle. I seriously doubt this deal was done as part of a larger rollup strategy. Kronos has products that complement and compete with Ultimate. Moreover, I’m not sure which investment fund the Kronos deal was in but I suspect it isn’t the same one this ULTI deal is in. A better rollup plan would be to acquire tuck-in products and more complementary solutions. Granted, I like both ULTI’s HCM and Kronos’ products, it’s just that a rollup seems doubtful. Also, the Kronos/SAP relationship would also need to be sorted out before a more substantial linkup between Kronos and Ultimate could occur.

Apparently, the rollup is happening after all. And, that begs the next question: What’s the next step in the new firm’s future? Several industry analysts believe an IPO would be logical. Given that the owners have pegged the combined firm’s enterprise value now at $22 billion, an IPO or sale to another PE firm would be the next logical liquidity event. However, before that happens, Aron Ain will need to bring the two firms together, harmonize operations, sort out product directions, and so on.

Headcount

The announcement regarding the merger mentioned that the combined firms would be looking to bring onboard an additional 3,000 employees or more in the next three years. That statement would be in contrast to other mergers where jobs are cut as a way to achieve deal synergies. According to a Kronos spokesperson, this deal is a “merger of growth not efficiency”.

Where will headcount grow? Like in many growing firms, the answer could be: all over. One area where headcount might certainly grow would be overseas. More software development could occur offshore. More growth in sales offices overseas is also a real possibility, too. Both firms could be more global in their product lines, in my opinion.

The product lines and architectures

When put together, the two companies possess several complementary technology solutions but there are overlaps as well. Specifically, the company will have to decide which HCM solution will be sold into very large enterprises, mid-market companies and small businesses. I would expect Kronos’ Workforce Management applications — Workforce Dimensions and Workforce Ready — to be cross-sold into the Ultimate install base and Ultimate’s UltiPro and PeopleDoc products to be cross-sold to Kronos customers. Many other cross-sell opportunities may be possible, too.

Alliances are another integration issue. Kronos has a great relationship with SAP regarding its Workforce Dimensions application. Whether SAP will continue to love this relationship now that Kronos/Ultimate is a much bigger HCM/HR player will be interesting to watch. Ultimate has an Infor relationship and both firms have partners in their software marketplaces, too. Likewise, implementation partners will want to know where they stand in all of this, too.

The real integration challenge may be in the underlying product architectures though. The various Ultimate and Kronos product lines were built by different development teams over a number of years. Some solutions were originally designed as on-premises products and others for the cloud. The new firm must develop a compelling story for all of its customers so that each knows the future of their product line and its architecture.

R&D spend could use a review as well. There’s simply no point in the two firms independently developing advanced capabilities around the same new technology (e.g., smart, workflow enabled, big data powered analytics). The new firm could spend the same on R&D but cover twice as many new technology innovations.

Post-merger integration

I did a lot of post-merger integration work during my Accenture days. I even led the development of the firm’s methodology for this kind of work.

What I learned in these projects included:

  • Bringing two firms together consumes a lot of top executive time –Now I realize this is an obvious point, but, recognize that all of this management time spent in merger integration activities may also be time spent away from the core business. The risk to the two firms’ growth plans, sales energies, etc. is real and must be managed. A Kronos representative confirmed that an Integration Committee of internal executives has been formed already. Whether or not this team needs or acquires outside help is not known yet.
  • A merger of equals is very different than an acquisition –In an acquisition, it’s clear who bought who. In a deal with equals, there will be people who want to know whether they will be one of the winners or losers at the end of the day. They suspect (and are often correct) that some people will get an effective promotion post-merger and some will feel or be demoted. The reality in a merger is that power, budgets and reporting structures will change and not everyone will be thrilled by the new firm. Managing expectations is a major post-merger concern.
  • Merging of cultures is tough — I recalled seeing people showing up for meetings still wearing the ID badges of their old firm — they wanted everyone to remember that they were from the acquired firm. I’ve seen command and control companies try to rein in people in from consensus-driven businesses. I’ve seen hip/cool firms try to work with starchy, suit-and-tie entities. And, I’ve seen constructive confrontation cultures being forced to blend in with touchy feely cultures. Aron Ain, the combined firm’s CEO, will have to work on this. No CEO I’ve met in deals like this has inherited cultures that are identical.
  • Geography matters — When the dust settles, some employees may be asked to move. This can trigger attrition as people have families, friends and other ties to where they currently live. Plus, some folks really like where they’re at and may not feel the same joy about the proposed location. In a merger deal, sales territories get re-jiggered, executive teams get moved together in one of the headquarter locations (for now, Ultimate and Kronos will retain their HQ offices) and back office functions (e.g., HR, Finance, support) may get consolidated into a single, shared services location. Geographic decisions almost always trigger some attrition. Getting ahead of this is top morale and HR matter for the combined firm to handle.
  • Synergies — To make a deal’s economics work, the combined firm needs to cross-sell solutions (e.g., sell Kronos workforce management applications and time clocks to Ultimate customers) to drive up revenues. The combined firm can better co-ordinate R&D efforts allowing two firms to take advantage of one investment (i.e., Do both firms need to pour millions into developing their own new machine learning based analytics?). The combined firm should also get economies of scale in how it completes common functions like Finance and HR. The faster the combined firm can identify and realize deal synergy opportunities, the healthier the balance sheet and the happier the shareholders will be.
  • Processes and business practices have to be standardized — Integration teams must design the new ways that work will get done. New policies and procedures will be required and need to be signed off. Customers, suppliers, employees and others will be impacted and they must get trained on or be communicated with re: these changes. This work can be substantial to be effective.
  • Two equals need one new brand — For now, it seems that the two firms are still retaining their original names/brands; however, that will likely change (but maybe not much since both firms have a combined 7 decades of brand equity) Should the new firm get a new identity, it will also need to address what the firm’s brand will stand for now. The merger was announced under the internal tagline: People Inspired. That’s a start but real branding takes time, repetition and clarity to stick.
  • Manage retention & engagement — Loss of key people, post-merger, is a very real concern area. Headhunters and competitors will target some of the best and brightest in both firms. As I wrote after Ultimate was taken private:

Longer-term, the new owners will be challenged to come up with another incentive program that keeps the best and brightest at Ultimate. The difficulty for them is that there will be no liquidity for any ‘shares’ or ‘tracking shares’ that they could offer employees as Ultimate will be privately held. I’ve seen this unfold in other firms that have been taken private and, contrary to the assurances and pie-in-the-sky projections from the private equity owners, I know of no one that’s ever benefited from these plans.

This week, combined firm CEO Ain is doing town halls at both company headquarters. That’s where he should be.

Bottom line

I can see why the deal is happening and it augers a new era/wave of consolidation and maturity in cloud HR solutions. I understand the financial underpinnings and synergies for the deal, too. I also think Aron Ain was a good choice for the combined firm CEO spot. Now, execution must be the focus of management.

We should expect competitors will try to turn this into a negative for prospects. Material changes of control often create FUD back stories for competing sales teams to whisper to their prospects. Some competitors will even try to hire great talent from the combined firm, too.

Customers of both firms will likely see only modest changes in the near term and should expect their software investment to be secure for some time to come. Global customers should hopefully see the product footprint expand internationally over time and provide more of a single firm solution for them.

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