Go your own way

Companies pull apart for all manner of reasons. Some separate after a merger has failed to deliver the expected benefits, while others demerge a subsidiary to raise extra capital, usually on a public market. The former can be a painful experience amid wrangles and upheavals for the business; the latter can, through careful planning, create a profitable offspring.

A failed merger can often lead to a lot of bad blood, but it is often better to take decisive action and cut your losses before events – and the competition – overtake you.

One of the more high profile failed finance sector mergers of recent years was that between corporate finance boutique Livingstone Guarantee (LG) and Tenon.

Six years ago, Tenon set out to effect a sea change in the UK accountancy profession by acquiring and merging smaller accounting and financial services firms into a larger, looser entity under the Tenon umbrella. In March 2000, it raised £50 million on AIM for this purpose. Its strategic goal was to expand the range of specialist services across the group, extend the client base and in the process boost profits. The goal was to build a business with annual sales of £100 million within a few years.

For ambitious corporate players, Tenon’s business plan looked a solid bet. LG was convinced and signed a £25 million merger agreement in 2000. But within just six months, the Tenon train was coming off the rails as profit warnings were posted. At
this juncture, Tenon blamed the cost of integrating 16 companies and hiring staff, as well as the lack of fees from the corporate finance side of the business. Despite all of this, it still believed profits of £16 million were realistic objectives on a 12 month view. Eventually though, as write downs and write offs ensued, losses of £114 million were posted by the end of 2002.

Strained relations
Along with Tenon’s woeful performance, business for LG also took a wrong turn in the mergers and acquisitions slump following 9/11. For corporate finance players, the next couple of years saw a deal famine across all areas. Compounding all of this was cultural differences between the corporate financiers and auditors, with LG claiming that Tenon directors were wrong-footed by the transactional nature of M&A fees.

Jeremy Furniss, a partner with LG, says it is often difficult for small corporate finance boutiques to predict revenue, which was something Tenon had failed to grasp. He says, ‘They didn’t like it when they asked, “What revenues are you going to make over the next three months?” and we put our hands on our hearts and said, “We couldn’t possibly tell you”.’

The relationship was strained further by what Furniss claims was a reluctance among Tenon’s managers to share their clients with LG. ‘The Tenon partners, who were looking after their clients, were somewhat defensive when they perceived a gang of marauding Viking-like corporate financiers charging over the horizon looking to plunder their client list,’ he says.

By 2002, discussions started within LG about dissolving the merger. Furniss and his colleagues maintained they would not stay with the group if their concerns were not going to be addressed. LG partner Tim Lyle subsequently proposed a possible management buy-out, which the Tenon directors rebuffed. As a result, Lyle was forced to take gardening leave.

Nevertheless, the partners eventually wrested the firm from Tenon and LG broke away in March 2003 through a management buy-out.

Both companies have since recovered. LG’s revival has coincided with it increasing its average deal size from £10 million to £30 million during the past three years. Total turnover improved to £11 million in the year to April 2006 and gross profit was
£9.6 million.

Tenon, meanwhile, has since started to post healthy returns after a period of restructuring. For its 2007 interim results it posted pre-tax profits of £5.1 million, comparing favourably to the £1.4 million profit it made in year end 2006.

The best-laid plans
Most dealmakers acknowledge that mergers often fail as a result of post-deal integration. Indeed, research by KPMG found that nearly two-thirds of acquirers did not fully realise the intended synergies that were included in the takeover and merger purchase price negotiations.

But things are changing. ‘If we were having this conversation five years ago, integration – especially at the smaller end – would be quite low on people’s agendas; now it’s much higher,’ says Adrian Dray, partner in KPMG’s corporate finance department. ‘There is greater success in merging companies, but there are still areas where it doesn’t work because of unrealistic views on synergies, and ill-thought-out plans.’

Dingwall-based Albanet, set up by the former drummer of 1970s rock band Uriah Heep, ran into immediate trouble after merging with Paisley-based IRW in early 2005. It was a £1 million deal that was backed by the private equity arm of asset management firm Aberdeen Murray Johnstone.

The company hoped to break into new markets with the merger, but soon ran up a reported debt of £1 million. International restructuring firm Kroll was appointed administrator a year later and sold both companies within a couple of weeks.

Albanet was sold for an undisclosed sum to management consultancy Alchemy Plus, while IRW re-entered the market through a management buy-out by its former managing director Ian Warnock in February 2006. Warnock bought an enhanced stake in the business with the support of funds from Aberdeen Asset Management.

‘The merger with Albanet last year was with the view of achieving the benefits of greater size, coverage and complementary services,’ he says. ‘With time it became apparent that this was not materialising and it made financial sense for us to split. This has created an ideal opportunity for us to rethink our strategy moving forward.’

Breaking up is hard to do
Dissolving an acquisition, or ‘unmerging’, is a significantly different business proposition to demerging a business. As a rule, demergers tend to be at the upper end of the corporate scale, but occasionally smaller public companies demerge an entity as a way of streamlining the business and raising extra revenue.

For example, property assets can be separated from trading assets to form two separate companies. Indeed, the common aim of a model demerger is to end up with different ownership of different parts of the business. This has a number of advantages: primarily, that the new companies will have increased focus. The future sale of the companies will also be more tax efficient than the sale of a subsidiary or division of a holding company. Moreover, a demerger can provide the opportunity to create a number of related benefits, such as more tailored share schemes, where the shares allocated to managers reflect more closely the sector in which the recipient is working.

AIM-listed Conroy Diamonds and Gold (market cap £4.6 million) first floated in 2000 with promises of large gold finds in Ireland. The initial share price of 25p has since dropped to just 6p after a failure by the company to deliver on its original plans. While drilling for deposits in Ireland, executive director professor Conroy started looking at prospects for gold and diamonds in Finland.

In 2005, he demerged his Finnish interests from CDG and listed the company on AIM as Karelian Diamond Resources, raising £500,000 in the process. With a market value of £1.5 million, Karelian now holds 57 claims in Finland’s ‘Karelian Craton’, a block extending over the border into Russia. Conroy says the demerger was carried out to help focus the company on Finland, and specifically on one product. ‘It was driven by administrative advantages and because people in the market prefer you to have one specific objective for the company,’ he says. ‘In a sense, they want to know whether you are a diamond company or a gold company.

‘For these reasons we were urged to create a separate diamond interest. We considered listing that company on PLUS (London’s tertiary share market), but the view of our advisers was that AIM would be the natural market for it.’

Demerger dangers
Other AIM-listed companies adopting this strategy in 2007 include Avanti Screenmedia – the demerger of its satellite networks business will soon go through and be listed on AIM. Likewise, 2ergo plans to list its secure mobile phone messaging service, 2safeguard, under the new moniker of Broca.

Despite the obvious benefits of a demerger, Ernst & Young’s David Overd does have a word of warning for companies considering the move.

‘Demergers can be costly, complex and time consuming,’ he says. ‘The cost of stamp duty is often high and professional advisers need to be engaged. In addition, a company may need to be liquidated and new ones formed, which can be a PR hazard. The process can be complex, particularly if there are loans attached to company assets that will attract the interest of the banks.’