by Melissa Klein
New York - Abandoning a planned run at the public markets, PwC Consulting instead found a willing suitor in global technology concern IBM Corp. and agreed to be acquired by "Big Blue" for $3.5 billion in cash and stock.
The deal ends a two-year quest by Big Four firm PricewaterhouseCoopers to divest its consulting arm and allows the unit to sidestep the headache and uncertainty of an initial public offering in a slumping market. In addition, with the signing of the sweeping Sarbanes-Oxley Act of 2002, it severed any auditor-independence conflicts between PwC Consulting and its former Big Four parent.
In anticipation of an IPO, which was scheduled for this month, PwC Consulting had filed to sell as much as $1 billion in stock. However, industry observers were not surprised to hear of PwC Consulting’s plans to scrap the offering.
"PwC didn’t have anywhere to go. Their chances for an IPO were always slim. There was no pent up demand in the market," said Dean McMann, chief executive of New York-based Ransford, a consultant to the professional services industry.
"I’m not surprised at all," said Lorrie Scardino, an analyst with Stamford, Conn.-based Gartner Group. "As it got closer to the IPO, I was wondering, ÔWhy the heck hasn’t something different happened?’ I don’t think they ever really wanted an IPO. When the full scale of Enron hit, PwC had to do something. The sale was definitely the better move. I think they would’ve had difficult time as a public company. In the period since the failed deal with Hewlett-Packard, PwC Consulting didn’t spend much time thinking about what it would mean to be a public company. They probably would not have been too successful."
In 2000, Pricewaterhouse-Coopers had structured a deal with Hewlett-Packard to divest its consulting arm for a price tag that hovered near $18 billion. Hewlett-Packard later retreated citing "unfriendly market conditions."
"Clearly the IPO route would have solved one major issue - that is to free us from the auditor independence constraints. However, this deal brings more. Acquisition offered things that an IPO would not," PwC Consulting spokeswoman Sehra Eusufzai said. "It enables us to offer a wider variety of solutions, access to technological innovation and access to capital. IBM gets our deep vertical industry expertise and our client relationships at the CFO level. IBM is traditionally known to have CIO-level relationships. And let’s face it, market conditions for an IPO were not exactly robust."
Meanwhile, others said that the sagging stock market made the deal with IBM that much more alluring.
"The IPO was going to net them nothing, with way the market was going," said Tom Rodenhauser, principal of Consulting Information Services, in Keene, N.H. "This deal is a coup given the price. The space that they’re [IBM] occupying an industry that is so broad, that being bigger is mandatory."
Observers said that the deal gives IBM added firepower against mammoth consulting rivals such as Accenture and EDS. "The major gain for IBM is the opportunity to become not just a leading information technology consultant but a leading business advisor to clients," said Anna Danilenko, senior analyst, e-consulting services, IDC, Framingham, Mass.
"It’s clear that IBM has lead brand recognition as an IT leader, but they were lacking the business advisory and business process outsourcing expertise. They didn’t have the mind share in the boardrooms of end users that PwC did. They badly needed that. In the past, IBM gained expertise by cherry-picking small boutique firms. They’re making a bold move by acquiring such a large company," said Danilenko.
Scardino said that by virtue of being acquired by IBM, PwC consulting can leverage Big Blue’s manpower and, in particular, its sales team.
"PwC gets access to IBM’s huge sales force. That’s a benefit, but also a challenge," said Scardino. "IBM also has a huge research and development budget. To be able to tap into that kind existing R&D infrastructure is certainly attractive."
In addition, Scardino noted, PwC gains a lower cost of capital, and the global footprint improves. "They also get access to the long-term outsourcing engagements that they haven’t had access to."
The deal fulfills PwC’s long-promised separation of its consulting arm from accounting and audit and momentarily leaves Deloitte Consulting, which plans to take its consulting business private, as the only Big Four firm with a consulting practice. Ernst & Young sold its consulting business to Cap Gemini in May 2001, while KPMG Consulting and Accenture, formerly Andersen Consulting, went public in February and July of 2001, respectively.
PwC Consulting’s 30,000 employees will join the Business Innovation Services unit of IBM Global Services, to create a new global unit headed by Ginni Rometty, general manager of IBM Global Services - Americas. Rometty will report to Doug Elix, IBM Global Services senior vice president and group executive. PwC Consulting chief executive Greg Brenneman will oversee the close of the deal and will return to his Texas-based private equity firm TurnWorks, Eusufzai said.
Since Pricewaterhouse-Coopers is IBM’s auditor, the firms worked with the Securities and Exchange Commission to complete the negotiations and resolve auditor independence issues. The unit under which PwC Consulting will be combined will be audited by another firm for three years after the deal closes. The rest of IBM will continue to be audited by PwC.
Overall, observers saw the strategy as a good fit for both firms. "PwC gets their pension funded, they get the payoff for the audit firm and the deal keeps a promise," said McMann, who added, "IBM probably fits PwC’s personality more closely than other potential suitors, like EDS, H-P or Hitachi. Both firms are very people-oriented. Both have long-term client relationships. Both are white shoe firms."
"Their operations are structurally similar. They both go to market by vertical industry. That makes it easier to integrate," said Rodenhauser. "The culture is always the sticky part. IBM business innovations doesn’t have a distinctive culture in the sense that you’d see from one of the Big Four. That will work to their advantage."
"It’s a good move for both, echoed Billy Allen, the managing director of Kennedy Information, Fitzwilliam, N.H "Clearly PwC is disappointed in the price, but the potential is very high for their partners in long-term opportunities. Two years ago, you had a buyer bidding three times revenues at a valuation that startup or small e-business consultancies were going for at the top of the market. This year, the consulting market has been flat to down 5 percent across all sectors. The larger players have been consolidating [market] share at the expense of the middle-tier companies. The $100 million to $1 billion in revenue companies are in the most exposed position. They’re getting squeezed out by larger firms who have broader capabilities globally."
According to Allen, "For IBM, this deal is aimed straight at Accenture and EDS. It gives them leadership in the industry and full end-to-end service capabilities. It’s also a great competitive maneuver against Sun Microsystems. PwC is the world’s largest integrator of Sun Systems. They’re also a key competitor of IBM. This disrupts that relationship."
The deal creates a consulting powerhouse with roughly $16 billion in revenue. At that size, Allen noted, IBM dwarfs its second largest consulting competitor, Accenture, which had $9.5 billion in consulting revenue last year.
However, PwC Consulting has alliances with a number of IBM competitors, such as Sun, H-P, and EDS, that could be at risk, and it will no longer have the benefit of referrals from its accounting brethren.
"Some consulting clients, like H-P, could cancel future contracts," noted Scardino. "The other issue is around relationships and alliances that PwC has with HP, EDS and Sun. Those could be strained as well. They have to really tread carefully on how to approach those client situations."
"From where we stand we’re committed to those relation-ships if the clients are," Eusufzai said of the firm’s alliance partners. "There might be a short-term impact if the clients are uncomfortable. But, this also gives us the chance to win back clients who are audit clients of PwC. During the past nine months, a lot of big companies have been reluctant to give contracts in certain consulting services to companies that were also doing their auditing. That concern is mitigated, if not completely eliminated."
Rodenhauser and Allen agreed that the loss of the referrals from the audit business would not have a huge impact. "In the old model, the benefit was the relationships to the audit clients. It was a natural feeder system for consulting business. But it’s a far less synergistic relationship between the two sides at any firms than they’d have you believe. And it makes them that much stronger in going after clients that were off limits," said Rodenhauser.
"As a result of the recent negative publicity [from Enron], they were not getting any lead flow from the audit side," said Allen. "They had no joint projects underway with PwC."
The death of the IPO also means the expiration of the much-maligned "Monday" moniker that PwC said it would adopt when it completed its separation from its accounting firm parent. "The fact that that it [Monday] will be buried is wonderful," said Scardino. "It was much mocked, and for good reason."
It also means a major transition for PwC, which faces the hurdle of moving from a cozy partnership to being part of a giant public company. "As a partnership, PwC had insulation from a lot of things," said Scardino. "Being a public company is so different from the insulated partnership world where you can say, ÔSorry, we don’t release that information.’ The quarter-to-quarter drive for revenue and margins, how you account for costs, how revenue is recognized, all changes. IBM is very bureaucratic and very huge. It will be a challenge."
A challenge that Eusufzai said the firm is ready for. "Having prepared for an IPO for the last nine months, we’re mentally prepared to be part of a publicly traded company," said Eusufzai. "It’s something we knew was in our future. While the culture change will be gradual, we knew it would have to happen."
However, McMann added, "[IBM’s] rules on how to do deals makes audit firms rules seem simplistic. They have book after book of rules. PwC has never dealt with that kind of bureaucracy."
As for layoffs, IBM said publicly that it doesn’t plan to make any. "As part of any transition you undertake an assessment of what the complimentary skill sets and duplications are," Eusufzai said. "It’s too early to speculate on the specific outcome. We’ll let the client demand drive staffing levels."
But Rodenhauser predicted "huge" layoffs, not only in support functions, but also at the professional level. "Based on the price they’re paying, IBM can afford to do that. Business is still relatively flat. They can afford to cut some people loose. They can take the best performers."
