Technology is a hidden cost in M&A – and it's bringing down the value of some the biggest transactions in the market.

Without a full, early understanding of how IT can impact your deals, additional risks and costs will emerge and force organisations to spend big in order to manage them.

However, with careful planning, this risk can be managed.

Increasing importance of technology in financial services

Like many industries, financial services has had a heightened focus on technology and digitisation over the last 18 months. Customers are more reliant and more comfortable with digital transactions, largely accelerated by the pandemic. The industry has also seen the introduction of open banking and client experiences being centred around online rather than face-to-face sales.

As a result, there is increasing interest from overseas investors in Australian fintech. For example, several United States-based investors are buying into the Australian market to pick up fintechs that they can commercialise through established global networks. This is typified by Square's acquisition of AfterPay in August.

In addition, domestic players, including ASX listed companies, are acquiring existing technology businesses in order to enhance their online offering. Judo Bank is making an impact as a tech-driven neobank lender which focuses on SME business lending. At the same time, players outside of the financial services industry are leveraging their customer base to move into financial services. One example is the recent move by retailer Woolworths to launch its standalone payment system WPay, which will be available to other retailers. Through WPay, Woolworths promises to extend the benefits of its own fintech investment to external merchants that lack the scale to build their own systems.

The Square-Afterpay merger, the tech-nimble Judo and the move by other ASX 100 companies to recoup their fintech capex through third party commercialisation all represent significant challenges to the established Australian banks, which account for 80% of the Australian deposit and loan market.”

Con Boulougouris, Partner

On the other side, as banks and other financial services institutions continue to streamline in the wake of the Royal Commission, many are demerging and divesting non-core businesses in order to fund more investment in fintech and to meet the challenges of the new entrants head on.

This is driving a very active Venture Capital fintech market in Australia, and valuation multiples continue to rise. Venture Capital exits present an opportunity for buyers to buy someone else's technology to boost their IT platforms. This by-passes the slow burn of internal technology development, which often requires significant capex commitments but carries the risk of delays and uncertain functionality and user experience.

Venture Capital exits do, however, present a number of issues for buyers which need to be managed as part of the sale process, such as ensuring that employee share option plans are closed out. So too do any 'verbal' promises made to issue options and shares to employees. Ensuring that employees and third party contractors are not able to assert ownership rights over the critical IP is usually another area of concern.

A key element of change in the financial services sector will be M&A as existing companies look to transform themselves. They will do this by slimming down and becoming more focused, expanding into areas promising higher growth, or acquiring or integrating with innovative fintechs offering superior customer experiences, or stronger regulatory compliance.”

MinterEllison FS Outlook report

In each scenario, there are risks to consider. For example, overseas investors need to factor in Foreign Investment Review Board (FIRB) considerations if there is data involved. Whether a target business is a 'national security business' under the FIRB regime due to having a direct interest in or being responsible for a 'critical infrastructure asset' within the Security of Critical Infrastructure Act 2018 is important. The Security Legislation Amendment (Critical Infrastructure) Bill 2020 is currently before Parliament and if it is passed, will significantly expand the concept of a critical infrastructure asset. In fact, financial services and markets is now a 'critical infrastructure sector' covered by the Bill.

For organisations where technology is their central product, IT considerations are front of mind during any transaction. This is particularly the case if the target is technology or software-based and outsources any of its core capabilities.

However, for those financial services organisations that use technology to enable what they do, IT is often forgotten or not prioritised during their transactions. It's here where costs can blow up.

Uncovering the hidden IT costs in M&A

Buyers need to start asking questions and understanding their target's IT systems before their deal is finalised. Key questions include:

• How can the target's systems (such as payroll and enterprise resource planning software) integrate with the buyer's own systems – or can they?
•  Are there other, unknown systems that the buyer will be taking on?
• How does the target use its data? If customer data is part of the target's value, how can the buyer integrate that into their own systems?
• How reliable are the target's systems? What support do they have for when things go wrong?

If the target's main product or service is their software, it is especially important to consider intellectual property issues, including:

• Whether any open source software has been used in creating the product;
• Chain of IP ownership; and
• Whether any IT vendors or third party contractors were involved in the product or software's creation.

Overlaying all of these questions is the objective of ensuring a simple, user-friendly customer experience.

In addition, considering the government's evolving risk and regulatory requirements, organisations need to take into account if the target complies with relevant APRA outsourcing, data and cybersecurity obligations (such as CPS 231, 234, and 235).

Without proper planning and due diligence, you could end up buying a service that's great on paper, but that will cost a lot to fix or replace the moment it falls over.”

Simon Lewis, Partner

Buyers need to bring a greater sense of IT knowledge and an understanding of what can go wrong in these situations to understand the genuine cost associated with a merger or acquisition. Some of this information will be elusive. For buyers, it is critical to ask the right questions – and to keep asking until they are satisfied with the response. Bringing in the right advisors throughout the whole deal lifecycle can help.

Demerging IT systems and 'unscrambling your egg'

For organisations looking to demerge or divest certain parts of their business, it's easy for costs to blowout if they aren't managed carefully.

Organisations are looking for synergies – but just because you cut your business in half doesn't mean it will cost you half as much to run.”

Simon Lewis, Partner

When organisations sell off part of their business, one of the most difficult factors is separating the 'sold' entity and its associated enabling technology from the original entity's IT systems. This applies equally across all elements of technology requirements – from customer-facing services to back-end processing.

Typically, organisations underestimate the time and cost involved in breaking up the systems they have in place.

For example, customer data and privacy are critical considerations for customer-facing businesses. Before selling, organisations need to consider how to deal with co-joined data and how to separate it while still complying with Australia's privacy legislation. Ownership of IP is important here as well.

If not managed carefully, supplier costs can also present a significant expense.

Many agreements with IT vendors are based on quantity and economies of scale. When an organisation separates part of its business, they are going to substantially reduce the volumes that go through their technology systems. Therefore, whatever agreements they have in place with suppliers may be impacted, and suppliers may legitimately start charging them a lot more.

If demergers are handled well, organisations can see this process as an opportunity to shed legacy technology and rationalise infrastructure and software to fit the new business. ”

Amanda Khoo, Associate

Minimising costs and risks

For financial services, digitisation has amplified and accelerated since the global pandemic started.

This activity won't stop, and the pace won't slow down.

As IT becomes more important in every organisation, the costs associated with ignoring it in M&A transactions become greater, and the risks more significant.

By bringing together technology and M&A specialists at every stage of your deal's lifecycle, we can help you ask the right questions, make your process seamless and ultimately, minimise your transaction's costs and risks.