At law enforcement agencies around the world, SWAT teams perform extremely dangerous operations, such as hostage rescues. They're equipped with a variety of weapons, including submachine guns and grenades. Now, with the help of Trammell Crow Co., health care services and technology provider McKesson Corp. (NYSE: MCK) has assembled its own SWAT program to swiftly and carefully hunt for what one executive calls potential “hand grenades.” These are the biggest commercial real estate risks in pending mergers and acquisitions.
McKesson's new weapon is commonly referred to as the M&A playbook. It's essentially a roadmap that covers everything under the real estate umbrella of an M&A deal — from the properties owned or leased by an acquisition target to the financial risks and opportunities associated with that space.
With its vast holdings, McKesson ranks 16th on the list of Fortune 500 companies and occupies about 16 million sq. ft. of commercial space for more than 26,000 employees in the United States, Canada, Mexico, Europe and Israel. About 11 million sq. ft. of that total is leased, and the balance is owned, according to Frank Robinson, vice president of corporate real estate at the $88 billion company. About 10 million sq. ft. is devoted to distribution, while the remainder is for office space and research and development.
McKesson's real estate team always has performed due diligence for M&A activity, says Robinson. However, because the company didn't have a well-documented process in place, McKesson executives feared that some key items — such as whether targeted M&A real estate assets would mesh with business goals — might be falling through the cracks.
So last year San Francisco-based McKesson teamed up with Dallas-based Trammell Crow, its sole provider of real estate services, to develop the playbook for McKesson's real estate team. The guidelines have helped remove “holes, inconsistencies and uncertainties” concerning property analysis in the M&A process, says Jeff Vines, director of real estate at McKesson. Furthermore, it has strengthened the role of McKesson's real estate in M&A deals and has established an M&A model for Trammell Crow and other real estate organizations, Vines and other executives say.
“Despite great strides in improving their operations, many organizations still view the real estate function as a cost, rather than a vital enabler of the corporate strategy,” states a recent report from commercial real estate consulting firm RealFoundations Inc. “In today's fast-paced, hyper-competitive business environment, such a narrow viewpoint is limiting.”
McKesson, whose specialties include distributing pharmaceuticals and developing software for health care providers, now has a broader viewpoint on real estate functions. During the roughly 60 to 90 days of due diligence for an M&A deal, members of the real estate team assigned to the transaction — at least five internal people for large acquisitions, plus some external advisors — turn to the playbook to get a firm grasp of their duties. The playbook also outlines the processes involved in the deal and provides tools, such as analysis templates, Robinson says.
In the past, the real estate team might not even have been brought to the M&A table until a pending deal was announced to the public, says Tony Zivalich, senior vice president at Trammell Crow in Atlanta. Armed with the playbook, McKesson's real estate team is better able to assess whether properties belonging to an acquisition target should be kept, expanded or shed. And the new process can more readily unearth “hidden jewels” among an acquisition target's real estate assets, Zivalich says. For example, could a current warehouse carry more value as a condominium conversion?
“Like a SWAT team, when we are called into action, we can perform more smoothly than a team that is inventing on the fly. We focus on being able to quickly assess potential risk,” Robinson says.
So what's changed? “I would say that when an M&A deal gets closed today, we are much more confident that we understand potential risks associated with the real estate of the target company,” says Robinson. “We are also able to respond to our M&A department much more quickly; the deal itself will close when M&A is prepared to close it.”
Executives at McKesson and Trammell Crow say other companies seeking to sharpen their real estate analysis during the M&A process could replicate this effort and construct their own templates. Already, some of Trammell Crow's clients have adopted models like McKesson's, Zivalich says.
Karen Ellzey, managing director of Trammell Crow in Boston, says an M&A model for commercial real estate reduces confusion and eliminates duplicate efforts by getting everyone on the same page.
Vines adds that the model has paved the way for “far more rigorous and comprehensive” reviews of properties affected by M&A deals that are under consideration. With the book, it's unlikely that McKesson will miss any steps that could lead to costly consequences, he says. “During the pressure of supporting a large M&A project, oversights are more likely if the process is not set out in advance,” says Vines.
The company undertakes four or five M&A deals a year, Robinson explains. Although the bigger-dollar deals tend to be in the health care products distribution business, a high-growth area for McKesson is the health care technology arena. Acquisitions in the distribution business tend to be large, mature companies that occupy a lot of real estate, while acquisitions in the tech business typically are small, younger companies that have fewer properties.
Already this year, McKesson has used the playbook in two acquisitions: RelayHealth Corp. of Emeryville, Calif., a provider of online physician-patient communications services, and Sterling Medical Services LLC of Moorestown, N.J., a provider of medical supplies and health management services for the home care market. Financial terms of the deals weren't disclosed.
In M&A deals, the new model allows the McKesson real estate team to more easily expose, for instance, environmental concerns or poor maintenance at properties owned or leased by acquisition targets.
“Where a real estate professional might look at a real estate portfolio and assess it through a range of traditional real estate filters, a deal team might be more focused on a business angle that's less obvious,” says Ellzey. “For example, they might be assessing a target's stated business objectives or growth forecasts, but they find that those statements aren't borne out by the condition, capacity or location of some of the company's real estate.”
Ellzey offers this scenario: An acquisition target might have given growth projections leading the M&A team to believe that the company has plenty of room for expansion. However, if the real estate team for M&A learns the target's space portfolio actually turns out to be one-third of the expected size and is operating at only 70% capacity, that casts doubt on the original projections and underscores the need for further due diligence. Coming across such issues raises a “red flag” and prompts a company's M&A team to dig deeper — not necessarily into the real estate assets, but into an acquisition target's entire business, Ellzey says.
“A tool like the playbook signals to the deal team that real estate has done its homework and is ready to proactively think through critical issues from a real estate perspective as it relates to mitigating risk, enabling speed and avoiding cost,” she says.
Because of the aggressive posture fostered by the playbook, McKesson's real estate team now is recognized as one of the company's best-prepared groups in supporting M&A activities, Vines says, and the real estate playbook is being incorporated into the overall M&A machinery.
One component of the model — the “top sheet” — was a particular hit with McKesson's M&A team, according to Robinson and Zivalich. The idea, borrowed from the investment banking community, gives a bite-size overview of the particulars of each property included in an M&A scenario, such as square footage, occupancy costs, location and number of employees.
Of course, the playbook goes on to offer voluminous details about the acquisition target's real estate portfolio. Robinson says McKesson's M&A team liked the top sheet so much that it's applying that innovation to other facets of deals, such as human resources and information technology. In effect, the M&A group is taking a page from the real estate framework, he says.
“In M&A, you have only so much time and only so much information you can get your hands on. The top sheet is a tool for rolling up and summarizing those key points that are embedded in a range of documents so that landmines can be seen clearly without having to dig into the supporting documentation,” Ellzey says.
The beauty of the playbook process is that it determines who “owns” various steps in the M&A process, according to Ellzey. “Done properly, it forces teams to think clearly about the actual process they are seeking to deliver and improve. Accountability and ownership for pieces of complex processes are harder to sort out once you're in the heat of the battle” of pursuing or closing a deal, she says.
Ensuring those processes are sorted out correctly spurred development of the playbook, according to Robinson. Before the model, there was a “cross your fingers” aspect to pinpointing major risks as part of due diligence on real estate in M&A deals, he says. The playbook has eliminated some of that guesswork from the equation.
Ellzey, Robinson, Vines and Zivalich began working on the real estate M&A playbook last year and completed it early this year. They describe it as a “virtual” project that was hammered out during numerous telephone conversations, with Robinson and Vines in San Francisco, Zivalich in Atlanta and Ellzey in Boston.
McKesson and Trammell Crow executives say neither company could have come up with the playbook without guidance from the other. Zivalich says the authors pooled knowledge from McKesson, Trammell Crow, other companies and industry resources to devise the book.
The group cast a wide net in its research, examining both best practices and not-so-great practices. Ellzey estimates a template of this kind would cost about $20,000 to $40,000 to generate, depending on the project's size and the amount of collaboration.
“The playbook makes smart use of existing and readily available tools, but aims them at solving new problems and putting them in the hands of the right people at the right time. The music, as they say, is not in the violin,” Ellzey says.
Ed Lubieniecki, managing director of commercial real estate consulting firm RealFoundations, says the McKesson-Trammell Crow playbook is the exception in Corporate America, rather than the rule. Lubieniecki says he has heard of companies incorporating some sort of defined process for assessing real estate into their M&A procedures, such as in the banking and pharmaceutical industries, but that kind of in-depth process isn't the norm.
Lubieniecki, a former partner in Ernst & Young LLP's real estate advisory practice and former national director of consulting at Grubb & Ellis Co., says one challenge for real estate units engaged in M&A deals is access to data.
Before a merger is announced, little or no public information is available about an M&A target's commercial real estate assets, he says. After an announcement is made and before the merger is completed, “there are frequently restrictions on the type and allowable sharing of corporate information,” Lubieniecki says.
Indeed, Trammell Crow's Zivalich calls the playbook a “living, breathing document” that can be modified over time. “There are a lot of times you do consulting work or process-oriented work and it gets dumped on a shelf,” he says.
Not so in this case. The playbook is being embraced by Trammell Crow because its principles are relevant to any company, says Zivalich, whether it occupies office, industrial or retail properties. The M&A playbook also has been tailored to several other Trammell Crow clients and a generic playbook is now available to clients who engage in M&A activity.
Mark Gorman, chairman of a judging panel for the CoreNet Global Innovator's Award and leader of global real estate at Nortel Networks Corp., closely reviewed the project, which is a finalist for the award, and says it goes beyond the traditional boundaries of corporate real estate by adding strategic value to M&A activities. “They created something that not only works for the client but works for the service provider.”
John Egan is an Austin-based writer.