# Itron Raises Stakes in Acquisition Spree

July 2003

Business research indicates that most acquisitions fail to create value, but a rare few firms are capable of acquiring new businesses and increasing shareholder value. Itron’s most recent acquisition of SEM for $255 M, their largest acquisition to date, meets three critical criteria necessary for success, but fails one. For investors, employees, and customer, the outcome of the SEM acquisition teeters in the balance with organizational capability as the key determinant. ### Failure Rate and Success Criteria Research studies by business academics and management consultants have repeatedly demonstrated that most mergers and acquisitions fail to accomplish their stated goals. In fact, the most common result of mergers and acquisitions is destruction of shareholder value. Depending on the research study being quoted, failure rates range from a low of 50% to a high of 80%. Given this backdrop of evidence, most executives and boards would better serve their shareholders, customers, and employees by pursuing organic growth strategies. On the other hand, the few executive teams that are able to make acquisitions strategies work are able to provide higher returns than the market average. Nohria, Joyce, and Roberson, in their recent book What Really Works, outline the factors that enable the 20% minority of firms to successfully execute merger and acquisition strategies. The four key criteria are a mixture of marketing, product development, and organizational issues. From a marketing and product development standpoint, the acquisition should either provide a new customer base in which to leverage existing products or provide new products to leverage to the existing customer base. One or both of these marketing or product development criteria must be met. From an organizational standpoint, the acquiring firm should be able to integrate the new business unit. This is most successfully accomplished when the firm executes multiple small acquisitions rather than a few large deals. Thus, the two organizational criteria for successful acquisitions are that the acquired firm is relatively small and that the acquiring firm utilizes practiced managerial processes to identify and incorporate the new unit. ### Itron’s Acquisition Strategy Itron, (www.itron.com) founded in 1977, initially served utility companies with handheld computers for recording meter data. Since shipping its first system in 1980, Itron’s offerings have expanded to include core products of advanced meter reading devices (AMR) and meter data management systems. Prior to its most recent acquisition, Itron had over 1400 employees and a market cap of over$400 Million (as of July l6, 2003 reporting).

AMR devices and meter data management systems provided the fuel for growth throughout the first two decades of Itron’s existence. Even today, Itron has yet to fully penetrate its core market. Only 14% of the 270 million electric, gas, and water meters in the US and Canada rely upon automated data collection and communication technologies.
Capturing the remaining 86% of the potential market for AMR devices and meter data management systems should be a sufficiently large opportunity in which Itron can execute organic growth and maintain a competitive and profitable position.

Apparently, for Mr. Nosbaum and his board, the potential gains to organic growth were too small. Itron’s 1999 Annual Report recorded a strategic change towards a focus on research and development and strategic partnerships that broaden the portfolio of offerings for their customers. Over the subsequent years, the fulfillment of this vision expanded to include acquisitions.

During a thirteen month period, Itron acquired four significant operations. First, LineSoft was acquired for $42 M in March of 2002. In October of the same year, RER and eMobile Data were acquired for$14 M and 6.2 M respectively. Then, in March of 2003, Silicon Energy marked their largest acquisition to date for 71.2 M. Many expected the acquisition spree to end there. But the strategy still had game. Now, just four months after their most recent acquisition, Itron is acquiring SEM.

### Expected Success

Prior to Itron’s acquisition of SEM, each acquired firm met the success criteria laid out by Nohria, Joyce, and Roberson. LineSoft, RER, eMobile Data, and Silicon Energy each enabled Itron to leverage its existing customer relationships with a relevant and broader value offering. The high frequency of the acquisitions implies a practiced managerial process to screen potential acquisitions for the best match. Appropriately, each of the first set of acquired firms was smaller than Itron.

Meeting the first of two criteria for success, acquiring SEM enables Itron to reach a larger customer base and, at the same time, leverage their existing customer relationships with a new value offering. The SEM acquisition includes a customer base of over 3,400 utilities and a solid state metering technology in which Itron’s AMR device can be embedded.

By riding the heels of the Silicon Energy acquisition, the SEM acquisition meets the third criteria of maintaining a high frequency of acquisitions. The size of the SEM unit however raises concerns of meeting the fourth.

The price tag for SEM is not what is raising the red flag. With an EBITDA of $33 M for the year prior, a$255 M price for SEM represents a P/E ratio of 7.7, conservative by many tech standards. In the market, SEM has a 30% share by install base for electricity meters. Unfortunately, Chartwell Inc, a utility and retail energy research company, reported a declining market share for SEM AMR products. In acquiring SEM, Itron’s highly regarded sales force can be expected to reverse this trend and provide future growth.

It is the size of SEM’s operation that is of concern. This is the one criterion for success that Itron’s current acquisition target may fail to meet. SEM includes over 1000 employees and a cash flow near that of Itron’s. All past acquisitions were much smaller. In incorporating SEM operations, products, and customer base, Itron must rely upon the managerial knowledge and skills it has developed through past acquisitions and apply it on a much larger scale. The scale of this challenge is much greater and raises the risk profile.

According to the Strategic Acquisition Scale, which incorporates market strategy, track record, and target size, Itron’s most recent acquisition target rates 8.0 out of 10. Any score above 5.0 implies expectations of a positive outcome.

### Operation Concern

The size of the SEM acquisition effects Itron’s operations in two critical areas: R&D and Sales. In both areas, Itron’s track record provides support for the expectations of a positive future. And, in both areas, the SEM acquisition will challenge management practices in order to produce a positive outcome.

In research and development, Itron has a positive track record with integrating newly acquired technology and producing stronger value offerings. Six months after acquiring LineSoft, Itron released TL-PRO Transmission Line Design Software from product development. Similarly, six months after acquiring eMobile Data, Itron’s product development team released the Mobile Data Collection System. However, each of these product development accomplishments was software in nature. SEM brings new technology in both hardware and software to the Itron R&D team. The expansion of the integration challenge to include hardware and the size of the SEM team will strain the new R&D team on both the organizational and product level. Success with SEM may require a change in the organizational structure and managerial approach to R&D.

Also, in sales and marketing, Itron has a positive track record with integrating the new sales team and reaching the market with an expanded solution portfolio. With the LineSoft and eMobile Data acquisitions, the sales team was able to call upon the same individuals within utilities and effectively bring the products to market. In acquiring Silicon Energy, the sales team had to expand the individuals within the same utilities to uncover opportunities and close sales. Recent financial data indicates their success in doing so. As with these prior acquisitions, the SEM deal will enable the sales team to reach their same prospect base with yet a broader offering. However, because of the size of the SEM acquisition, territory realignment may be required. Furthermore, the structure for managing relationships with clients and prospects may require adjustments. In order to successfully implement these changes, management strength and organizational flexibility will be challenged. It may take some time to bring the expanded sales and marketing responsibilities and team back to full productivity.

### Stakeholder Future

Itron’s track record for finding good acquisitions and incorporating the new business unit is strong. Their recent acquisition of SEM meets most of the criteria for success determined by business research but falls short in one. Best practice management would dictate holding-off on future large acquisitions until the SEM operation is fully integrated, but wouldn’t preclude further small acquisitions. Yet, with Itron’s performance exceeding investor’s expectations, as they have in the second quarter 2003 reports, few will question the sagacity of Mr. Nosbaum.