Diamond to be Acquired by PricewaterhouseCoopers for $378 Million
Monadnock Research (VIII N35) – 24 August 2010
NEW YORK and CHICAGO – PricewaterhouseCoopers has entered into a definitive merger agreement where PricewaterhouseCoopers LLP will acquire all of the outstanding shares of Diamond Management & Technology Consultants for $12.50 per share in an all-cash deal.
The transaction represents a premium of 31 percent to Diamond’s closing share price of $9.54 on 23 August, valuing Diamond at around $378 million…
When Mark O’Conner of Monadnock Research asked for my initial reaction to the PwC/Diamond deal, I had to admit I hadn’t thought much about it. Diamond Technology, a true-blue Chicago born and bred company, is small potatoes. Diamond never achieved the billion dollar revenue goals the founder had dreamed about. Mel Bergstein is reputed to be a lot like a lot of former Arthur Andersen partners – an egomaniac. Huron Consulting provides another recent example. Their egos get in the way of realistic business sense and their self-serving grasp frequently exceeds their true market reach.
There are Chicago River tour boat-size stories here about Diamond, which used to be called Diamond Cluster. But I knew more about the firm based on my attendance in 2003 at Harvard Business School’s Leading Professional Services Firms executive education program. We discussed a case study on Bergstein and Diamond called, “Diamond In The Rough.”
The HBS case study was created in February of 1999 and discusses Mel Bergstein, his co-founder Chris Moffitt, and the challenges they faced during the first two years of the firm, 1994-1996.
Old colleagues and friends, they had doubled Diamond in each of its first two years from nothing to $12.8 million in 1994 to $26.3 in 1995. Earlier in 1996 they had planned to double again. The information technology consulting and systems integration market was huge and rapidly growing…Bergstein and Moffitt, having been part of this industry for decades, believed there was a need for an independent and objective voice that could assess the needs of a digital strategy without being biased toward trying to sell a big outsourcing or systems integration job. They estimated that this independent advice market was approximately 10% of the total market, or $10 billion…In April at the beginning of Diamond’s third fiscal year, two major clients, representing 50% of the prior quarter’s revenues, had pulled out of deals. All of the partners had hunted up projects to cover these losses, but their heroic efforts produced only damage control. Having lost $0.7 million in the past quarter, Diamond was now operating below break-even. To add to the seriousness of the situation, a long-planned IPO was imminent; Diamond had recently offered jobs with signing bonuses of $20,000 to $30,000 each to 50 MBAs, 28 of whom had accepted; and staff and employees were expecting their standard year-end bonuses (which were budgeted between $1.5 million and $2 million). Now, all this was on hold…
Diamond finally IPO’d in 1997. At the end of fiscal 2010 in March, Diamond Technology reported revenues of $210 million. 2009 revenues of $175 million were a 17% drop from 2008’s of $205 million. EBITDA is flat 2008 to 2010 with a loss of almost $16 million in 2009.
I said to Mark O’Connor, “Frankly I don’t see the point of PwC buying this tiny firm given all its legacy issues. The cult of Mel Bergstein was well documented by Harvard Business School. PricewaterhouseCoopers is grasping at straws.”
Mark went a step further in his research note.
He did the math:
This acquisition price is a multiple of 1.2 times revenues. Huron and Navigant, two other Chicago-based publicly traded consultancies, had market capitalization to revenue ratios of between .63 and .71, respectively, at the close of trading on 24 August.In addition to the BearingPoint transactions, several other recent deals have concluded at multiples far smaller than what PwC and Diamond have agreed upon. So it appears to be an attractive deal for most Diamond shareholders.
Most Diamond shareholders… That would be Diamond’s employees and directors who own about 30% of the company. Mel Bergstein, who limited his role to Chairman after he acceded to a succession plan and gave up the CEO job in September of 2005 when revenue declined and the company posted a quarterly loss, will make the most. He still owns more than 1 million shares. That should put more than $14 million in his pocket.
What happened after PwC bought Bearing Point and its “highly talented professionals with a proven track record of consistently delivering world class service” ? That’s the way PwC US Chairman Bob Moritz describes the Diamond consultants. First, PwC rescinded all the offers to BearingPoint professionals who were on a visa of any sort. Then, last November, they cut 300+ of their own consulting professionals to make room for the BearingPoint gurus of their new SAP/Oracle systems integration practice.
PwC’s gross revenues from operations for global member firms in 2009 were $26.17 billion, down from $28.19 billion in the same 2008 period. The firm’s Advisory services revenues were hardest hit by the recession of all PwC business areas, down 11.4 percent to $6.11 billion.
Mark O’ Connor at Monadnock Research again did the math and shocked even me with the enormity of what PwC has offered for, what we assume will be, most of Diamond’s consultants – that is if those technology consultants really want to work under the constraints of a public accounting firm:
Diamond has 532 consultants and 652 total employees at the firm. PwC’s acquisition cost was close to $580,000 per employee. But since many administrative staffers will likely become redundant post-transaction, the more relevant figure is acquisition cost per client-facing professional, which is a little more than $710,000 per consultant. Annualized revenue per Diamond employee was $393,000, unchanged from the prior period.
Diamond’s attrition increased to 17 percent on an annualized basis in Q1 of Fiscal 2011. That’s up from 14 percent in the prior period ended in March, and 13 percent in the same period last year. The increase in voluntary attrition indicates increased mobility in an economic environment that had shown signs of improvement, with professionals moving to client organizations and to other firms.
Diamond and PwC have been talking since March. Did some of the employees bail out before they were signed on as sterile strategists for an ineffective firm struggling under the weight of consulting “leadership” with audit-shaped heads? I know for sure that there were significant groups of BearingPoint consultants that would have rather masticated glass shards than work for a public accounting firm again. They took their teams to firms like CSC rather than join Deloitte and especially PwC.
I was quoted in the Monadnock Research note: “PwC tried to buy experienced ERP professionals and their revenue stream with the BearingPoint deal. Now they’re buying IT strategy leadership and Diamond’s revenue stream. Maybe successful technology professionals won’t go to work for an accounting firm unless they’re bought and paid for at a premium.”
PwC has potentially bought a pig in a poke. Hopefully they negotiated lock-ups for key revenue producing consultants, validated current revenues and reported client receivables, and quantified the value of only free and clear clients that will be able to produce for them in the future. Otherwise they’re likely to find the business they thought they bought vaporizing within 18 months. After all, Diamond has not changed much since those heady days of 1996 when they lost two major clients, representing 50% of the prior quarter’s revenues, and went into a tailspin.
From the Monadnock Research report: Diamond’s top 5 clients represent 42 percent of the firm’s net revenues, flat from the prior period, but up from 34 percent in the same period a year ago. So Diamond has increased its business dramatically with a few very large clients. This has been a trend for many large and mid-sized consulting firms over the last 18 months. But the trend also presents risks to clients and firms if those client relationships must terminate as a result of an acquisition. This will likely be the case for a number of strategic Diamond client relationships if the acquisition concludes.
While Diamond does not disclose its revenues by client, it is highly probable that Diamond will need to end its relationships with some of them due to conflicts with PwC as their auditor. The firm has particular exposure in Financial Services and insurance, its largest industry segments, where clients like Goldman Sachs and American Express, both audited by PwC, present obvious conflicts. Goldman Sachs may be among Diamond’s top 5 clients.
PwC had better make sure that the entrepreneurial former Arthur Andersen partner Bergstein does not make the same mistake the former Arthur Andersen Huron guys made and pay off favorite folks without accounting for it properly.
Wait… PwC is Huron’s auditor. PwC certainly knows how to help Diamond make everyone happy this time without getting caught.