A recent spate of M&A activity has focused the minds of finance directors on the need for good due diligence by their organisations in any deal-making.
Amongst the high profile transactions, conference group Informa has turned its sights on rival UBM while investment vehicle Melrose Industries has sought to acquire automotive and aerospace parts group GKN.
One lesson learned in recent years is that speedy deal-making may impact on the quality of the outcome- and even result in value erosion over the long term. So good due diligence needs to be a critical aspect of any M&A process- something the finance director should get a grip on.
FDs should be prepared to ask questions around the wider cultural as well as financial and legal aspects of a target company when undertaking due diligence, so that deals don’t prove costly, in terms of finance and reputation, say experts.
Asking the right questions
Peter Williams, chairman of online fashion retailer- who has held senior board roles across a number of companies, says: “Good due diligence is important in any deal situation. When I was on the board of cinema operator group Cineworld we undertook plenty of due diligence when we acquired rival group Cinema City in 2014 to be certain its owners were good operators- which proved be the case,” he says.
“Whether its bolt-on acquisitions or stand-alone deals, you’ve got to make sure you ask the right questions. After all, the financial engineering part is only one aspect of a deal,” says Williams, who is also Senior Independent Director of property website group Rightmove. “It’s vitally important to understand what’s going on at the heart of the targeted business, so question whether those in operating roles of the target company know what they’re doing,” he says.
It’s important to understand that non-financial due diligence is as important as financial, says George McKillop, CEO of consultants Haymarket Risk Management, which undertakes investigations of target companies. “The management of a company being acquired aren’t going to say if there’s anything untoward in the company, especially if they stand to make a lot of money in the transaction.
“So it makes sense to undertake in-depth due diligence to understand if there are any agendas or issues they wouldn’t want the buyer to know about. It’s usually the kind of material that won’t usually be discovered in normal financial and legal due diligence,” he says.
McKillop says the cost of this form of due diligence is relatively small compared to financial and legal due diligence. “It makes a lot of sense to undertake this work first, so that you don’t unnecessarily undertake expensive financial and legal due diligence, if you discover something that is a deal breaker,” he adds
Michel Driessen, Senior Transaction Advisory Services Partner, at EY says“It is important for financial directors to exercise caution against overpaying but it depends on how you define overpaying.
“When assets are priced, there is a need to look at factors that are driving that price. It could be, for instance, how the asset fits within a company’s strategy and what the rationale is for buying. Many factors could come into play including geography, customer base and the product itself, if relevant. Each of these factors will have a certain value attached to them which will therefore influence the price.
Driessen says: “Overpaying, itself, isn’t the end of the world as long as the buyer knows how to extract money/value from the asset. There could be companies that many analysts and commentators may say are overleveraged or overpriced in the first instance. However, if the buyer has done their due diligence, they can, for example, combine the newly acquired asset with one of its portfolio companies or can use it as a platform for bolt-on acquisitions.
“By undertaking thorough due diligence, there is the potential to drive synergies and overpriced companies can deliver much more value for the buyer than the market previously anticipated,” he adds.
There should always be careful scrutiny of the rationale for the deal, says Driessen. “When deals go wrong, there is often no connection between growth strategy and acquisition rationale. The buyer needs to have a well thought out and detailed deal strategy.”
“Once the deal is done, there will be a need to deliver the anticipated savings and benefits through integration. If this hasn’t been thought through and the savings cannot be realised, the company will have overpromised and under delivered to the market which can be disastrous for reputation and value.”
Driessen says there shouldn’t necessarily be a clear distinction between business decisions and due diligence. He says due diligence should enable and support business decisions. “By looking at everything that is potentially missing from an asset, it will either validate or contradict initial assumptions which leads to better decision making.”
“One should remember that asset prices are also driven from other external factors, including unconventional monetary policy such as quantitative easing, and therefore might not reflect the value identified through due diligence,” he adds.