Due Dilligence

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Corporate Due Diligence for Business Combinations

FT MBA - Trim VI Teaching MaterialMergers & Acquisition Dr. Paritosh BasuAcknowledgement

The author acknowledges that freely available graphics through internet have been used for this presentation with the objective of propagating knowledge3Corporate Due Diligence - Business Combinations

Operational and Financial Due Diligence

Large Deals and Transactions

Merger - Entities, Business Groups

Acquisition Entity, Division, Business Group, CGU, Set of Assets

Demerger

Investment IPO, Equity, Quasi Equity, Long Term Debt

Repetitive large transactions Precursor to a prospective Deal

Long Term Procurement / Supply Arrangement

Anciliarisation

Wet-LeasingOther Due Diligence Services

Technological

Human Resource

Supply Chain / Logistics

Legal

Strategic Alliance

CommercialDue Diligence is a counter-weight to the excitement when managers begin to pursue a target

4Big Questions ??What synergies do we see with the target?Do we know what are we buying?What is the right time to close the deal?Is there any competitive synergy with target?What competitive advantages do we get ?Is there any indicative price from Others?What is our walk away price?What is the target control premium we pay?Shall we face any cultural change management issues ?Is there any Tax Advantage?Is there any technological advantage?Will Orgnl. restructuring be needed? What happens if some key people leave?DownsizingRightsizingSynergy MaximisationDelayeringCross-functional MultitaskingRe-engineeringFunctional RestructuringBrightsizingRevitalisingTimesizingAncilarisingChange Management NeedsRepositioningSource: faculty.css.edu/dswenson/web/Powerpoints/ChangeDrivers.pptOrganisational realities to be identified and managed post the deal from BPM perspective 56

DD to Assess Nine Elements of Organisational Healthhttps://www.linkedin.com/topic/m%26a-due-diligence7Deal Making is glamorous, due diligence is not

Due Diligence is neither a pure science not an art. It is a combination of both. It also demand lots of sixth sense and professional intellect.

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About of half of deals fail to deliver the expected resultsThe most important need for success in M&A are

What objectives are to be achieved Scale or Scope

What are the hidden upside or down side effects

DD capabilities

Total discipline at each stage of the deal value chain

Discover what is not known about target

Not relying on the target for intelligence

What will be the effects on existing business 9Human aspects of financial due diligence

http://www.bain.com/publications/articles/human-due-diligence-video.aspx

Mitigating Risks While Doing Diligence Financial Due Diligence

https://www.youtube.com/watch?v=ysKvSx_SINk

What the Experts Opine about Mitigating Risks through Financial Due Diligence10

Corporate Due Diligence is also about detecting the skeletons in the cupboards of the target companyOne of the tasks for detecting skeletons is to strip away all accounting idiosyncrasies11

Illustrative Check List for Corporate Due Diligence12

http://www.eperinc.com/mergers-and-acquisitions-ma-environmental-due-diligence/ Two Stages of Corporate Due Diligence

Exploratory analyses to assess Potentials to generate return in a given time frame Due diligence is a rigorous process that finally determines whether or not the DEAL will go through. The process involves

Asking and answering a series of questions to evaluate all the aspects of the entity and the opportunity

Rigorous review and scrutiny of a large number documents past periods financial statements and projections;

Quantitative and qualitative review of synergies and integration

Qualitative review of managerial personnel and leadership team

Finding misrepresentations in the document of the prospective investee

The process is of two stages

Initial Screening - Whether the proposal fits the funds mandate or criteria, e.g., the business stage, geographic region, deal size, industry sector.

Detailed DD13Initial Screening Questions Quick Litmus Test questions for initial screening

Exact nature of business, product / service What is Unique?

Product potential

Possible areas of synergies and competitive advantages

Possible Intangible Assets not accounted for in Books of Accounts

Reasons of failure vis--vis previous suitors, if any

Post deal fund requirement and subsequent tranches if any

Board value settlement strategy expected by acquiree

Present location of business and plan for expansion in new areas

Broad operating plans and expansion

Technology Stage Uniqueness, horizon of substitution

Product / service life cycle

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Perspectives of FS Analyses for Broader UnderstandingIn-depth Study of Operations, Profitability and Financial State of AffairsDeeper Understanding BusinessRisk AnalysisSWOT - Raisepost deal ReturnsEnhanced Credibility of DD as An exercise DD as a Tool for Deal Negotiation16Financial Due Diligence Desk Top Financial Due Diligence(With or Without Internal Inputs)Post FactoFuturistic AnalysisOff - Balance Sheet FundsLT Arrangements with Customers & SuppliersContingent Liabilities and Commitments 17BusinessCombinationsInvestment in Equity18

Source: http://www.bain.com/bainweb/media/flash/popup_funnel_chart.asp

Strategic Due Diligence for Introspective Analysis Essential for Deal Closure

19 Analytical Due Diligence Bridging the Gaps in Understanding about the Target Product pipeline - Quantitative Growth Analysis of past and future with impacts of new products if any

Customer Contracts - Onerous or probability to turn onerous to profitable, volume commitments if deal is for backward integration

Supply Chain Arrangements for both Inputs and Outputs - Scope to rescind if tending to be loosing proposition - Price, Logistics, Product , Input and / or service availability

Existing Intra-group contracts - Need for Father-hooding / closure

Operating Profitability Identify any infected limb

Arresting down trend in Gross Margin - Efficacy of concrete remedial measures initiated or to be initiated post the deal

Order book (Construction Cos.) - With or without escalation

Trends in Prices - Inputs and Outputs

Inflation Adjustment - Success factor in passing cost increases to customers - Industry trend

Objectives of Transaction for DD - Specific issues to be addressed

Review & Analyses - Business Plan, Earnings Guidance and FSs20Nice, Essential & Must (NEM) - Outcomes from Analyses of Expenses

SWOT Leadership team view points revealed in MD&A Section

Capital Expenditure - Maintenance / Sustenance and Expansion

Projects in hand - Status for expansion, diversification, etc.

Market, Customer and Vendor - Major changes if any

Working Capital Model - Going Concern with our without fresh injection of short term funds

Projected FS - IS, BS, CFS in comparison to previous years after eliminating extra ordinary impacts; Past instances of failures in guidance - Earnings and Capital Expenditure to market

Cash Flow Forecasts - FCF, Term Loans, Quasi Equity Conversion with optional / compulsive commitment for Dilution

Sensitivity Analyses - for projected IS CF and BS

Contingent Liabilities - Possible, Probable and Remote (PPR) Analysis

Review & Analyses BP, EG and FSs 221Commitments and Insurance Contracts - Impacts on future performance

Employee Benefits Defined Benefits and / or Contribution

Statutory Audit Report Immediate and long term financial impacts of (a) Qualifications (b) Drawing Attention / Matter of Emphasis Paragraphs (c) Qualifications in CARO Value, Systems, Compliance, Failures

Corporate & Brand Images - Respect amongst industry peers

Sustainability Management 4P Approach

Status of Corporate Governance

Corporate Social Responsibilities

Regulations - Effects of any regulatory provisions on the anvil

Second Tier Focus Areas of DD Specific areas of focus and in depth analysis second tier reviewReview of BP, EG and FSs 32223Review of BP, EG and FSs 4A typical method for projecting each of General & Administration Expenses

Last years actual expenses MinusExpenses for last years one time activities MinusTargeted reduction from normal expenses MinusReduction arising out of planned discontinuation of old operations PlusExpenses for new activities contemplated for the budget year PlusExpenses for the budget years one time activities Plus/ MinusInflationary adjustment Plus/ Minus Increase/ decrease due to statutory provisions Plus/ Minus Increase/ decrease due to changes in regulatory provisions Equal to Next periods projected expenseNote: Certain expenses originate from oganisational culture and legacies Specific review is needed to understand whether those will continue.Review of BP, EG and FSs 5Exploratory analyses for assessing ability to ensure sustainable growthWhat are the plans, action points, capital and revenue expenditure for Reducing material intensity

Utility audit and reducing consumption of power, fuel, steam, water, etc.

Optimisation and substitution of raw natural resources

Minimising dispersion of toxic substances

Green logistics for renewable and used products

Recycling of scrap, wastage and spoilage

Prolonging product life at minimum differential price

Increasing service intensity to reduce frequency Similar points are also to explored for vendors CXOs to ensure viability and growth after absorbing all these expenditure 24Understand the revenue streams from MD&A and contemporary and foreseeable business ecosystemBusiness Segment (CGU)Product(s) Volume, Price, Customer SegmentGeography Domestic and Overseas (Country-wise)Competition, Regulatory changes, Coupling effects, etc.

Historical trends in pricing and gross margins

Business Model Revenue Generation, Growth & Expansion, Capital Structuring

Post sales events Trends in Sales ReturnsRework, Warranty and Customer Loyalty obligationsProvision for Doubtful Debts and write-off

Exceptional non recurring items

Write-off / impairment Receivables, FA, Investments

Review product profitability trends covering 80 % of turnover

Pricing pressures Competition, Materials and Conversion Costs

25Quality of Historical Earnings, Assets & Liabilities(If possible, with enquiries Industry Research reports and internal inputs)Sustainability of margins and recoverability of dues

Impact of changes in Key accounting policies Methodologies for measurement; affecting Accrual of IncomeDepreciationFixed Assets, Intangible Assets and GoodwillDebtors provisioning, Inventory Valuation, Capitalisation Valuation of Assets

Impact of material changes in financing arrangements and of any other profitability adjustments on Net Worth / Net Assets

Charges created on various assets Terms and conditions

Reconciliation of Profit as per IS and Tax RecordsStatus of Tax Assessments Availability of tax losses and other tax benefits / exposures Implications of tax liabilities and disputed demandsImpacts of pending disputes at various levels of judiciary

26Quality of Historical Earnings, Assets & Liabilities 22627

28Your Questions?