Creating Shareholder Value
Author:
Richard Lombard
[Excerpt] In 2001, global deal values fell by 26% compared with the previous year1; in volume terms the decline was as steep. Ireland's current economic climate and turbulent market conditions contribute to a tougher deal making environment- for the corporate sector, for private equity investors and indeed for anyone with an interest in doing deals. If, however, growth-driven transactions are in abeyance, current market conditions are creating opportunities of a different kind.
According to Robert Dix, head of KPMG Transaction Services, Dublin; "Companies with cash reserves or low gearing are well placed to pick up assets at a keen price. Consolidation is still seen as an effective way to increase shareholder value."
A case in point is the well-publicised Hewlett-Packard / Compaq merger2 which is based on the rationale that consolidation will deliver breadth and scale for a combined entity to go head to head with IBM in the computer industry. Similarly, in the rising popularity of vendor initiated due diligence (Figure 2) we have seen that the active disposal of non-core and/or under-performing assets is still seen as a mechanism to increase shareholder value.
In the diverse circumstances in which deals are done and the equally diverse cultures of the organisations that get involved, a single prescriptive approach to transactions is not appropriate. Based on a blend of our experience and research in the M&A field3, KPMG has found that the companies which succeed in unlocking long-term shareholder benefit are those which can identify "hard" keys which open the door to value-realisation, as well as the "soft" keys which can access the enormous potential of an organisation's people and culture. (Figure 1).
"Hard" Keys
The "hard" keys can be defined as
â?¢ Synergy evaluation
â?¢ Integration planning
â?¢ Due diligence
Synergy is a word often bandied about in an M&A context, yet acquisitive companies seldom move beyond the cliché to work out how and indeed whether synergies can actually be achieved. Deals often fail to create value either because they take the business in a new direction for which it is not prepared or because the assumed synergy benefits turn out to be either a mirage or too difficult to implement. By the time these weaknesses come to light - if they do at all - it's likely that substantial emotional as well as financial commitment will have been invested in the deal. The overwhelming effort put into the transaction process is geared to overcoming problems and achieving a positive outcome, and to pull out at this stage may be difficult. Thus, deals get done under the weight of their own momentum. To avoid this requires a painstaking process of evaluation, beginning as early as possible in the pre-deal phase. The scale of this investment should not be underestimated.
In one of the most bruising corporate merger battles ever fought, HP and Compaq say they have spent over 500,000 hours planning integration in order to avoid the pitfalls that have doomed past technology mergers.4
Such a process involves detailed work with operational managers to assess the "deliverability" of synergy assumptions and provide the reassurance during negotiations that the identified benefits are robust and capable of delivery within planned timescales. The pace of achievement of the synergies is often the critical success factor in the achievement of profit and cash flow targets necessary to deliver shareholder value. In the case of HP/Compaq, success will hinge on the ability of management to pull off a feat never before achieved in the computer industry: the efficient and rapid integration of two large companies with multiple product lines and global operations - without letting competitors take advantage of the inevitable internal focus and disruption which can accompany such a combination.
Given the potential for M&A negotiation difficulties, particularly involving the shape and composition of new management, companies may be tempted to delay integration planning until after completion. The short honeymoon period after completion, when people are ready for change, can be squandered and some of the best talent may seek other
opportunities. Once this has happened, implementation of the "soft" keys becomes progressively more difficult.
Due Diligence
The final "hard" key is due diligence. Forward-looking acquirors will use a range of investigative tools designed to assess all the factors affecting value, such as market review, risk assessment and appraisal of financial performance.
Nobody would dream of buying a house solely on the advice of an estate agent. Rigorous checks by independent experts may uncover serious problems requiring vital and expensive building work which may mean you end up paying more for the property than it is actually worth; a new sewage plant might end up on your doorstep. In short you need to know what you are buying and what might affect its value.
Traditional financial due diligence tended to concentrate on reviewing past trading and an in-depth review of the balance sheet. Increasingly, transaction evaluation has become more forward-looking and concentrated on key issues, forcing advisers to make a wider contribution. It encompasses not only the factors, which could affect the price, but whether this is the right price in view of the potential benefits, which are expected from the transaction. To do that, the advisor needs to understand fully the rationale behind the deal and the impact of the acquisition/disposal on the business as a whole, rather than on a standalone basis. That means focusing on value creation rather than the historic financial statements, and quantifying the risks and uncertainties inherent in the deal.
According to Robert Dix, "increasingly we are asked to combine financial and commercial due diligence in a single package, encompassing in-depth analysis of market behaviour and trends as well as a review of systems and financial data".
Accountancy Ireland Vol 34 No 3 June 2002