An opening word of caution: informed opinion is that mergers and acquisitions are rarely successful and most erode shareholder value rather than create it. Transactions should, therefore, be carried out as part of a deliberate strategy. Opportunistic deals carry a greater risk of falling into this category.
When planning a transaction, the first task is to create a long list of possible targets that are defined by the nature of the deal, be it expansion, diversification or supply-chain integration. To reach the shortlist, the candidate should offer measurable benefits aligned to your strategy and your research should indicate success.
After you have made initial contact with the chosen firm, either directly or through an intermediary, and received some encouragement, how do you avoid making an expensive mistake? Although there is no catch-all solution, it is practical to estimate the value that will be created by the acquisition and prepare a plan to realise it. The value calculation should include financial and non-financial elements such as shareholder value, reputation, workload quality, cultural fit, strength of management and quality of staff. The discipline of this process will help in three main ways.
First, knowing the realisable value will help you to maintain focus when negotiations intensify. The most frequent error in mergers and acquisitions is to be swept along by the momentum of the deal and pay too much for the realisable value. This normally results from loss of objectivity as time, effort and personal credibility are all invested in completing the deal, raising the emotional tension of the negotiations. Experienced advisers can help here by counter-balancing the internal acquisitive excitement.
Second, it will force you to consider integration after the merger. Here, speed is of the essence. A good rule of thumb is to take control quickly and announce your integration plans during the first 90 days. After that, the expectancy for change evaporates and control becomes increasingly difficult. You also risk stalling the business through worries over your post-merger strategy. Approaches range from business as usual to the more challenging option of changing the acquisition to fit a business model. If you choose the latter, be sure that you are doing it for the right reasons and that the change will actually create value, otherwise 1+1 could end up equalling substantially less than 2.
Make sure that the change will actually create value, otherwise 1+1 could end up equalling substantially less than 2
Third, validating your value calculations will bring into play proper, objective, commercial due diligence, the importance of which cannot be overstated.
My own experience is that a typical firm will have a mix of good projects that tick along unspectacularly, and howlers. Quantifying the problem on these projects is a serious consideration, but you should also look for discrepancies between the site's profit and loss accounts and the management accounts. These could result from management's optimistic view of the project's likely outcome. If you were to view the site's figures in isolation, you may find yourself counting on profit that has already been spent.
The risk in today's plethora of bonds, warranties, parent company guarantees and third-party interest clauses also needs to be assessed in detail. Central records should be checked to validate the existence of these documents, as this is not always the case.
On the issue of advisers, I have heard it said that the closer they are to the negotiations, the longer the deal takes to do, but the further away they are, the less chance there is of detecting the hotspots. The answer lies in striking the balance, and it is important to have an initial brief and scope of engagement. Be careful over due diligence – your own staff could take their eye off their own projects.
Postscript
Frank Devoy is a managing consultant in Ernst & Young's real estate group.
