Market outlook: Front-end deal management key to returns from M&A

Maximising value in a deal requires some up-front analysis from both the buyer and seller perspective. What does it take to improve the deal making process?

The chemical industry is showing signs of the much anticipated uptick in mergers and acquisitions (M&A) activity with a 47% increase in deal volume in 2013 compared to 2012. As the industry restructures due to shifting demand, desire for returns, and the resurgence of the US industry, there are many strategic and financial investors entering the fray.

With deal volume and pace increasing, the key question on the minds of many business leaders is: “How can we maximize the value of the deal for both buy and sell side opportunities?” There is a natural tension between a buyer wanting the highest value and a seller not wishing to sell cheaply which goes beyond the headlines of price and multiples.

Buyers and sellers should map out the overall process and key resources Copyright: Rex Features

Deal value does not happen by accident. Our experience and research suggests there is a “pot of gold” of value available which may be influenced substantially with the right preparation and knowledge of the levers available right from the start, when the deal is little more than a twinkle in the eye.

The lower graphic (below) shows an example of the potential for increasing deal value over a base case valuation. This is based on a recent outside-in study of a large business currently on offer in the market using references from our M&A work and research into transactions.

Conventional divestments should include a series of performance improvement steps which the seller sets in motion to deliver approximately 10% improvement in EBITDA, with 15% more value available from tailoring the business to the buyer, and an additional 25% or more coming from running a highly competitive sales process, including an initial public offering (IPO) option.

Sellers will try to package up and enhance an asset prior to any sale by normalisation of the accounts to eliminate any historical one-offs and by stripping out corporate costs which do not transfer. These are the minimum mechanical steps taken before a sale, leaving the seller a choice of selling “as-is” or capturing further value by improving the business prior to sale.

Often tensions within the targeted business occur as the employees and management disengage from the parent, risking both transaction timescale and price, so a clear pre-divestment plan, with values attached, is needed to keep the deal team on track.

Further, advisers often persuade owners to sell “as-is” as advisers are incentivised by the transaction occurring and not necessarily by the net price and value created. The most glaring examples of this risk are companies which are flipped and sold a short time later in a second sell at a much higher value with relatively little change to the business.

From a buyer perspective, the main risk comes from buying a business without understanding the full value potential and underestimating the possible downsides. A buyer may over-pay or fail to deliver the anticipated long-term value if its assessment of value is based solely on the seller’s information memorandum and an internal review. Changing one’s mind about value after the deal is an expensive mistake and in the most extreme cases can lead to contentious litigation with the subsequent loss of value for one or both parties.

De-risking any transaction across all elements – including legal, financial, technical, environmental, and commercial risk – is a must for a buyer and is important to understand, quantify and, where possible, mitigate.

How do you identify value?
Whether you are a buyer or seller, preparation is the key to unlocking value. When deals fail it, is usually because there has been a failure to understand the base value of a business or asset, the key drivers of profitability, the sensitivities, and the major risks.

For buyers the main concern in deal-making should be ensuring that, post-acquisition, the value is extracted from the new business. The deal really starts at the initial evaluation of targets, when it is critical to have a clear strategic rationale for the purchase and a full deal execution plan from target identification through to pre- and post-merger integration.

It can be helpful to think of an acquisition like a major capital project. CEOs have learned to push engineers to ensure that comprehensive Front-End Loading (FEL) is completed as a first step in successful major capital projects with benchmarking and peer reviews forming part of the process. So why not develop an acquisition plan using the same principles for deal teams?

For sellers the same principle applies, with preparation the key to a successful sale process. In addition to this, our experience suggests that understanding the buyer’s drivers will help the seller tailor their package to the broadest audience, and thereby maximise the price. It is especially important if the business for sale is a carve-out or will retain a key relationship with the seller, as a failure will continue to impact the retained business.

Using parallel divestment options such as running an IPO process at the same time as an auction may be the best option to ensure a sale and maximise the value. The benefits of this dual-track sales approach were demonstrated by the estimated $2bn uplift in value generated by BP using this process during the Innovene business sale to INEOS in 2005.

Buyer and seller will have their own perceptions of the value in any deal – from an opportunistic purchase from a distressed seller to a highly strategic purchase based on growth or a defensive strategy.

We recommend that sellers analyse the potential buyers in advance of any deal and in figure 2, we explore the priorities of the competing buyer groups.

How to improve deal making
As a buyer or seller, the main elements of successful deal making are essentially the same once you have identified the target business. We recommend that both buyers and sellers use the same principles as a typical major engineering project with significant effort put into the Front-End Loading of the deal. To start that process we suggest undertaking the following steps:

Establish Project Responsibilities

• Appoint single project deal maker with clearly defied authority and access to the key decision makers
• Agree on an “Authority to Negotiate” document with the board outlining the price, level of authority for the negotiator, and key risk framework

Develop a Front-End Deal Management Plan

• Develop a “Front-end Deal Management Plan” as part of an overall project plan for the acquisition or divestiture project
• Map out the overall process and key resources with the major roles and responsibilities identified (including advisers)
• Develop a deal budget and overall timescale

Create Value, Risk Management Frameworks

• Write down the scope of the deal and identify the gaps and opportunities
• Identify potential buyers or sellers, value levers, key sensitivities, and base valuation
• Develop a deal and business risk and interdependency matrix
• Create a budget and business plan for the new business and its integration or separation
• Peer review the deal at the earliest opportunity and regularly throughout the process

Irrespective of the sale process, front-end deal management is the key step in a successful project. Fast-track processes can use the same principles but will increase the risk. This is manageable, but will mean that more resources are needed upfront to not sacrifice value and risk for speed.