28 May 2020 Ankit Chadha

Financial Due Diligence: 3 Things To Look For Before Completing M&A

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Hewlett Packard (HP), in 2012, recorded a spin-merger of nearly $8.8 billion, following an $11.1 billion acquisition of Autonomy a year earlier. HP alleged that after an internal audit, Autonomy had 'Accounting Irregularities' that led to overpricing their business (which Autonomy actively denied).

At about the same time, HP was sued by creditors/shareholders for the incurred losses, ultimately settling for $100 million. It begs the question: if a giant like HP is unable to get their financial due diligence right, what is the hope for other companies? In this scenario, as with many other catastrophic M&A decisions, the most critical issues are triggered by the things you don't know.

Regardless of whether or not Autonomy defrauded HP, through comprehensive due diligence, HP would have found the issues. It was the financials that tripped them up in this case, but due diligence needs to go far deeper than that. Financial documents, statements, intellectual property, management, litigation, tax, regulatory issues, insurance: there is no shortage of things to investigate. These are just the obvious ones, and there's plenty of other areas you can explore.

Here are four things you need to look at before you confirm a deal (which you may not already have thought about):

  1. Calculate The Real Value Of Synergy

Once split, synergies raise the profitability of the new combined business above the valuation of both firms. In simpler terms, the sum is more than equal to the shares (parts). That can arise from cost savings in the form of reductions (e.g., eliminating unnecessary staff, combining resources) or revenue synergies (e.g., cross-selling).

The trouble is, the value of synergies is often challenging to quantify, so buyers habitually fail to measure the expense of integration: understanding these synergies come at a price, and it's not usually considered worth paying for.

In 2005, eBay purchased Skype for $2.6 billion, intending to use its apps to boost connectivity on its marketplace. What eBay hadn't realized is that its consumers didn't even want this functionality – they preferred to remain anonymous. It did not work out. Consequently, in 2009, eBay later sold Skype for $1.9 billion to private investors.

  1. Acquire Details On Every Contract

You know contracts are important as once the M&A transaction is complete, any deal that the other company has signed will become your issue.

So, have you found them all?

Some of the contracts acquire details from:

  • Indentures and agreements for workers, labor unions, employees, consumers, suppliers, distributors, and dealers
  • Loans & credits, including equity finance agreements
  • Past acquisitions, sales, settlements, and developments
  • NDAs and non-competition agreements

And a whole lot more!

Any formal and oral communication that affects the company must be understood thoroughly. One effective way to do so is to start using virtual data rooms to store, coordinate, and exchange these records securely.

  1. Consider Company's Tradition and Values

A business is far more than just financial statements, intellectual properties, and retail inventory; each organization has its own philosophy, principles and way of operating. Even when everything is working on paper, it is sometimes harder to make it work in real life.

For instance, in 2005, Nextel Communications was acquired by Sprint for $35 billion. The match looked good: Sprint has been popular in the home market, while Nextel has been great in marketing to companies. Combined, they expected that each company would be able to cross-sell its goods to clients of the other.

Yet their two styles could not work together. A significant cultural divide was reported: many Nextel executives left, coordination between the two sides was weak, and integration was costly, complicated, and more expensive than expected. Sprint later wrote off the deal at $29 billion.

 

How TRC Helps With Financial Due Diligence?

Any organization that considers a deal must check all the assumptions that it makes about that deal. We, at TRC Corporate Consulting, offer financial due diligence services to corporate and institutional investors by evaluating and validating all the commercial, economic, organizational, and strategic assumptions. We use our past trading experience to form an idea of the future and confirm that no loopholes exist.

Our financial due diligence services include:

  • Sales
  • Revenue
  • Synergy Validations
  • Reliable Profitability
  • Maintainable Earnings
  • Financial Due Diligence (Buy Side)
  • Financial Due Diligence (Sell Side)
  • Strategy Confirmations
  • Operational Issues
  • Cash Flows
  • Restructuring Services
  • Structuring Services

Our professionals, at TRC, offer detailed reports on the company's financial stability. It allows vendors more leverage over the selling process and the pace of purchases, which in turn helps secure a better price for the business. Additionally, our professionals enable vendor assistance by delivering tailored solutions to help vendors complete divestments successfully. Consult with us for your financial due diligence requirements, and for any further understanding, contact us!