Business Management & Administration
Business Valuation / Mergers & Acquisition /
Post Merger Integration
Pankaj Khanna, Siemens AG
Stuttgart, July 2014
Lecture BM&A, Junly 2014 1
Business Valuation
Content
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Lecture BM&A, Junly 2014 2
Starting with some basics
What is Business valuation?
Business Valuation is the process of determining how much a business (as a whole) is
worth. A business valuation looks at all aspects of a company from the equipment and
buildings to their employees and intangible assets, and comes up with a total “value” for
the company as a whole.
Why do we need to determine the value of a business?
Transaction related reasons e.g.:
- Acquiring or selling a business
- Pay-out of a shareholder
Non-transaction related reasons e.g.:
- To check the credibility of a business
- Tax reasons
Lecture BM&A, Junly 2014 3
Starting with some basics
Definition Mergers & Acquisition
-> An ‘acquisition’ normally involves the purchase of another firm’s assets and liabilities,
with the acquired firm continuing to exist as a legally owned subsidiary of the acquirer.
-> ‘Takeover’ is often used for hostile acquisitions.
-> A ‘merger’ of equals on the other hand is a combination of two firms where a new
corporate entity is created by exchanging the shares of both companies for shares in the
new company.
-> Most M&As, however, are simple acquisitions since only around three percent of all
deals can be classified as real mergers between equals
Lecture BM&A, Junly 2014 4
There are several types of mergers/acquisitions
Types of Mergers
9
Horizontal mergers: two companies in the same industry
Vertical mergers: along the value chain of a good/service
Product-extension: access to complementary products
Market-extension: access to complementary markets
Conglomerate mergers: different industries
Lecture BM&A, Junly 2014 5
What are reasons for mergers and aquisitions?
- M&A as a Tool to Achieve Synergy (2+2=5 effect )
- M&A as a Tool to Achieve Strategic Objectives
- Increased market power
- increase vertical integration
- Increase speed for certain technologies
- M&A as a Diversification Tool
- Other “real” reasons:
- Investments of free cash flows (instead of paying dividends)
- To keep on track with competitors
- Angency Issue (increase management power)
- overestimation of one's own capabilities
Lecture BM&A, Junly 2014 6
The M&A process includes the integration of the acquired business
Lecture BM&A, Junly 2014 7
Business Valuation
Content
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Lecture BM&A, Junly 2014 9
Business Valuation: What is the issue?
The basic problem of business valuation is
how to set a value on all the assets of a
business, including the intangibles.
Lecture BM&A, Junly 2014 10
We will focus on market valuation and discounted cash flow method
Overview valuation methods
Valuation methods
Earning value method
Earning value
DCF-method
method
mit
Netto-Cash-Flows
beim Eigner
Bruttoverfahren
(Enterprise
mit NettoAusschüttungen
des Unternehmens
Nettoverfahren
(Equity-
mit Einzahlungsüberschüssen
des Unternehmens
APV-Verfahren
(Adjusted Present
Value)
Asset value method
Market valuation
Mixed valuation methods
With “full production
values”
(going concern)
Comparative
Company
Approach
Fair value
calculation
-Approach)
Approach)
mit
Netto-Einnahmen
des Unternehmens
mit
Periodenerfolgen
des Unternehmens
With liquidation
values
Similar Public
Company Method
Übergewinnverfahren
Recent
Acquisitions
Method
Mittelwertverfahren
Initial Public
Offerings
Multiples
Other valuation methods:
-
Leverage buy out analysis
-
Break-up analysis
-
EPS1) accretion / (dilution)
-
52 week trading high-low
1) EPS: Earnings per share
Source: Prof. Dr. Volker H. Peemöller
Lecture BM&A, Junly 2014 11
The DCF*-method is the most exact but time consuming method
Classification of methods concerning time consumption and meaningfulness
high
Discounted
Cash-Flow
Liquidation
values
Earning valuemethode
Effort for
valuation
Asset value
method
Market
valuation
low
low
Meaningfulness
of valuation
high
Lecture BM&A, Junly 2014 12
There are substantial differences in usage of evaluation methods regarding
seller or buyer perspective of the transaction
Usage of evaluation methods by seller and buyer side
Seller
Buyer
85%
77%
72%
67%
63%
61%
46%
34%
DCF 1)
Comparable Multiples
Analysis 2)
Earning
value
Earning
value
DCF 1)
Comparable Market
Analysis 2) capitalization
31%
Multiples
Multiple-method shows biggest difference regarding user group
1) DCF: Discounted Cash Flow
2) Based on transaction price
Source: P. Beck 1995
Lecture BM&A, Junly 2014 13
The most appropriate valuation method strongly depends on the valuation task
Overview market valuation methods
Market valuation
Comparative company
approach
·
·
·
·
·
·
Key business data
Multiples and ratio's
Stock figures and analysis
Transaction prices
Share deal information
Volume based
comparison (e.g. floor
space, ...)
· Sales based comparison
Þ For private / public
companies
1) P/E: Price / earning ratio
2) P/G: Price / growth ratio
3) P/B: Price / book ratio
New valuation for
start-up companies
Multiples
Based on earnings
·
·
·
·
·
·
·
1)
P/E ratio
P/EBITDA 7)
P/G 2)
P/B 3)
P/cash flows
EPS 4) forecast
ROI 5)
Þ For public
companies
4) EPS: Earning per share
5) ROI: Return on invest
6) EV: Enterprise value
Based on sales
· Business plan ratification
· Top management
· Number of internet
site visit
Spending per internet
page visit
Visibility in market
Predictability
Reputation / credibility
Quality of products
Strategy, organization
· Sales multiple
· EV 6) / sales
·
Þ For public
Þ For private / public
companies
·
·
·
·
·
companies
7) EBITDA: Earnings before interest, tax,
depreciation and amortization
Lecture BM&A, Junly 2014 14
Market valuation enables to come up quickly with an order of magnitude value
Pros and cons of market valuation approach
Pros
Cons
·
·
·
·
·
·
· Highly depending on quality of gathered data
· Key data, crucial information is difficult to find (e.g.,
Clearly focused on market conditions
High acceptance by non-valuation specialists
Focused on key issues / results to be achieved
Valuation can be achieved in a short period of time
Focusing on future expectations rather than history
Can be based on real performed transactions, much more
hands-on (Somebody really paid that much money)
· Prognoses problem not relevant and reduction of complexity easily to be adapted
· While comparing only with one company in traditional
DCF valuations now several companies are compared
· External facts and relations are dominant
· Focus of analysis on market data rather than fundamental analysis of valuated company
· Use of market perspective already includes several
different definitions, mixed publication of EBIT, EBITA,
EBITDA figures, etc...)
· Comparability of defined peer group to be ensured (e.g.,
technology, size/volume, service portion, etc..)
· Market data is past oriented; data from different periods
of time
· High volatility of stock markets in some industries
· Country differences to be taken care off
· Deal prize conditions are difficult to figure out (e.g.,
special agreements with strong influence, golden
parachutes,..)
· Acceptance by client (e.g., tendency to create own
“artificial” multiples,..)
additional variables such as power, market share, etc. ...
A further detailed analysis should be conducted for relevant targets
Lecture BM&A, Junly 2014 15
Enterprise and equity value have to be distinguished
The enterprise value concept
Enterprise value ("EV")
· The value of the business as
presented by the sum of the market
value of the various claims on
business profits and cash flows
· Essentially the market capitalisation
plus all other sources of capital
utilised by the business
· Used in ratios that measure the
Equity value ("EqV")
· Essentially the same as market
capitalisation (number of shares
times share price)
· EqV is the capital source that
belongs to the shareholders only
· Used in ratios that measure the
return to shareholders
return to all sources of capital
Lecture BM&A, Junly 2014 17
Different multiples are used for either enterprise or equity value determination
The enterprise value concept (continued)
Enterprise value ("EV")
Equity value ("EqV")
Selected flows or values available to
satisfy all the claims of capital providers
Selected flows or values available (left)
to shareholders or equity providers
· Sales
· Operating cash
·
·
·
·
·
flow
· Operating profit
· Operating free
cash flow
· Invested capital
("EBITDA")
("EBIT")
("OpFCF")
Earning before tax
("EBT")
Cash earnings
("CE")
Net earnings
("E")
Net assets
("NA")
Shareholders'
equity books
("Eq")
("IC")
Consistent application of the matching principle is key to arrive
at meaningful results
Source: Warburg Dillon Read
Lecture BM&A, Junly 2014 18
Calculation schemes for selected multiples
Calculation of selected multiples
Enterprise value ("EV")
Equity value ("EqV")
Based upon measures which relate to the
whole business - the enterprise
Based on measures relevant to the equity
shareholders' interest in the company
· EV / operating cash flow (EBITDA)
· Price / earnings ratio (P/E)
Enterprise value
Equity market value
EBITDA
Net earnings
· EV / operating profit (EBIT)
· Price / cash earnings ratio (P/CE)
Enterprise value
Equity market value
EBIT
Cash earnings
· EV / operating free cash flow (OpFCF)
· Price / book ratio (P/B)
Enterprise value
Equity market value
OpFCF
Net asset book value
Source: Warburg Dillon Read
Lecture BM&A, Junly 2014 19
The sales multiple can be used to determine the company value and for
comparison to competitors
Sales multiple
Definition
· Sales multiple =
Enterprise value*
Sales
· Origin in business valuation for rapid growth companies that are not profitable in the
Original purpose
beginning due to up-front investments and start up cost
· Goal: Industry branch-specific multiples deliver a rough estimation / explanation of
the potential market price for acquisitions
· Much relevance for acquisition negotiations in the Anglo-American area
Relevance / rationale
Application for value
benchmarking
(approximate estimation of business value)
· Determination of exact business value usually by using different method
· Relevance based on purely empirical foundation
· Comparison between businesses of different sizes
· Business value is scaled via sales
* Enterprise value = market capitalization + long-term debt - cash;
business value allows assessment of the value independent of capital structure
Lecture BM&A, Junly 2014 21
Discounted Value Method
Lecture BM&A, Junly 2014 28
What is a discounted cash flow (DCF) analysis?
Philosophy of discounted cash flow method
· In essence, DCF is the net present value of future (projected) cash flows of a business or project
- future cash-flows are discounted to the present, reflecting the time value of cash
(opportunity cost of capital) and the risk of these cash-flows
· In a DCF analysis, there are three main components
- the projected future cash-flows
- the terminal value
- the discount or hurdle rate
· DCF allows a more sophisticated approach to valuation than is possible through the use of multiples
- many value drivers can be separately included in a DCF-model
- DCF is a multi-period approach
· But ... DCF is subjective, difficult to use and can easily incorporate mistakes
Source: Warburg Dillon Read
Lecture BM&A, Junly 2014 29
Preparing an enterprise DCF valuation
Elements of DCF valuation
· Produce integrated forecast cash-flows, profit & loss account and balance
Forecast
sheet
· Calculate ratios for the forecast-period and check against historic ratios
· Check that the forecasts are properly funded and are realistic
· Project the cash-flows over a reasonable time period, generally 5 to 10 years,
Free cash flows
depending on the situation
· Last year in the projection period should reflect steady growth and profitability
(normalization)
· Taxation
Other elements
only deduct taxation which relates to EBIT
· Working capital
all elements, excluding those which relate to financing activities
· Provisions
only include here changes which relate to operating items in free cash-flow
Lecture BM&A, Junly 2014 30
Analyzing the future free cash flow is the main task within a DCF analysis
Definition of enterprise free-cash flow
· Enterprise free cash flow ("FCF") is the cash available to all the providers of capital, it may be
- used to pay interest or repay debt
- used to build cash balances or other investments
- used to pay dividends or buy-back shares
è Free cash flow = debt cash flow + equity cash flow
· Free cash flow must be post tax and post all investments expenditure needed to support the future
forecast FCF
Lecture BM&A, Junly 2014 31
How to calculate the free cash flow?
Free cash flow - Standard calculation
EBIT (normal operating profit)
Taxes on EBIT
X
(X)
NOPAT (normal operating profit less adjusted taxes)
X
Depreciation and amortisation
X
Gross cash flow
X
Capital expenditure
(X)
Change in working capital
(X) / X
Non-cash changes in operating provisions
(X) / X
Enterprise free cash flow
X
Lecture BM&A, Junly 2014 32
The net present value of a corporation is the sum of its future Free Cash Flows
discounted with the wacc-rate to the achieve the present value
Net present value of FCFs
Net present value
of future FCF
DCF-valuation depends on:
Present value of
Continuing value
=
or
Terminal value
· Business plan and assumptions for the
(1+wacc) N
Free Cash Flows within the explicit
forecast period (typically 5-10 years)
· Assumption for cost of capital - wacc
· Formula used for the determination of the
Terminal Value
Present value of
N
FCF (n)
FCFs
for explicit
=
(1+wacc)
n=1
forecast period
Σ
terminal value
n
Lecture BM&A, Junly 2014 33
For Discounted cash flow valuation the present value of the future free cash
flows have to be calculated
Elements of DCF valuation
...
...
FCF
Time n
1
2
3
4
5
6
7
8
9
10
N
N+1
oo
1
(1+wacc)n
Discount
rate
...
...
Time n
1
2
3
4
5
6
7
8
9
10
N
oo
FCF n
Continuing period
for terminal value
Explicit forecast period 1..N
Present value FCF /
N+1
(1+wacc)n
Discounted
FCF
...
...
Time n
1
2
3
4
5
6
7
8
9
10
N
N+1
oo
Lecture BM&A, Junly 2014 34
Terminal value is extremely critical for the valuation of companies
Definition of terminal value
· A terminal value is a simplified valuation assumption - the hypothetical value of a
business beyond the forecast period
· It is used to replace a much longer period of explicit projections
· Typically, it would require an explicit forecast period of
- 25 years to capture 66% of the total business value
- 50 years to capture 90% of the total business value
- 100 years to capture 99% of the total business value
· There are two primary methodologies to calculate terminal value
- terminal multiple approach (sector or trading multiple driven)
- constant growth in perpetuity (cash flow driven)
Lecture BM&A, Junly 2014 35
Depending on the valuation assumptions three formulas* for the calculation of
the Terminal Value are used…
Terminal Value Calculation
Name
1
2
Convergence Formula
Constant Growth
Formula
Formula
Comment
FCF (N+1)
TV =
wacc
FCF (N+1)
TV =
* Where formula 1 and 2 can be derived form the value driver formula
wacc-g
FCF(N)
wacc
g
NOPAT
· Assumption: the net improvement
in future FCF will not generate
additional value
· Assumption: the net improvement in
future FCF underlie a constant growth
rate g (only valid for g<wacc)
= the expected free cash flow in year N
= weighted average cost of capital
= the growth rate in perpetuity (in general the GDP growth)
= Net operating profit after tax
Lecture BM&A, Junly 2014 36
Shareholders value can be described as achieving a positive return
on cost of capital
What is cost of capital?
· It is the required return of investors ...
- the discount rate which equates the present a value of future cash flows with the
price investors are willing to pay for those cash flows
· Cost of capital is a key component in valuations ...
- the discount rate in DCF valuations
- a basis for interpreting differences in valuation multiplies
- a mean of evaluating the effects of changes in capital structure
· Cost of capital is one of the most intractable problems in finance!
- ... so be not surprised if there are more questions raised than answers given
The EVA or GWB methodology is based on this philosophy
Lecture BM&A, Junly 2014 37
How to calculate the cost of capital?
Weighted average cost of capital - WACC
· Most DCF valuations are done from an enterprise perspective and therefore as WACC
· WACC is simply the average of the costs of equity and debt, weighted by their relative
market values
WACC =
Equity
Total capital
x COE +
Debt
Total capital
x CODpost-tax
COE: Cost of equity (the required return of equity investors)
COD: Cost of debt (post-tax to reflect the tax-shield a company has when borrowing)
The following will illustrate the complexity involved in estimating the WACC
Lecture BM&A, Junly 2014 38
The WACC can be derived from the cost of equity and cost of debit
Weighted average cost of capital
COE
1)
Equity risk
premium
[x]
Company risk
premium
Levered
company Beta
[+]
Levered cost of
equity
80.0%
[x]
Risk free rate
Levered
company cost of
debt
WACC
Net cost of debt [x]
20.0%
Levered debt
premium
COD
2)
[+]
[+]
Tax rate
1) COE: Cost of equity
[x (1 - tax rate)]
2) COD: Cost of dept
Lecture BM&A, Junly 2014 39
Valuation experience is key factor for DCF-valuation analysis
Additional rule of thumbs for DCF-valuation
Risk free rate
· Yield on government bond
· Most common practice is to use a ten year band rate
· This yield already includes a premium for risk - inflation and interest rate risk
Equity risk
premium
· It is largely a guess - but US tends to be higher than Europe
· A most commonly used range is 4.0 - 6.0%
· In practice often simple government bond yields of currency which accounts
Cost of debt
are denominated in with a premium added
· Premium is the margin above government yield where the company is able to
borrow (higher rating è lower premium)
Financing
structure
· Should it be actual or target (long-term average) capital structure?
· Suggestion ... use actual, unless this is clearly inconsistent with the past or
future financing plans
Source: Warburg Dillon Read
Lecture BM&A, Junly 2014 42
A thorough company's evaluation has to be based on more than one method
Estimated applicability of single evaluation methods
Method
applied
Situation of
evaluation
International
National
(è German)
Big
companies
(Complementary)
(Complementary)
Focus on
assets
Small
companies
„Quick & dirty“
(intangible +tangible)
Earning value
method
Discounted
cash-flow
Asset value
method
Market value
approach
(Complementary)
1)
1)
1)
2)
(Indirect)
Liquidation
value approach
Mixed
approaches
1) Public companies
2) Private companies
multiplier approach/
Swiss model
Fully applicable
Not applicable
Lecture BM&A, Junly 2014 43
Several approaches should be used to triangulate Valuation Approaches and
achieve the "Fair value"
Unsind different valuation methods
Market Multiples:
Market / Book, Price / Earning, Price / EBITDA
Discounted Cash Flow (DCF)
· Free cash flows are operating cash
flows after taxes less cash needed to
grow the balance sheet
· Discount at the weighted average cost
of capital
· Continuing value
In some cases, real options may be useful
Lecture BM&A, Junly 2014 44
Five major steps have to be accomplished to come up with a "Fair Value"
for the company
Proceeding for fair valuation of a company
Business plan
analysis
Action:
Identify
peer group
· Internet research
· Analyze historical
for comparable
companies /
competitors
performance
· Check planning status for next 3-5 years
· Check sales values
· Determine critical
carefully (e.g. Where
are the sales really
generated?)
figures ( e.g. EBIT,
CAGR8), sales / employees, liquidity, …)
· SWOT5)- analysis
· Check quality of CFO
· Check documents
concerning seller or
buyers side focus
· Check stock market
documents
Endproducts:
· Understand business
plan
· Identification of peer
group
Market
valuation
· Determine market
valuation figures (e.g.
KGV 1), KUV 3), KCV
2), PEG 4), EV7) /
sales, EV7) / EBITDA,
EV7) / EBIT)
DCF6)
valuation
· Averaging the different
· Conduct
DCF6)-valuation
Determine
"Fair Value"
for
company to be
valuated
· Sensitivity tests
values with multipliers
achieved from market
and DCF-valuation
(e.g. KGV 1), PEG 4),
DCF6), KUV 3))
· Contact peer
companies to gather
relevant data
· Analysis of peer
companies planning
mode (e.g. conservative or aggressive)
· Market valuation for
peer group
· Data collection for
· DCF- value of own
· Fair Value
company and for peer
group
peer companies
1) KGV: Kurs / Gewinn Verhältnis
3) KUV: Kurs / Umsatz Verhältnis
2) KCV: Kurs / Cash Verhältnis
5) SWOT: strength, weaknesses, opportunities and threats
4) PEG: Price earnings to growth = KGV / CAGR earning per share 6) DCF: Discounted cash flow
7) EV: Enterprise value
8) CAGR: Compound annual growth rate
Source: Interview with Andreas Weiß; Baader Investmentbank,
Lecture BM&A, Junly 2014 45
Value and price are not linked together
Relationship between Value and transaction price
Step 2
Total value expected by buyer
Total price paid by buyer
(Effect on value)
Stand alone value to be
acquired from seller
(Current market
capitalization)
Low
Valuation methods
(e.g. DCF*) are based on
forecast figures which
are depending on
planning data
Value that buyer hopes to
create
(Synergies)
Price of
acquisition
High
Step 1
Buyer loses
Seller wins
Net value
lost by buyer
(Price minus
Total Value to Buyer)
Buyer wins
Seller wins
Net value
added to buyer
(Total value minus price)
and
Premium to seller
(Price minus market cap)
Buyer wins
Seller loses
Loss to seller
(Market cap
minus price)
Goal of acquisition: Additional value creation based on business
Lecture BM&A, Junly 2014 49
Business Valuation
Content
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Lecture BM&A, Junly 2014 50
Due Diligence is the systematic analysis of a business
Definition of Due Diligence
The Due Diligence study is
the systematical legal and business analysis (including Technology)
for the evaluation of the advantage of a contract
for an intended company transaction.
Source: Deutsche Steuer-Zeitung Nr. 3 1999,
Lecture BM&A, June 13 51
Due Diligence serves to identify risks of an acquisition
Goals of Due Diligence
Due Diligence serves
-
to identify and evaluate risks of an intended acquisition as well as
-
to provide the buyer with arguments for transaction price reductions or
improvement of the contract conditions
-
to find arguments for the funding of the demanded selling price from the
vendor's point of view
-
to enable the buyer to get a fair view of the company for the closing
phase
Source: Deutsche Steuer-Zeitung Nr. 3 1999,
Lecture BM&A, June 13 52
Due Diligence is focused more on qualitative than on quantitative values
Differences between Due Diligence and Company Valuation
More
qualitative
oriented
Due Diligence
Detailed illustration of transactionrelevant data for the principal, e.g.
factors that influence the transaction
price
Market position of company, internal
situation, chances and risks within
the scope of the transaction
Rather qualitative description
and rating
Present situation
Qualitative statements
Company Valuation
More
quantitative
oriented
Goal
Evaluation of company value (as
stand-alone or integrated business
with synergies)
Focus on
Deduction of future earnings and
withdrawals flows, future capital
cost, selection of method important
Basis
Relates to
Results
Quantitative and monetary values
Future situation
Figures and numbers
Lecture BM&A, June 13 53
Only a combination of Due Diligence and Company Valuation leads
to a fair deal
Focus of Due Diligence and Company Valuation
Due Diligence
· Detailed illustration of
transaction-relevant data for
the principal, e.g. factors that
influence the transaction price
Buyer wins - Vendor wins
Company Valuation
There must be a rational
relationship between
synergies, value and price
· Evaluation of company value
€
· Deduction of future earnings
· Market position of company,
internal situation, chances and
risks within the scope of the
transaction
· Rather qualitative description
and rating
Expected
synergies
Current
company
value*
Buyers
expectation
· Present situation
More qualitative
oriented
and with drawals flows, future
capital cost, selection of
method important
· Quantitative and monetary
values
Price
paid
The paid price is
dependent from the market
situation (demand) and
from negotiation
· Future situation
More quantitative
oriented
* Calculated with company assessment methods like Discounted cash flow (DCF)
Lecture BM&A, June 13 54
A systematic Due Diligence will avoid tricks of vendors and buyers
Tricks of vendors and buyers, examples
Behavior of the vendor
· "Cooking the books," e.g. restatements,
consolidations, Goodwill
· Conversion to so-called transparent accounting
· Patent entries in private names, but no agreements
· Artificially lower costs for group-internal agreements
· Limitation of Due Diligence via guarantees
· Drafting rights for sales contract
· Inadvertent indiscretions
· Concealment of serious illnesses of key personnel
Behavior of the buyer
· Coalition with management
· Exclude parts from the deal / reintegrate them later
· Negotiate parts of the deal separately
· Disguise the real object of interest
· Let the vendor calculate "worst case" for every risk
· Request negative arguments for the transaction
· Claim to have own formulas / rules of thumb
· Make the decision-making procedures seem more
complicated than they are
· Skillfully worded competition clause
· Drafting rights for sales contract
· Rumors about purchase prices
· Exclusive rights
· ...
· Gradually worsen deal
· Coalition with bank / other investors
· ...
Lecture BM&A, June 13 55
The Due diligence will be realized within three main steps
Phases of a Due Diligence
Planning
Phase
Team and
Organization
Due Diligence execution
Reports
Information gathering
· Definition of
investigations
scope
· Priorization of
selected areas
· Definition audit
systematic
· Time frame
· Project
organization
· Ressources
- Internal
experts
· Data room
· Interviews
· Company and site
and evaluation
· Segmentation and
evaluation of
information
visits
· Expert reports
- External
experts
- Deal team
Lecture BM&A, June 13 56
The deal team synthesizes the internal and external information and
delivers the DD report
Due diligence, Team and Organization
Internal
experts circle
External
market studies
External
technical
reports
External
specialized
lawyers
Controlling/
strategic
Planing
Marketing /
Sales
R&D
Real estate
Production
reports
Operation /
Laws /Taxes /
Finance
Law, taxes,
finance
HR / corporate
citizenship
Technologies
IT
Insurance
specialists
Tax
Accounters
Deal team
Management
decision head
Negotiation
Team
Accounting
Environment
Environment
Consultants
Certified
Public
Accounters
Inside / out statement
· Company information
· Financial data
· Company structure
Investmentbankers
Management
Consultants
Outside / in statement
· Third part financial
statement
· Company performance
· Market
· Competitive landscape
Redaction and
delivery of the
Due Diligence
report
Externer
experts circle
Lecture BM&A, June 13 57
3 main sources for the information gathering have to be considered to acquire
an objective opinion about the company
Information gathering of a Due Diligence
Planning
Phase
Team and
Organization
Due Diligence execution
Reports
Information gathering
1
Data room
and Evaluation
2 Site visits and interviews
3 External information sources
Get the hard facts about the company...
...complete with soft facts...
...get fairness opinions from third party
Concentration of company information
documents in one room for a limited
timeframe (P&L, balance sheets, taxes
declaration, production plans, salary,
supplier and customer contracts,
patens)
Direct contract with the management and
the employees brings subjective opinion
and increase the "soft fact" knowledge
about the company
Interview with supplier, customer,
competitors
Interview with banker, lawyer, broker,
industry experts
Information from press articles,
publication, broker report
Confidentiality level of the documents which will be used during the due diligence have to be discussed and cleared within the letter of
intend (e.g. copy of documents from the data room have to be destroyed,...)
Lecture BM&A, June 13 58
Backup
The main problem with Due Diligence in small and mid-sized companies is the
gathering of information
Exceptional case: Due Diligence in acquisition / merger involving mid-sized companies
In general, there are no differences between smaller and bigger companies
concerning the course of Due Diligence,
but some particularities in a small company's structure complicate Due Diligence
Structural Aspects
Middle-sized
Consolidation
company
of tasks:as
Mid-sized
central knowledge
entrepreneur
basis
as
central
*Aufgabenbe...tung:
knowledge base
Mittelständische
Insufficient
Unternehme... als zentraler
accounting
Wissensträger
(reporting system)
*Aufgabenbe...tung:
Impact on Due Diligence
· The company itself is extremely heavily
involved in Due Diligence process
· There are no year-end financial
statements examined by an auditor
Mittelständische
Underdeveloped /
Unternehme... als zentraler
missing
Wissensträger
controlling
*Aufgabenbe...tung:
· Obtaining information becomes a central
problem
Lecture BM&A, June 13 59
Each aspect has to be analyzed in detail
Clusters of Due Diligence
Financial
·
·
·
·
Income
Balance Sheet
Cashflow
Legal & taxes
Production and Technology
·
·
·
·
·
Plants & Sits
Capacity
Quality
R&D
Factor Costs
Marketing and Sales
·
·
·
·
Sales & Revenue recognition
Market & Customer
Product & Services
Marketing & Pricing strategy
People, Organization, Culture
·
·
·
·
·
·
·
Management
Human resources & Recruiting
Pensions and Salary
Organization
Information Technology
Communication
Culture
Supply Chain
·
·
·
·
Purchasing & Supplier
Inventory
Logistics
Sales and Distribution
channels
Environment
· Environmental exposure
· Locations sensitivity
· Management system &
compliance
· Legal aspect
Lecture BM&A, June 13 61
The Financial Due Diligence is the overarching roof of a Due Diligence
Financial Due Diligence
Income
Balance Sheet
·
·
·
·
Profit and Loss accounts, long term and segment information
Sales and quantities analysis
Revenue and expenses analysis
...
·
Value and existence of all fixed assets listed, e.g. plants,
equipment, and financial assets
Evaluation of inner reserves, e.g. real estate
Working capital structure: Receivables assessment, stock
evaluation, securities, liabilities, accrued liabilities
Financial structure: long term bank loans, borrowings, etc.
...
·
·
·
·
·
·
Cash flow
·
·
·
Legal & taxes
·
·
·
·
Information
· Annual or
Monthly
Reports or
from
databases
· Head of
Cash flow analysis, history and future plans
Existence and Quality of cash management,
interest management and currency management
Financial status, liquidity
...
Accounting /
controlling,
CPA's, tax
departments
etc.
Company law aspects: Legal form (external and internal structure
of companies), list of partners, relations, ...
Pending lawsuits
Tax liabilities, tax risks, tax aspect during/after acquisition
Special arrangements with third parties, e.g. private persons or
trade unions
...
Lecture BM&A, June 13 62
Interface with the customer and sales strategy are the main scope of the
Marketing and Sales due diligence
Marketing and Sales Due Diligence
Sales & Revenue
recognition
Markets & Customer
Product & Service
Marketing & pricing
strategy
·
·
·
·
·
·
Volume and growth rate by region and product line
Identification and analysis of significant changes
Identification of non-operating & non-recurring revenues
Type of contract completion method (percentage or completed)
Impact on the revenue recognition
...
·
·
·
·
·
·
·
Description of the market (volume, growth rates, segmentation...)
Estimated market shares and markets penetration
Key success factors / Factor affecting the demand (e.g., price, technology, political issues...)
Overview of the main market trend
Analyse and ranking by region and product (ABC analysis...)
Identify key account customers, check contratcs
...
·
·
·
·
·
·
·
Breakdown of major product / service category by sales and profit contribution
Basic buying considerations (e.g., price, quality, service, engineering, reputation...)
Description of the past and prospective pattern changes in the industry
Analysis of the product mix
Consideration of the life cycle stage of each major product (maturity)
Impact on the further R&D requirements
...
·
·
·
·
·
·
·
Advertising / Promotional plan
Budget breakdown
Forecast systematic
Trade & Company image
Pricing policies (fluctuation, sensitivity, ev. leadership...)
Pricing scheme by product line
...
All adoptions have to be
proven, especially for
market and competitors
Lecture BM&A, June 13 63
Due Diligence reports can have different addresses
Reports of a Due Diligence
Planning
Phase
Team and
Organization
Due Diligence execution
Reports
Information gathering
and Evaluation
Due Diligence report
Fairness opinion
Expert opinion
· Detailed or comprehensive
· Detailed or comprehensive
· Detailed or comprehensive
report
· Referee function, lawyer and
vendor authorize you to
make a proposal
report
· Specialist or expert, i.e., if
you have knowledge in
special sectors or
businesses
· ...
report is exclusively
mandated by one of the
parties
Lecture BM&A, June 13 64
Business Valuation
Content
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Lecture BM&A, June 13 65
Lecture BM&A, Junly 2014 66
Creating value is the key challenge
of any M&A project
What
Companies
Want
Break Even
Create Value
KPMG Study results:
Pre-and Post-Acquisition
Cost
Premium Paid
What
Companies
Typically Get
Destroy Value
30%
31%
39%
Add value
Destroy value
No discernable
difference
Combined
Value
Deal
Announced
Deal
Closed
90 Days
1 Year
Source: KPMG
May 2012
Siemens AG / 2012. All rights reserved
The implementation phase
bears still the greatest failure risk
Which phase bears the greatest failure risk?
Strategy
Transaction
Implementation
44%
28%
May 2012
28%
Siemens AG / 2012. All rights reserved
Typical Reasons for Integration Failures are missing perspectives,
inefficient communications
Integration mistakes and success factors
Mergers often fail because of inefficient integration
ineffective communication
finance- /synergy - expectations
unrealistic or unclear
compromises on new
organisation
47%
47%
missing masterplan
37%
missing integration dynamics
missing commitment
of top management
37%
32%
unclear strategic concept
26%
slow integration speed
26%
IT-issues brought on
table too late
Success factors for integration
58%
·
·
·
·
·
Clear target setting and tracking
ensure speed
establish professional communication
use the best people
put together a strong (joint) management
team
· ensure excellent integration management
· be pragmatic
· concentrate on value creation
21%
… and poor integration management
Source: AT Kearney, McKinsey, Mercer, KPMG Press Releases, SMC
Siemens AG / 2012. All rights reserved
We have improved our proceedings
by capturing learnings from past projects
Do the
Right Projects
§ Have a clear strategy
§ Select the right projects
§ Buy / Sell at the right point of time
Do the
Projects Right
§ Have a clear process in place and follow through
§ Analyze the risks and opportunities diligently
§ Pay / get the right price and a fair contract
§ Integrate / Carve Out professionally
With the
Right People
May 2012
§ Ensure that you have experts included
§ Take advantage of the corporate experience
§ Enable systematic learning and know-how transfer
Siemens AG / 2012. All rights reserved
Fundamental questions drive integration
A successful integration depends on the early definition of the integration cornerstones
How will we
create value?
§ What must we preserve to realize the potential of this deal? What are we
prepared to give up?
§ Where do we redesign, create, adopt or eliminate (by segment, portfolio,
organization, process, geography) ?
§ What must be integrated immediately? Where do we have to set priorities? What
can wait?
How will we
approach this
merger?
§ Do we absorb, integrate, create or attach?
§ Will we apply the “best of both” philosophy, or is there a preference for either company’s model?
§ Will this philosophy apply to the leadership team selection?
How will this
merger be led?
§ What role should the CEO play?
§ How will we run the business while simultaneously maintaining focus on the integration and the
realization of the synergies?
§ How aggressive to we want to be?
§ How should the teams be formed? How much line involvement?
What people
strategy is
required?
§
§
§
§
What is the decision-making model? Top-down or bottom-up?
What degree of cultural change is required to make the integration work?
How do we identify, select and retain a superior team?
How can we ensure that we treat all people fairly and with respect?
Source: BoozAllen; M&A Practice
Siemens AG / 2012. All rights reserved
Learnings from past PMI projects clearly indicate the keys to a
successful integration
Key success factors for PMI projects
Integration team
§ Early staffing of qualified Integration
Integration planning & controlling
§ Involvement of integration experts
§ Definition of non-negotiables /
Manager & Workstream Leaders
§ Involvement in Due Diligence with
§
early verification of integration concepts
Empower Integration Manager with
decision authority and resources
§
cornerstones (strategic objectives) based
on explicit choices & trade-offs
Setup of PMI controlling
Value creation of
an acquisition
§ Early definition of business model and
value drivers
§ Preserve value of legacy business
§ Effective and consistent execution
§ Tracking of synergies /
growth targets
§ Long term review of deal
Fast adoption of non negotiables
§Accounting & Controlling
§
§
§
§
requirements
Compliance Program
IT Infrastructure & Security
HR policies
Chain of Command / LOA
Implementation
Communication & Change
management
§ Cultural assessment
§ Open and effective
communication based on a clear
& shared value creation vision
§ Trust building is paramount
§ Pulse checks
Key success
factors for PMI
projects
Key pillars of an
integration
§ Organizational clarity
§ Immediate divestiture of parts not
needed
§ Branding decisions
§ Governance & legal
country setup
Interface management
§ Corporate departments
§ Siemens Regional Companies
§ Leverage on existing integration know-how
Setup of new
management team
§ Ramp-up of new
leadership group
§ Management commitment
Siemens AG / 2012. All rights reserved
In post mergers, collaboration and building
trust are paramount
„Boy, I‘m glad it isn‘t leaking on our side!“
Siemens AG / 2012. All rights reserved
Synergy trap: Frogs and Princesses
Synergy trap: Frogs and Princesses
Many managers were apparently over-exposed in impressionable childhood years to
the story in which the imprisoned, handsome prince is released from the toad’s body
by a kiss from the beautiful princess. Consequently, they are certain that the
managerial kiss will do wonders for the profitability of the target company. Such
optimism is essential. Absent that rosy view, why else should the shareholders of
company A want to own an interest in B at a takeover cost that is two times the
market price they’d pay if they made direct purchases on their own? In other words
investors can always buy toads at the going price for toads. If investors instead
bankroll princesses who wish to pay double for the right to kiss the toad, those kisses
better pack some real dynamite. We’ve observed many kisses, but very few miracles.
Nevertheless, many managerial princesses remain serenely confident about the
future potency of their kisses, even after their corporate backyards are knee-deep in
unresponsive toads.
Warren Buffet, 1981 Berkshire Hathaway Annual Report
END
Lecture BM&A, Junly 2014 77