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