Evolving commercial due diligence: value creation in M&A
January 2019 | TALKINGPOINT | MERGERS & ACQUISITIONS
Financier Worldwide Magazine
January 2019 Issue
FW moderates a discussion on evolving commercial due diligence and value creation in M&A between Sheil Malde, Colin Terry, Gabriele Vanoli, Michael van der Boom and Marc Becker at Deloitte.
FW: To what extent are you seeing corporates take bolder bets on smaller acquisitions, to balance out the risk/reward equation and find new potential avenues of growth? What types of acquisitions are they making?
Becker: Small-size acquisitions are a way for corporate buyers to access growth options, like new geographies, technological innovation, disruptive business models and collaborations across industries. For longer-term growth plans, small acquisitions have a higher risk/reward profile. For minority deals, corporates can mitigate this higher risk with their corporate venture arm by building a portfolio of investments. On the other hand, depending on the deal rationale, a full control of the target along with complete integration into the acquirer’s operations can be the route to a successful transaction. For example, gaining access to some new geographies would require starting with a smaller acquisition due to the lack of alternative market entries. Corporates should be prepared for some of their acquisitions to fail to deliver the expected value. It is even likely that failures will precede the first successes across the portfolio, as there is usually some lead-time to achieve the full potential of a new technology or product.
Malde: Corporate venture capital (CVC) is increasingly important in the deal space, both as a funding source and from an ecosystem perspective. The number of CVC departments has increased tenfold over the past two decades, with an estimated 1800 units currently operating globally. The number is likely to be higher as smaller or less formal CVC teams are not as visible in the market. Deal volumes have trebled since 2010 and coverage of the funding cycle now extends from seed or early stage through to late stage. Average deal sizes have increased, although a large proportion are still valued below €100m. A number of deals have even broken the €1bn mark. However, if available capital comes under pressure, the market is likely to see increasing focus on early-stage and smaller-value deals. While CVC started primarily in research-led industries such as technology and pharmaceuticals, it now comprises most industries. An increasing focus of CVC is the software sector, particularly artificial intelligence and machine learning. Traditional CVC departments are comfortable with the nuances of this segment; however, it creates some risks for corporates which do not have experience of the business models in play, nor fully understand the importance of scaling rapidly.
Vanoli: There is a trend toward early-stage acquisitions. The two main reasons for this are the limited availability of targets at a reasonable price, and the high complexity and costs related to mega-deals. Bolt-on acquisitions come with a limited risk of disruption to the acquirer’s operations – as well as a greater opportunity to shape the acquired business. In the life sciences industry, for example, the acquirer can contribute to the design of phase III and IV clinical studies, leveraging its experience of market and regulatory requirements. One common presumption is that deal success depends mostly on the product or technology, while the culture of the target – usually more agile than a larger acquirer – is an important component. The ability to retain the culture, foundational to the success of the target, is more than important: it is pivotal. The founders, along with a few other key individuals, and the entrepreneurial culture they bring to the table, can play a critical role in the acquired business.
FW: How can commercial diligence (CDD) help provide comfort around the scalability of a growth acquisition?
Terry: The aim of commercial due diligence (CDD) in the context of growth acquisitions is the assessment of two types of risk: market risks and growth hypothesis execution risks. The first is addressed through an assessment of market growth rates and drivers, providing understanding of macro dynamics in the short- to long-term horizon, as well as competitor capabilities and growth ambitions. The latter is addressed through understanding capabilities and gaps in the organisation that will translate to above- or below-market growth of the acquired asset. Competitors are an important part of understanding execution risks – what might their reaction be and how can the acquirer understand the impact of their reaction?
Vanoli: CDD should not only cover market attractiveness in terms of size, growth and competitive landscape, but the commercial operations of the target as well. An end-to-end view of value creation should be gained pre-deal to ensure the feasibility of the plans cross-functionally – for example, can supply chain operations enable the growth plan? Despite the inherent limitation of CDD in terms of short turnaround time and access to data, there is a lot to learn from interviewing the target’s key commercial and operational leads, as well as reaching out to other players in the market.
Malde: CDD helps unearth customers’ unarticulated needs through deep-dive interviews that focus on understanding why customers behave as they do and the underlying drivers for decisions and choices made. It brings fresh insights beyond asking what customers want or how they buy. The process involves asking questions to build a picture of the context surrounding a customer’s needs and, ultimately, purchase decision. The ambition is to identify the core problem, enabling companies to develop new or novel solutions to meet these unarticulated needs. Private equity (PE) is familiar with using CDD to understand the value creation potential of a target company. Some corporates are beginning to understand the benefits of an independent viewpoint when executing a deal or when entering new markets, including new geographies or products and services. In some industries or situations, using in-house expertise to perform CDD is the most effective path; however, internal bias or preconceptions can undermine the robustness of the findings, especially when identifying unarticulated needs.
FW: In what ways can CDD help bring transparency to the fundamental unknowns associated with disruptive innovation?
Malde: The CDD approach has a side benefit of naturally articulating ‘what if’ situations, enabling investors and companies to simulate different scenarios and develop mitigating actions and plans. CDD focuses on the key drivers of the target company’s industry and positioning in terms of customer proposition and the competitive environment. The hypothesis-driven approach used in CDD frames the key assumptions that need to be true for the company to achieve its business plan. Companies can quickly understand the sensitivity of these assumptions, and which ones are most critical, by taking a contrary view during the hypothesis testing part of a CDD. This is the foundation of the ‘what if’ analysis. While it is not practical to test out all combinations of scenarios, facilitating a debate on relatively extreme but still realistic scenarios helps management teams play out their strategic choices in the event of key assumptions not developing as expected. In a PE investment context, this is used to populate the ‘bank case’ versus the ‘equity case’; however, it is just as applicable in a corporate context to ensure good governance during a deal or investment.
van der Boom: An important objective to consider for CDD is to gain an understanding of the go-to-market strategy necessary to exploit the value of the asset. It is paramount for the acquirer to validate, as early as possible, whether the acquirer has the right infrastructure to support this go-to-market or there are choices and investments to be made. CDD helps unfold considerations on customers’ coverage optimisation, sales force effectiveness, and traditional and digital channels optimisation. With smaller and early-stage acquisitions, the acquirer has greater influence on the definition of the targeted markets and priority segments based on the outcome of the CDD. The acquirer can then also input into the value proposition, thus increasing its control over the growth path.
Terry: There are a number of benefits in utilising CDD in disruptive acquisitions. First is gaining access to domain specific or functional knowledge, often around the technology and regulatory aspects of the acquisition – allowing the buyer to address domain specific market risks during the due diligence process. Second is a rigorous evaluation of deal hypothesis through quantitative and qualitative evidence. In particular, when assessing new business models or markets that are yet to mature and where quantitative evidence is scarce, a thorough expert-based qualitative assessment tends to bring ‘castle-in-the-sky’ discussions back to a grounded reality. Last but not least, commercial advisers act as a sparring partner to the deal team, giving much needed outside-in perspective and helping to remove bias and ‘deal fever’.
FW: How is technology enabling financial investors and their advisers to gain commercial insight and valuation more quickly?
Becker: In a world of Big Data, there are numerous tools that can help gain insights on the target. Text-based data analysis tools review news articles, blog posts, company profiles and patents to map out an ecosystem. These tools analyse investment trends, create an overview of competition and provide the innovation landscape in a domain. Web crawling plus data mining can gather influencers’ perspectives and scientists’ views on a new technology. Such automated tools can also provide more descriptive market information to document a player’s footprint in a market. Finally, social media listening and reputational checks can assess the perception of the market for a given asset and its offering.
van der Boom: In addition to web-based and social media tools, there are specific M&A analytics solutions that help accelerate the most time-consuming data assessment tasks. These tools automate the manual-intensive assessment and provide detailed insights contributing to high-level decisions during due diligence and after deal announcement. For example, machine learning and automated indexing can speed up contract reviews to identify potential contract-related risks, obligations and opportunities. To identify cross-selling opportunities, customer name matching across various lists can be supported by fuzzy matching software. Dealmakers recognise more and more the pivotal role that M&A analytics will play in the future, and many are looking to build capabilities in that space. When it comes to doing deals, a company that can make decisions smarter and faster has a crucial competitive advantage.
FW: Are you seeing corporates and private equity (PE) firms pivot toward leveraging CDD as a way to mitigate risk and develop future upside value?
Becker: Historically, PE firms have used CDD as a way to assess the sustainability of their target’s business and potential for growth in order to build their equity story. Beyond supporting bank financing, CDDs are critical to identify and document value creation levers that would support the PE firm to offer the right acquisition price. Corporate buyers have been sometimes reticent to engage a third party to conduct CDD on the basis of their existing internal market knowledge. However, corporate buyers use CDD frequently for acquisitions outside their core business to gain a perspective on upside potential and downside risk. Today, CDD is increasingly perceived as critical to create alignment within the corporate on the true potential of the target, on the avenues to create value including complexity and realistic timeline, and on the integration strategy. It also helps to sharpen the equity story and identify the risk of doing an acquisition, as well as the cost of not doing one. It also addresses the requirement to provide an independent view to the corporate’s board on the full value creation potential to prepare the auction process.
Vanoli : There is more and more reliance on CDD, even from corporate acquirers which used to rely on internal knowledge for large acquisition cases in their core business. CDD can help answer ‘what you have to believe’ questions in order to highlight uncertainties and risks, and consequently develop mitigation plans. When it comes to acquisitions in non-familiar markets, corporate buyers are keen to clarify the route to market for the innovation or technology prior to making the deal. Identifying the buyers, the referral pathways and the drivers of adoption pre-deal is critical to mitigate the risk of acquiring a business at an early stage of development. An external view can bring objectivity, a fact base and independent perspective complementing the internal assessment, which might be biased due to conflicting interests.
FW: In your opinion, what is best practice when it comes to operationalising pre-deal commercial analysis for successful execution and accelerated value delivery?
Vanoli: A best practice is to link the financial, commercial and operational due diligence to form a comprehensive and end-to-end view of the value creation case. A holistic understanding and definition of the growth drivers is the foundation of deal value delivery. The target’s management team should be involved in transacting the due diligence outcome into a detailed integration plan. Clear milestones and accountability are key to deliver the promised results. Particular attention should be given to the appointment of integration managers with the right skill set and leadership to drive the programme. Finally, right after the transaction, a thorough validation of the levers to value creation is needed: this step adjusts the plan and replaces hypothesis and high-level estimations with more robust assumptions and actual data.
van der Boom: Translating the CDD results into an operational plan requires a concerted effort involving a large cross-functional team from both organisations. Time is of the essence: some sources of revenue synergies and growth will require time to materialise in incremental sales, for example due to the timeline for new technology adoption and sales life cycle. It is therefore important to create momentum with a 100-day plan focusing on quick wins that will set the tone. Robust project management and aligned incentives will help maintain the effort over the long run. A typical concern when introducing changes across a commercial organisation to drive growth is the risk of disrupting day-to-day activities. To tackle that challenge, a good practice is to set up a value creation team. This team drives growth initiatives as part of normal business operations, for example by including training and joint account planning within usual sales meetings.
Sheil Malde leads Deloitte’s M&A Strategy team in the Nordics, specialising in business due diligence and strategy consulting. He has 19 years of experience serving corporate and private equity clients in executing deals, developing growth strategies and identifying value creation opportunities. His industry experience includes technology, telecoms, media, retail and industrial products. Before moving to the Nordics, he was based in London for 11 years, serving UK and international clients. He can be contacted on +47 23 27 67 43 or by email: email@example.com.
Colin Terry is a partner in Deloitte’s Life Sciences practice. He is responsible for the UK Life Sciences Strategy and Operations Consulting practice. Mr Terry’s client advisory work in the life sciences sector spans across the fields of strategy and operations, including: operating model development and implementation; post-merger integration planning and execution; contract services advisory support including due diligence and market sizing / trends analysis. He can be contacted on +44 (0)20 7007 0658 or by email: firstname.lastname@example.org.
Gabriele Vanoli is a partner at Deloitte Switzerland and a member of the life sciences leadership team. In his last 20 years of consulting and industry experience, Mr Vanoli has led multiple end-to-end commercial transformations enabled by digital and analytics in both mature and emerging markets. Over the years, he has served most of the top global pharmaceutical companies in commercial due diligence and commercial M&A. He can be contacted on +41 58 279 91 61 or by email: email@example.com.
Michael van der Boom is a partner in the Deloitte Integration & Separation team in Switzerland and leads the value creation capability. He works with corporate and private equity leaders to deliver complex deals and identify incremental value in their businesses. Mr van der Boom’s work is triggered by M&A events or a need to create a step-change in performance. He has worked across various industries with a significant focus on life science and consumer goods clients. He can be contacted on +41 58 279 76 53 or by email: firstname.lastname@example.org.
Marc Becker is a senior partner in the Monitor Deloitte Paris office in charge of M&A and private equity activities. He has 18 years of experience working in strategy consulting in Paris and London, where he has conducted more than 200 projects, including due diligences, corporate development and value creation projects, for both private equity and corporate clients. He has also set up and developed corporate venture capital activities for large corporates. He can be contacted on +33 1 58 37 05 21 or by email: email@example.com.
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