June 1, 2020
As companies start to emerge from lockdown and gain better visibility to the economic environment they face, those with a healthy balance sheet will be presented with opportunities to consider acquisitions that can create strength, eliminate competitors, vertically/horizontally integrate, and consolidate an industry, geography, or client.
Are there any sellers?
With challenged valuations, there will be few sellers of companies or divisions, other than those under financial pressure. As the market evolves, companies or divisions will be in a sale process or raising capital if they do not have the balance sheet strength to sustain operations or because they are in a formal insolvency process.
Target assessment considerations
Often buyers are attracted to businesses that can be acquired at discounts and embark on buy-side projects with enthusiasm only to realize that execution is difficult.
Acquisition opportunities must fulfill the following elements:
- Fit into existing portfolio strategy
- Have feasible synergies
- Show ability to fund post-acquisition, capital expenditures (CapEx), working capital and losses
- Consistency with management and board’s risk appetite; commercial and legal risks (e.g. lower level of warranties).
Cash outlay considerations
There are two main components of the acquisition price:
- On acquisition
- Consideration paid for the inherent value in the brand, customers, and platform.
- Net cash outflow required to restructure the business and any immediate working capital and CapEx requirements that the acquirer needs to fund.
Tailored due diligence
For a strategic investor, the diligence process can be managed more efficiently if broken into two phases:
- Profit and Loss: sustainability of revenue and margins, identification of areas where synergies can be realized or where costs can be reduced; forming a view on timeline and complexity to execute, capture, realize, and integrate.
- Balance sheet review: evaluation of working capital and off-balance sheet and contingent liabilities.
- Cash requirements: estimate post-acquisition working capital, CapEx and restructuring costs, as applicable.
Phase 1 should give the buyer enough information to assess whether the implied risk of the acquisition is acceptable and if it is worthwhile progressing. Avoid spending too much time on historic analysis beyond the past 12 to 24 months; except to identify high level causes of decline or technological changes or trends. This phase must identify areas for further review.
- Review specific areas identified in phase 1.
- Prepare a post-acquisition integration model for the first 12 months. In the re-emergence “new normal”, there is good visibility only in the near-term as businesses adapt.
- Allot time within your diligence period for post-acquisition planning, even if it is a relatively smaller acquisition.
Further considerations before embarking on an acquisition process
Do you need this target, or would it be a nice-to-have adjacency?
A candid assessment will determine your risk appetite and how swiftly and competitively you should move during the process.
Typical structuring of such opportunities
As a buyer, if you can get comfort on the legal entity (i.e., tax, no litigation), a share sale is easiest, but many buyers aim to structure a selective asset, liability and employee transfer structure to pick the most attractive components of the business.
In a selective asset, liability, and employee transfer approach, be mindful that after a certain point, the exclusions will make your bid unviable to the seller as they will need to resolve residual liabilities.
In select cases, we have seen acquirers of relatively smaller businesses acquire the business in its entirety for $1. This approach is more suitable when the acquirer is confident of boosting the revenue line through immediate synergies and costs are already relatively lean.
Tailor your diligence and negotiation to the circumstances
Stressed and distressed M&A processes are destined to fail if both parties do not tailor their approach to the nature of the transaction. Make sure that you have members of your deal team with restructuring experience who understand the motivations of the other side and the specific process, contingencies and risks associated with a turnaround situation. As a buyer, communicate openly with the seller or insolvency practitioner, as appropriate, and be forthright in discussions regarding risk and value. Long games of attrition negotiating value come at the expense of the continued deterioration of the underlying assets.
You cannot warrant your risk away.
Know upfront that there will be few or relatively low levels of warranties available in such circumstances, especially if the vendor is a company in a formal insolvency process.
Know your walk-away price as a buyer
The implicit tension between the seller’s perception of the value of their brand, customer base and platform in comparison to the current situation makes a price target and range vital.
An acquisition at an attractive valuation can be an opportunity for financially strong buyers to grow in the current environment, only if they embark on this process aware of their own risk appetite, armed with a clear understanding of risks associated with the target, and the cash outlay they are willing to make. Further, orchestrating a tailored diligence and negotiation process is crucial.