Special Situations M&A: Transacting Imperfect Assets

In the past nine months, we have noticed a value disconnect between buyers and sellers in special situations transactions in Australia, often right from the start of the engagement process. While this condition is expected given the uncertainty reflected in company forecasts and the resulting flow-on effect to valuations, we are observing that the disconnect is a result of buyers opportunistically seeking bargains as opposed to value acquisition opportunities and not tailoring their approach to target businesses and assets. We see buyers and sellers trying to navigate the “risk vs value” see-saw, especially if they have not transacted in similar circumstances previously. This bulletin provides tips and recommendations on how both buyers and sellers can reach decision points quickly and give these opportunities the best chance to transact without being a drain on resources.

What is a Special Situations M&A Transaction?

We define special situations as any circumstances where the seller has a challenge defending value and the buyer has a challenge in forming a view on acceptable risk. It is a liminal space which includes targets which are underperforming, financially stressed or distressed businesses, businesses with litigation in the background or simply, any business in industries which face large scale disruption.

Why are These Transactions Challenging?

1. Disconnect in value
   As mentioned in the article, Special Situation M&A – Should you consider an acquisition at this time?, there are targets that may be in a sale process that are not in the best of shape because there is no further capital support, the asset is non-core to the broader group’s strategy or the target needs to be in the hands of a more strategic owner for its next stage of growth.
2. Challenging due diligence
   Putting these targets through a traditional due diligence approach without tailoring to the target-specific situation can waste time and costs for both potential buyer and the seller without there ever being a prospect of consummating the transaction.

Buyers will be better suited to capitalise on opportunities by following a tailored engagement process with targets and structuring their diligence to zero in on the risk vs value trade-off.

Tailored due diligence is necessary as these opportunities have an inherently higher element of risk and imperfection due to the circumstance. A standard due diligence report which is designed to identify all potential risks, so they can be eliminated or reduced is often not possible or relevant for special situations M&A. In the interest of swift decision making, due diligence should be preceded by a short, sharp review to identify key areas that will assist in a quicker go or no-go decision. Buyers in special situations must be prepared to accept certain risk associated with the situation and that these transactions are often warranty light or warranty free.

Making The Best Decision, Quickly

For the Buyers:

1. Is this asset a nice-to-have or core to your ongoing strategy?
   • The response to this question will dictate how much risk you are willing to take and how it impacts your view on valuation.
2. Make sure your advisors have situation relevant experience.
   •  Situation relevant experience in your transaction team can immensely assist you as a buyer. Experienced advisors can preemptively run through different scenarios to help tailor your approach to the deal and, more importantly, save time and get to the critical points sooner.
3. Manage expectations on due diligence and get to a go or no-go decision as soon as possible.
   • Due diligence is imperfect. For a company undertakinga turnaround, in administration, or battered by macro socio-political changes, historical performance cannot serve as a benchmark to validate future performance.
   • Work with your advisors such that they help you quickly get to a decision point of go or no-go quickly by focusing on critical matters. Experienced advisors can cut through lots of important details to sieve out the critical ones.
   • It is okay to move on if there is no deal to be made. It is unlikely that you can change the seller’s view on their perceived value at a point in time. If the value disconnect reduces over time, the seller already knows they can reach out to you based on your prior interest.
4. Know up front that you cannot warrant your risk away. Risk sharing is required.
   • Success in such deals often hinges on an element of risk-sharing and the ability to accept relatively limited warranties in the share purchase or business sale agreement.
   • In some cases, when the target is in a formal insolvency process, it is critical to note that warranties will be minimal, if at all. The seller’s vendor may not be there afterwards in any case, so the value of any warranties are limited.
   • There are risk-mitigating options such as synthetic Warranty and Indemnity insurance designed for warranty light or distressed situations, but the uptake of such insurance has been limited in Australia.
5. Structuring – strive for simplicity amidst complexity.
   • The key to risk-sharing is appropriate deal structuring. However, note that the more liabilities that are excluded from the transaction, the less attractive your bid may be.
   • More importantly, keep it simple, spend time thinking through the structuring of the deal with your advisors and continue to stick with first principles as you devise innovative structures to make the bid work for you.

For the Sellers:

1. Discuss what is an acceptable value range to you before you embark on a process
   • From the outset, discuss and agree with the Board as to what would be considered an acceptable value range for the asset being sold. This guidepost will serve as a benchmark to review any bids received.
   • This approach will prevent the seller from investing time in dealing with parties who may not have the ability to make a transact-able offer.
2. Strive for a broad process
   • If you have an unsolicited approach, this might be the right time to engage an advisor who can help to identify the buyer universe and run a short and sharp process.
   • Even if the party who has made an approach says they do not want to participate in a broader process, such a process should be considered to maintain leverage.
3. Dealing with exclusivity requests
   • If you are willing to give exclusivity, break up the entire exclusivity period into two phases. The first short phase can be the provision of crucial information to confirm the buyer’s view on value. If there is no agreement of key terms including value at the end of phase one, move on. The second phase allows the buyer to engage in more extended due diligence. This approach encourages a faster pace transaction and mitigates the seller’s time investment in an unrealistic buyer.

Seemingly simple, a strategic tailored approach to the circumstance will make a difference to navigating the uncertainty, process, and complexity of special situation transactions. With this approach, buyers and sellers will be able to execute on special situations transactions resulting in good outcomes for stakeholders. The seller exits a business at an acceptable value while the buyer gains access to an asset which may otherwise have been out of reach. Risk vs value are the two key levers in these types of deals and success lies in is finding balance for both parties.

© Copyright 2020. The views expressed herein are those of the author(s) and not necessarily the views of Ankura Consulting Group, LLC., its management, its subsidiaries, its affiliates, or its other professionals. Ankura is not a law firm and cannot provide legal advice.