Intelligence for M&A: Reducing the Risk of Post-deal Disaster

July 25, 2012. When Hewlett Packard (HP) bought Autonomy for more than $11 billion in 2011, analysts said it was a bold move for HP to make and that the ongoing contribution of Autonomy’s CEO Mike Lynch would be crucial to its success. Unfortunately, Lynch was shown the door just seven months later, against a backdrop of disappointing quarterly earnings and rumors of a clash in corporate cultures. Could this have been foreseen? The answer is yes, but only if the right questions had been asked beforehand. Traditional financial or legal due diligence is critical prior to any M&A, but many managers make the mistake of not insisting on market intelligence prior to a deal.

Simply put, market intelligence collects information about market players and strategically relevant topics and processes it into insights that support decision-making. For M&A, you would be looking at locally validated intelligence on the target company, its market and competition environment and should as a result, be able to identify future growth sectors and screen the key players in any acquisition with greater insight.

Legal and financial due diligence can capture some important dimensions of a company’s market potential and risks, but neither will be sufficient in providing a holistic view of the company’s current position and likely future. Financial reports and forecasts by the target company itself will inherently tend to be optimistic, due to the natural desire of any company to achieve the highest possible sale price.

“You may wish to acquire companies for their future earnings potential, but all legal and financial due diligence can effectively do is to show you how they have performed to date. It’s always important to talk to customers and the other players within the ecosystem that your target operates in. While we were advising one buyer on a target in China that they were particularly keen on due to the strong financials they had seen, we found that local distributors found their products to be of low quality and were planning to drop their lines. The financial reports alone would not have revealed this and the acquisition could have been a disaster or simply grossly overpriced,” explainsPete Read, head of Strategic Analysis & Advisory at M-Brain (formerly Global Intelligence Alliance).

“Some sellers are also more open to revealing certain information to a consultant than directly to the potential buyer. Market intelligence by a third-party consultant can hence provide more objective information. It can also reveal the priority issues that will have to be dealt with in the first 90 days after acquisition,” said Read.

So what are the questions you should remember to ask? We list a few examples* here.

1. External market forces

What are the opportunities and threats for the target industry? Is the target well placed to succeed? Could there be any new game-changing new technology that should be taken into consideration? Are there any looming new industry policies or regulations?

2. Local market reputation / Brand strength

Does the target have a strong brand that will allow it to extend its product or service offering? Does it enjoy a high level of trust amongst its customers?

“In one case, M-Brain (formerly GIA) helped a buyer ascertain the brand strength of a target in Indonesia that had little data on its marketing, sales or branding success. In speaking with industry players, M-Brain (formerly GIA) found that the target was not the largest industry player but was performing exceptionally well in its selected niche. As such, it was a good target for acquisition,” said Read.

3. Product or service

What are the future growth opportunities for all the target’s market segments or products? How secure are the costs or supplies for the target’s products or services? Is the supply chain efficient and reliable?

4. Customers

What do the target’s customers and distributors think of its products or services? Have they been satisfied with the entire sales and after-sales process? Is the projected business pipeline realistic or overly optimistic? Are customers loyal or thinking of defecting to another brand? Is there a high percentage of repeat customers or is the attrition rate high?

5. The competition

Where are new competitive threats coming from – locally, overseas or both? What are its current competitors up to, and how will this impact the target? Are there any patents that competitors have secured, to the possible detriment of the target?

6. Future revenue streams / Projected earnings

How secure is the future price point and demand level, and therefore the revenue stream? Are customers likely to change their buying habits?

7. Corruption or triad links

In many emerging markets where commercial loans may be harder to come by, companies may turn to local money-lenders or other sources of capital. In certain business environments, it may be deemed normal for relationships with local officials to be oiled with gifts and tokens of appreciation. Where many such dealings may be hidden behind legitimate looking accounts or company structures, such possible sources of capital should be checked through the local intelligence.

8. Cultural intelligence

What is the corporate culture that has made the target successful in the past? How well does this match the acquiring company’s culture, and will a merger or acquisition affect the culture adversely?

9. Political affiliations

Has the target any strong political affiliations that may work against it in future? Is it a possible target for nationalization? Does the local government see the target as a “˜national champion’ that it might block from foreign ownership?

“Considering the large amounts of money that go into M&A investments, it certainly makes sense to invest just 0.1 or 1 percent of the deal value into conducting due diligence on the market beforehand. The process need not take up more than three weeks to one month, if the market intelligence consultants you work with have the right people, expertise and local set up. You could end up saving millions of dollars by identifying dud investments or potential problems that need to be addressed immediately upon acquisition. Financial due diligence doesn’t tell you such things, it only shows you how the company has performed in the past – not how it will continue to perform in the future. With markets being so volatile and economies teetering on uncertainty, examining a target company’s future against its many external variables is an absolute “˜must’,” says Nicolas Pechet, Senior Vice President of M-Brain (formerly Global Intelligence Alliance) Asia Pacific, and head of M-Brain (formerly GIA)’s global Private Equity and M&A practice.

When evaluating a third party market intelligence consultant, do take into the account the following:

  1. Ensure that the consultant you work with has a strong track record in M&A screening and commercial due diligence.
  2. Ensure they have a local presence in your target’s markets and sound industry knowledge.
  3. Choose a consultant with the capability to conduct hands-on research in the target market by meeting and speaking with other ecosystem players.
  4. Outline the scope of work clearly. Check that the market intelligence methodologies applied are suited to the context of your needs and address all missing gaps.
  5. Seek the consultant’s advice on what to study and ensure that the team that gets assigned to you are not junior level staff.

* This list is not exhaustive but is meant to only act as a guide for further discussion.

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