business management & administration management & administration . ... -> a ‘merger’...

Lecture BM&A, June 13 1

Pankaj Khanna, Siemens AG Stuttgart, June 2013

Business Management & Administration Business Valuation / Mergers & Acquisition / Post Merger Integration


Business Valuation

Introduction to Business Valuation

Valuation Methods

Due Diligence

Post Merger Integration

Content


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


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


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


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


The M&A process includes the integration of the acquired business Overview of usage for different valuation methods

Lecture BM&A, Julne 13 8

The M&A process is divided into three phases

M&A phases Strategy Transaction Imple-

mentation

P-Proposal Signing

Core tasks Identify strategic gaps / technology evaluation Explore opportunities for external growth Market and competitive research Define acquisition goals Candidate screening / deal book Selection of target companies Manage interfaces

Support on screening and selection (e.g. financial reports)

Create indicative evaluations and initial business plan

Define financial dealbreakers / IRR considerations Support on P-Proposal

Continuous review of strategic fit of target (incl. Participation in DD

Support integration plan Manage interface to CD, Sector Strategy

Coordinate due diligence (incl. Financial, HR, Compliance, Legal, etc.)

Develop business plans and scenario analysis Perform valuation Deal structure Develop integration plan and retention concepts Follow-up negotiation process Manage interfaces to Business Owner Legal, tax

experts, treasury, functional experts (e.g. HR, Compliance),


Business Valuation


Valuation Methods

Due Diligence


Content


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.


We will focus on market valuation and discounted cash flow method

Overview valuation methods

1) EPS: Earnings per share Source: Prof. Dr. Volker H. Peemöller

Valuation methods

Earning value method Asset value method Market valuation Mixed valuation methods

DCF-method Earning value method

mit Netto-Cash-Flows

beim Eigner

mit Netto- Ausschüttungen

des Unternehmens

mit Einzahlungs- überschüssen

des Unternehmens

mit Netto-Einnahmen

des Unternehmens

mit Periodenerfolgen

des Unternehmens

Bruttoverfahren (Enterprise -Approach)

Nettoverfahren (Equity-

Approach)

APV-Verfahren (Adjusted Present

Value)

Similar Public Company Method

Recent Acquisitions

Method

Initial Public Offerings

Comparative Company Approach

Multiples

With “full production values”

(going concern)

With liquidation values

Übergewinn- verfahren

Mittelwert- verfahren

Fair value calculation

Other valuation methods: - Leverage buy out analysis - Break-up analysis - EPS1) accretion / (dilution) - 52 week trading high-low


The DCF*-method is the most exact but time consuming method

Classification of methods concerning time consumption and meaningfulness

high low

low

high Discounted Cash-Flow

Earning value- methode

Asset value method

Liquidation values

Market valuation

Effort for valuation

Meaningfulness of valuation


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

1) DCF: Discounted Cash Flow 2) Based on transaction price Source: P. Beck 1995

Multiple-method shows biggest difference regarding user group

DCF 1)

85%

Comparable Analysis 2)

72%

Multiples

67%

Earning value

61%

Seller Buyer

DCF 1)

63%

Earning value

77%

Comparable Analysis 2)

46%

Market capitalization

34%

Multiples

31%


Overview market valuation methods

The most appropriate valuation method strongly depends on the valuation task

• 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

• 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

1) P/E: Price / earning ratio 2) P/G: Price / growth ratio 3) P/B: Price / book ratio

Market valuation

Comparative company approach

New valuation for start-up companies Multiples

Based on earnings Based on sales

• P/E ratio 1) • P/EBITDA 7) • P/G 2) • P/B 3) • P/cash flows • EPS 4) forecast • ROI 5)

• Sales multiple • EV 6) / sales

4) EPS: Earning per share 5) ROI: Return on invest 6) EV: Enterprise value

7) EBITDA: Earnings before interest, tax, depreciation and amortization

⇒For public companies

⇒For private / public companies

⇒For public companies

⇒For private / public companies


Market valuation enables to come up quickly with an order of magnitude value

Pros and cons of market valuation approach

Pros Cons

• 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 com-

plexity 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 funda-

mental analysis of valuated company • Use of market perspective already includes several

additional variables such as power, market share, etc. ...

• Highly depending on quality of gathered data • Key data, crucial information is difficult to find (e.g.,

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,..)

A further detailed analysis should be conducted for relevant targets


The comparative company approach is mainly used to evaluate private companies

Overview comparative company approach

Methodology: • Valuation based on real

transactions values for comparable companies

• Transaction values are published in:

– Financial journals / magazines (e.g. M&A review, FT, FAZ, manager magazine)

– Internet sides like: − Northern light − Hoover´s online − Thedeal.com − more-IPO.com

– Databases like: − Investext − Dun & Bradstreet − Reuters − Moody´s

Pros: • Quick, easy and market

oriented • Value based on real prize

not theoretical estimations • First approach for an order

of magnitude value

Cons: • Identification of truly

comparable transactions very difficult

• Transaction contracts and prizes may have not publicly known clauses like golden parachutes golden handshake or side deals included that deteriorate the transaction price

Submethods: A) Comparable company analysis (CC) B) Similar public company method

(SPCM) C) Recent acquisition method (RAM) D) Comparability method

Fields of usage: • Mostly used for private companies • For assets and real estate • For small, medium sized companies

whereas earning or cash flow approach seems overwhelming

• Used for tender valuation • Acquisition prize estimation


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 return to all sources of capital

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


Different multiples are used for either enterprise or equity value determination

The enterprise value concept (continued)

Source: Warburg Dillon Read

Enterprise value ("EV")

Selected flows or values available to satisfy all the claims of capital providers

Equity value ("EqV")

Selected flows or values available (left) to shareholders or equity providers

• Sales • Operating cash

flow ("EBITDA") • Operating profit ("EBIT") • Operating free

cash flow ("OpFCF") • Invested capital ("IC")

• Earning before tax ("EBT") • Cash earnings ("CE") • Net earnings ("E") • Net assets ("NA") • Shareholders'

equity books ("Eq")

Consistent application of the matching principle is key to arrive at meaningful results


Calculation schemes for selected multiples

Calculation of selected multiples

Enterprise value ("EV") Equity value ("EqV")

Based on measures relevant to the equity shareholders' interest in the company

• Price / earnings ratio (P/E)

Equity market value Net earnings

• Price / cash earnings ratio (P/CE)

Equity market value Cash earnings

• Price / book ratio (P/B)

Equity market value Net asset book value


Based upon measures which relate to the whole business - the enterprise

• EV / operating cash flow (EBITDA)

Enterprise value EBITDA

• EV / operating profit (EBIT)

Enterprise value EBIT

• EV / operating free cash flow (OpFCF)

Enterprise value OpFCF


The sales multiple can be used to determine the company value and for comparison to competitors

Sales multiple

• Sales multiple = Definition

Relevance / rationale

• Origin in business valuation for rapid growth companies that are not profitable in the 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

Original purpose

Application for value benchmarking

• Much relevance for acquisition negotiations in the Anglo-American area (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* Sales

* Enterprise value = market capitalization + long-term debt - cash; business value allows assessment of the value independent of capital structure


Discounted Value Method


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


Preparing an enterprise DCF valuation

Elements of DCF valuation

Forecast

Free cash flows

Other elements

• Produce integrated forecast cash-flows, profit & loss account and balance 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, depending on the situation

• Last year in the projection period should reflect steady growth and profitability (normalization)

• Taxation 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


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 • Free cash flow must be post tax and post all investments expenditure needed to support the future

forecast FCF

Free cash flow = debt cash flow + equity cash flow


How to calculate the free cash flow?

Free cash flow - Standard calculation

EBIT (normal operating profit) X Taxes on EBIT (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


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

DCF-valuation depends on: • Business plan and assumptions for the

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

Net present value of future FCF

Present value of FCFs

for explicit forecast period

= Σ FCF (n)

(1+wacc) n

N

n=1

Present value of Continuing value

or Terminal Value

= Terminal value

(1+wacc) N


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

... ...

Discount rate

Time n 1 2 3 4 5 6 7 8 9 10 N N+1 oo

... ...

Present value FCF / Discounted

FCF

Time n 1 2 3 4 5 6 7 8 9 10 N N+1 oo

... ...

1

(1+wacc)n

FCF n

(1+wacc)n Explicit forecast period 1..N Continuing period

for terminal value


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)


Depending on the valuation assumptions three formulas* for the calculation of the Terminal Value are used…

Terminal Value Calculation

* Where formula 1 and 2 can be derived form the value driver formula

FCF(N) = the expected free cash flow in year N wacc = weighted average cost of capital g = the growth rate in perpetuity (in general the GDP growth) NOPAT = Net operating profit after tax

Name Formula Comment

• Assumption: the net improvement in future FCF will not generate additional value

TV = FCF (N+1)

wacc 1 Convergence Formula

• Assumption: the net improvement in future FCF underlie a constant growth rate g (only valid for g<wacc)

TV = FCF (N+1)

wacc-g 2

Constant Growth Formula


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


How to calculate the cost of capital?

Weighted average cost of capital - WACC

Source: Siemens Management Consulting, Practice M&A

• 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

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)

Equity Total capital

Debt Total capital

WACC = x COE + x CODpost-tax

The following will illustrate the complexity involved in estimating the WACC


The WACC can be derived from the cost of equity and cost of debit

CO

E 1

) C

OD

2)

Equity risk premium

Levered company Beta

Levered debt premium

Tax rate

Company risk premium

Levered company cost of

debt

Net cost of debt

Levered cost of equity

[x]

[+]

[+] [x]

[x]

[+]

[x (1 - tax rate)]

20.0%

80.0%

WACC Risk free rate

1) COE: Cost of equity 2) COD: Cost of dept Source: Practice M&A

Weighted average cost of capital


Source: Warburg Dillon Read, Siemens Management Consulting, Practice M&A,

• Based upon portfolio theory, investors required return depends upon the contribution of a stock to portfolio risk not the total risk of the investment

− beta is a measure of market (non-diversifiable or systematic) risk

• Under the CAPM framework, the cost of equity can be broken down into two components

− a rate component (or minimum return component) − an excess equity return component

• CAPM fails when used as an ex-ante model, especially in a simple firm valuation context

• As a result, CAPM is heavily criticised but is the most generally accepted basis for estimating the cost of equity

CAPM-framework is heavily criticised but is the most generally accepted basis for estimating

The capital asset pricing model (CAPM)


1) Public companies 2) Private companies

Fully applicable Not applicable

A thorough company's evaluation has to be based on more than one method

Estimated applicability of single evaluation methods

International National ( German)

Big companies

Small companies

Focus on assets

(intangible +tangible) „Quick & dirty“ Method

applied

(Complementary) (Complementary) (Complementary)

(Indirect)

multiplier approach/ Swiss model

Earning value method

Discounted cash-flow

Asset value method

Market value approach

Liquidation value approach

Mixed approaches

Situation of evaluation

1) 1) 1) 2)

- DRAFT -

Football Field

1) Comparable Companies: Alstom, Bombardier, Invensys, Thales; plus 40% premium on equity value, assuming Thomas's net cash of 310' EUR2) Implied transaction multiples of Siemens‘ Peers (ABB, Alstom, Emerson, GE, Honeyw ell, Schneider, Tyco) acquisitions >0.5bn $ transaction value since 2009

0,00 1,00 2,00

Current trading (share price € 7.30)

12 month range (€ 5.29 - 9.13)

Broker target prices (€ 7.94 - 9.70)

DCF Valuation (Standal. + Synergies)

EV / 2012E Sales

EV / 2012E EBITDA

EV / 2013E EBITDA

EV / 2012E EBIT

EV / 2013E EBIT

Sales multiple paid

EBITDA multiple paid

EBIT multiple paid

Siemens Peers EV / EBIT - all sectors(high - low range) 2)

Thomas Valuation

Precedent transactions

0"97

0''71

0''43

1''050''80

0''53

1''02 @30% Premium1''12 @40% Premium

9.36 16.50

Trading comps1) (low /high + 40% prem.)

Implied Thomas share price in €

Enterprise Value (€m)

Median: 0''67

Median: 2''01

0''54

0''77

0''72 1''61

0''66 1''45

max 2''61

0''79

1''941''06

1''21

0''83

1''88

1''02 1''58

Median: 0''72

Median: 0''87

Median: 0''76

Median: 1''19

Median: 1''08

Median: 1''20

0''60 1''29

0''55 1''20Median: 0''65

1''06

0''95

1''27

1''31

Median: 0''95

0''77


Value and price are not linked together

Relationship between Value and transaction price

Total value expected by buyer

Step 1 Step 2

Total price paid by buyer (Effect on value)

Loss to seller (Market cap minus price)

Net value added to buyer

(Total value minus price) and

Premium to seller (Price minus market cap)

Buyer wins Seller wins

Buyer wins Seller loses

Hig

h Lo

w

Pric

e of

ac

quis

ition

Net value lost by buyer (Price minus

Total Value to Buyer)

Buyer loses Seller wins

Stand alone value to be acquired from seller

(Current market capitalization)

Value that buyer hopes to create

(Synergies) Valuation methods (e.g. DCF*) are based on forecast figures which

are depending on planning data

Goal of acquisition: Additional value creation based on business


Business Valuation


Valuation Methods

Due Diligence


Content


Definition of Due Diligence

Source: Deutsche Steuer-Zeitung Nr. 3 1999,

Due Diligence is the systematic analysis of a business

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.


Goals of Due Diligence

Source: Deutsche Steuer-Zeitung Nr. 3 1999,

Due Diligence serves to identify risks of an acquisition

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


Due Diligence is focused more on qualitative than on quantitative values

Differences between Due Diligence and Company Valuation

Due Diligence Company Valuation

Detailed illustration of transaction-relevant data for the principal, e.g. factors that influence the transaction price

Evaluation of company value (as stand-alone or integrated business with synergies)

Goal

Focus on Market position of company, internal situation, chances and risks within the scope of the transaction

Deduction of future earnings and withdrawals flows, future capital cost, selection of method important

Basis Rather qualitative description and rating

Quantitative and monetary values

More qualitative oriented

More quantitative

oriented

Relates to Present situation Future situation

Results Qualitative statements Figures and numbers


Only a combination of Due Diligence and Company Valuation leads to a fair deal

Focus of Due Diligence and Company Valuation

Buyer wins - Vendor wins

The paid price is dependent from the market

situation (demand) and from negotiation

Price paid

• Evaluation of company value

• Deduction of future earnings and with drawals flows, future capital cost, selection of method important

• Future situation

• Quantitative and monetary values

More quantitative oriented

Company Valuation

* Calculated with company assessment methods like Discounted cash flow (DCF)

• Detailed illustration of transaction-relevant 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

Due Diligence

More qualitative oriented

€

Expected synergies

Current company

value*

Buyers expectation

There must be a rational relationship between

synergies, value and price


A systematic Due Diligence will avoid tricks of vendors and buyers

Tricks of vendors and buyers, examples

• "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

• Skillfully worded competition clause

• Rumors about purchase prices

• ...

Behavior of the vendor 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

• Drafting rights for sales contract

• Exclusive rights

• Gradually worsen deal

• Coalition with bank / other investors

• ...


The Due diligence will be realized within three main steps

Phases of a Due Diligence

• Definition of investigations scope

• Priorization of selected areas

• Definition audit systematic

• Time frame

• Project organization

• Ressources

− Internal experts

− External experts

− Deal team

• Data room

• Interviews

• Company and site visits

• Expert reports

• Segmentation and evaluation of information

Planning Phase

Team and Organization

Due Diligence execution

Information gathering and evaluation Reports


The deal team synthesizes the internal and external information and delivers the DD report

Due diligence, Team and Organization

Inside / out statement • Company information • Financial data • Company structure

Outside / in statement • Third part financial

statement • Company performance • Market • Competitive landscape

External market studies

External specialized

lawyers

Certified Public

Accounters

Tax Accounters

Management Consultants

Investment- bankers

Insurance specialists

Real estate reports

External technical reports

Environment Consultants

Marketing / Sales

Controlling/ strategic Planing

Law, taxes, finance

Accounting

HR / corporate citizenship

IT

Technologies

Environment

Production

R&D

Operation / Laws /Taxes /

Finance

Externer experts circle

Deal team

Redaction and delivery of the Due Diligence

report

Management decision head Negotiation

Team

Internal experts circle


1 2 3

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



Information gathering and Evaluation Reports

Data room

Get the hard facts about the company...

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)

Site visits and interviews

...complete with soft facts...

Direct contract with the management and the employees brings subjective opinion and increase the "soft fact" knowledge about the company

External information sources

...get fairness opinions from third party

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,...)


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 Impact on Due Diligence

Middle-sized company as central knowledge basis

*Aufgabenbe...tung:

Consolidation of tasks: Mid-sized entrepreneur as central knowledge base

Mittelständische Unternehme... als zentraler

Wissensträger *Aufgabenbe...tung:

Insufficient accounting

(reporting system)

Mittelständische Unternehme... als zentraler

Wissensträger *Aufgabenbe...tung:

Underdeveloped / missing

controlling

• The company itself is extremely heavily involved in Due Diligence process

• There are no year-end financial statements examined by an auditor

• Obtaining information becomes a central problem

Backup


People, Organization, Culture

• Management • Human resources & Recruiting • Pensions and Salary • Organization • Information Technology • Communication • Culture

Each aspect has to be analyzed in detail

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

Environment

• Environmental exposure • Locations sensitivity • Management system &

compliance • Legal aspect

Supply Chain

• Purchasing & Supplier • Inventory • Logistics • Sales and Distribution

channels

Clusters of Due Diligence


The Financial Due Diligence is the overarching roof of a Due Diligence

Financial Due Diligence

Income

• Profit and Loss accounts, long term and segment information • Sales and quantities analysis • Revenue and expenses analysis • ...

Balance Sheet

• 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

• Cash flow analysis, history and future plans • Existence and Quality of cash management,

interest management and currency management • Financial status, liquidity • ...

Legal & taxes

• 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 • ...

Information

• Annual or Monthly Reports or from databases

• Head of Accounting / controlling, CPA's, tax departments etc.


Interface with the customer and sales strategy are the main scope of the Marketing and Sales due diligence

Marketing and Sales Due Diligence

• Advertising / Promotional plan • Budget breakdown • Forecast systematic • Trade & Company image • Pricing policies (fluctuation, sensitivity, ev. leadership...) • Pricing scheme by product line • ...

• 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 • ...

Sales & Revenue recognition

Product & Service

Marketing & pricing strategy

Markets & Customer

• 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 • ...

All adoptions have to be proven, especially for

market and competitors


Due Diligence reports can have different addresses

Reports of a Due Diligence

Planning Phase



Information gathering and Evaluation Reports

• Detailed or comprehensive report

• Referee function, lawyer and vendor authorize you to make a proposal

Fairness opinion

• Detailed or comprehensive report

• Specialist or expert, i.e., if you have knowledge in special sectors or businesses

• ...

Expert opinion

• Detailed or comprehensive report is exclusively mandated by one of the parties

Due Diligence report


Business Valuation


Valuation Methods

Due Diligence


Content

Siemens AG / 2012. All rights reserved May 2012

Creating value is the key challenge of any M&A project

Deal Announced

Deal Closed

90 Days 1 Year

Source: KPMG

Break Even

Destroy Value

What Companies Typically Get

Create Value

What Companies Want

Premium Paid

Combined Value

Pre-and Post-Acquisition Cost

KPMG Study results:

30% Add value 31% Destroy value 39% No discernable

difference


The implementation phase bears still the greatest failure risk

% of respondents

Which phase bears the greatest failure risk?

28% 28%

44%

Source: Corporate Strategy Board Survey 2006

Transaction Implementation Strategy

Siemens AG / 2012. All rights reserved

Typical Reasons for Integration Failures are missing perspectives, inefficient communications

Mergers often fail because of inefficient integration

26% slow integration speed

21% IT-issues brought on table too late

missing integration dynamics 37%

missing commitment of top management

37% missing masterplan

finance- /synergy - expectations unrealistic or unclear 47%

compromises on new organisation

unclear strategic concept

47%

32%

26%

58% ineffective communication

Integration mistakes and success factors

Source: AT Kearney, McKinsey, Mercer, KPMG Press Releases, SMC

Success factors for integration

• 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

… and poor integration management


We have improved our proceedings by capturing learnings from past projects

Have a clear strategy

Select the right projects

Buy / Sell at the right point of time

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

Ensure that you have experts included

Take advantage of the corporate experience

Enable systematic learning and know-how transfer

Do the Right Projects

Do the Projects Right

With the Right People


Ongoing Business

Our integrated process framework builds the basis for sucessful M&A projects

Know-How Transfer, Improvement

Integration

Carve out / Stand alone

Acquisition Joint Venture Divestment

Post Closing Management


Strategic Planning M&A Projects

Clear processes are a pre-requisite of successful M&A Projects


Q-Gates and predefined formats ensure consistency over the entire process

Performance Controlling Strategy

A two step decision approach and consistent deal tracking ensures high success rates of M&A Projects

Pre Signing Decision

Pre Negotiations Decision



Combined Siemens Unit

Acquired Unit

Acquiring Siemens Unit

Deal Execution

We consider Integration from the very beginning and focus our management attention on it

Integration

Signing Closing 1

Year 2

Years

New Structure, Value Creation Program

Business Plan, Purchase Price, Contract

Acquisition Goals

Business Results

Shareholder

• Make people from different environments working together and shape the new, combined organization to manage growth

• Leverage synergies, improve value and market position

• Keep old and win new customers to realize projected revenues

• Give direction and keep momentum to achieve strategic goals


Fundamental questions drive integration

A successful integration depends on the early definition of the integration cornerstones

Source: BoozAllen; M&A Practice

How will we create value?

How will this merger be led?

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?

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 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?

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?


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

Manager & Workstream Leaders Involvement in Due Diligence with

early verification of integration concepts Empower Integration Manager with

decision authority and resources

Integration planning & controlling Involvement of integration experts Definition of non-negotiables /

cornerstones (strategic objectives) based on explicit choices & trade-offs

Setup of PMI controlling

Key pillars of an integration Organizational clarity Immediate divestiture of parts not

needed Branding decisions Governance & legal

country setup

Communication & Change management Cultural assessment Open and effective communication based on a clear & shared value creation vision Trust building is paramount Pulse checks

Setup of new management team Ramp-up of new

leadership group Management commitment

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

Interface management Corporate departments Siemens Regional Companies Leverage on existing integration know-how

Key success factors for PMI

projects

Fast adoption of non negotiables Accounting & Controlling requirements Compliance Program IT Infrastructure & Security HR policies Chain of Command / LOA Implementation


In post mergers, collaboration and building trust are paramount

„Boy, I‘m glad it isn‘t leaking on our side!“


Synergy trap: Frogs and Princesses

END

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

business management & administration management & administration . ... -> a ‘merger’...

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