Finding the right company to buy can be a risky process, but help is available. CFO August 2003.
Searching for mergers and acquisitions (M&A) is an inexact science. In addition to accountancy firms, the mergers and acquisitions departments of investment banks and venture capitalists, there are boutique firms that offer an exclusive service.
The big investment banks are, naturally, targeted at the bigger end of the market where more money is made.
Brian Wilson, vice-chairman of Citigroup, says that the bank is dealing in the hundreds of millions of dollars range rather than the tens. Fees are on a sliding scale. Wilson says a $1 billion deal would attract fees of up to 0.5 per cent or $5 million. A $200 million deal would cost about 2 per cent.
Boutique search and selection company CDI, which deals in small- to medium-sized companies, charges a $5000 a month retainer and a 5 per cent fee.
For stockmarket quoted and other large companies the market is also influenced by stockmarket trends. Wilson says with the conglomerate out of fashion, most companies are focused enough to know what opportunities are open to them.
“The Australian market is obviously small and therefore most people in any industry are aware of the opportunities,” he says. “I don’t think you would build a worthwhile business sitting at a desk trying to think up ideas for a business.”
Many large companies have specialist M&A departments that also dream up acquisition ideas. Wilson says that his team may become involved when dealing with companies whose management are more focused on day-to-day operations. He says the bank is also briefed to look for opportunities when the deal is cross-border, and the company may not have as good a network as the bank.
Rick Millen, head of corporate finance and recovery at PricewaterhouseCoopers (PwC) says mid-sized companies often don’t have the in-house expertise or capability to research opportunities. “Medium and private companies can’t justify the resources and tend to be more reactive to the opportunities brought to them by investment banks,
accountancy firms and brokers,” he says. “And it’s those people that are more exposed to doing the wrong deal because they come across something that sounds attractive and they immediately bore in. They do the deal on what seems to be reasonable terms to them without perhaps stepping back and saying, ‘Is this the right deal to do anyway and should we look more broadly across the sector to see if more opportunities are there?'”
Pieter Looringh van Beeck, managing partner CDI Australia and New Zealand helps companies in identifying targets.
“We will go into the marketplace based on a very specific brief, which we draw up with the client. [We] identify the right target.” Key to the process is developing an information memorandum which in scope is similar to a business plan. It identifies all the key information about the client and can be used to give to targets.
According to van Beeck this factual document helps ensure that a company is neither undersold nor oversold verbally during the process.
CDI then draws-up a long list, which is reviewed with the client. “We don’t physically get involved in the due diligence or the legal process. We just focus on getting the right strategic fit,” he says.
Nevertheless, van Beeck aims to assist companies and help ensure the due diligence process is progressing as planned. PwC’s Millen says that the real issue is whether the information being provided is credible and will stand up. Cashflows coming out of a business must be examined, in addition to profitability. “Private companies are driven by wanting to minimise their profit because of tax … that is detrimental in the sale process and they need to show a very high earnings multiple to try and maximise the sale value.”
He says the profit and loss and balance sheet may need to be rebuilt. For instance,
an item of machinery may be booked as
an expense rather than depreciated on the balance sheet.
Millen says medium-sized companies do tend to be bullish about acquisition opportunities: “They tend to be a bit reactive to opportunities that come in front of them and they will then get excited about a particular opportunity and will want to pursue that rather than say, ‘does it make sense for us to do something in this space’.”
Millen recommends looking around to see what other opportunities are available. “The risks of going into a deal too quickly without really working out whether it is the right transaction, and in particular doing adequate due diligence to ensure you are not taking on unnecessary unrecognised risks, is critical.”
He points to the example of Pan Pharmaceuticals, which until April 2003 was a well performing share on the Australian Stock
Exchange. “An acquirer of that business could have done a transaction three to six months ago and if they missed the correspondence file with the TGA (Therapeutic Goods Administration) all this could have come up as a horrible surprise,” Millen says. “There are quite often little time bombs ticking away in these businesses. That’s what makes public company takeovers so much more risky because very often, especially if it’s a hostile takeover, you may never get access to some of that information.”
In the case of overseas transactions, local companies will find it useful to deal with companies with experience. Not only are there different work practices to take into account but also differing expectations for profitability.
According to van Beeck, an Australian manufacturing company would usually show a net profit of 15 per cent. In Australia companies with a manufacturing infrastructure will sell for three to six times their earnings
before interest and tax multiple, whereas in Europe or the United States would sell for two to three points higher. A public company would sell from six to 12 times, with again more in Europe or the US.
From year to year, the type of M&A business on CDI’s book’s changes. One year may be dominated by IT; another may be manufacturing or food. At present, the company is doing a lot of work in the automotive industry, where smaller companies are looking to merge in an effort to rationalise, and thus strengthen, the industry. According to van Beeck: “If we find that there is a general decline in … growth, we find that there are more sellers. The companies that have been running efficiently and are astute enough to take advantage of this decline say, ‘Let’s pick up a few struggling companies.'”
Meanwhile, conglomerates, a one-time staple of investment bankers, are awaiting a comeback. Citigroup’s Wilson says, “History has shown if you take a long enough view everything comes along again. I have little doubt that sooner or later we will move to a diversification model.”