M&A – Deal Integration, Accounting

& Commercial Issues

Sumir Verma

About Me

• Over 18 years of experience in Corporate Finance

• Roles in Investment banking, Strategy, M&A and Change management

• Been in M&A across

– Corporate Strategy Team – Aditya Birla Group

– Acquisitions & integration in Scandent/Cambridge/Xchanging

– Investment Banking at Meghraj Capital

• Done acquisitions across Technology, IT services, Business Services,

Garments, Auto Components etc.

• A Chartered Accountant and an MBA from XLRI Jamshedpur

• Merisis is a boutique investment banking firm focused on Technology,

Consumer and Industrials. Work with mid market and growth clients in fund

raise and M&A advisory

Outline

Deal Integration – Best Practices Strategy

Accounting challenges in M&A Accounting/ Diligence

Valuation & Pricing – Best Practices I Banker

M&A Integration Best Practices

Rationale for M&A

Integration /

Portfolio expansion

Diversification

Consolidation

Entry Strategy

Pro

du

cts

Exi

stin

g

Ne

w

•Adding

Capabilities

•Leveraging

Consumer Base

•Innovation

•Size

•Management

Control

•Management

Incentive

•Defending against

competition

•Tax Benefits

•Economies of

Scale

•Efficiencies

•Higher

Distribution

•Cross selling

Existing

Markets

New

•Expanding

Geographically

• Financial

Growth

M&A Realities….

Sources: The Wall Street Journal, Forbes, Fortune, CFO Magazine, Mckinsey

Deal announced • 70% of M&A deals fail to achieve

anticipated synergies

• 50% report overall drop-off in

productivity in first 4-8 months

• 47% of acquired company executives

leave in the first year – 75% leave within

the first three years

• Just 23% of all acquisitions earn their

internal rate off return

• On average, management grade the

financial performance of their

acquisitions as a “C minus”

• 58% off mergers “fail to create

substantial returns to shareholders” (A. T.

Kearney)

Only about 50% of all M&A transactions actually tend to create value for

the acquirers

M&A success outweighs the risks…

• Deals still happen because the returns from M&A can be very significant

• Implementation of the Darwinian principle in corporate life

• Earlier the confines of the larger companies and new age industries

• Increasingly family businesses have recognized M&A as a valid end to their tenure.

• India continues to attract FDI who recognize the pitfalls of a green field entry

strategy –

– USD24.3 billion worth of inbound deals recorded during the year 2010

• India is increasingly acquisitive –

– 2010, most active year in terms of outbound investments for the country

– 95 transactions boosted outbound deal value to USD24.6 billion

Principles for Integration Success…

1. Start with strategy

2. Focus on Quick Wins

3. “Best practices” are where you find them

4. Move fast

5. Link Payouts to create a Win Win

6. Over-communicate

7. Culture matters

8. Structure the chaos

9. M&A’’s must be led, not managed

1. Start With Strategy

Integration Philosophy

Culture & Knowledge

Transfer

Balancing Stakeholders

HR Alignment

Strategy for Integration

Brands / Products

Process Redesign

Operations, Sales &

Distribution Network

Integration Philosophy

• Company Integration Philosophy

� As a division v/s full functional integration

� As a division doesn’t bring out synergy benefits as of Full functional integration

� E.g. IOCL acquisition of Assam Oil Division (AOD). As a division, AOD still

competes with IOCL in eastern retail oil & gas market

• Balancing diverse stakeholders Interest

Sr. No. Stakeholders Dominant Interest

1 Dealers / Distributors Continued business relationship

2 Employees Employment, Benefits and Self esteem

3 Customers / public Continued availability of products

4 Shareholders Increased earnings (from Synergy realization)

5 Suppliers Continued business opportunities

6 Government Tax revenue / No controversies

Slide on difference in Integration between Asian and US companies

• Among Western companies it’s a given that that acquirers must integrate quickly, to

capture the momentum and the synergies

– Typically the day of announcement – Email addresses are changed, forwardign

activated, site goes down, press release, those who are to be retrenched handed

pink slips, new organizational structure announced, clients met and reassured

etc. – all in the same day.

• However among Asian companies there is a distinct deviation

– Over a third of the Asian deals involved only limited functional integration and

focused instead on the capture of synergies in areas such as procurement, with

an overwhelming emphasis on business stability.

– An additional 10 percent attempted no functional integration whatsoever.

• Indian deals have also been typically in the Asian mode, specially on

cross border acquisitions

– Moved slowly on factory rationalization to avoid public opinion backlash

– Organizational integration has been slow paced

– Culture of the acquiree company has been left untouched

2. Focus on What matter most..

Brand

Rationalization

Consolidating

Sales &

Distribution

Teams

Creating Shared

Services

Other Cost

Synergies

Ruthless focus on creating Quick Wins, which invariably comes from Cost

Synergies

3. “Best practices” are where you find them

Source: Harvard Business School Study

6

5

4

3

Willingness to 2

Accept Best 1

Practices 0

-1

-2

-3

-4

Best Superior Average Inferior

Self Perception of business unit performance

. . . And aggressively search out best practices regardless of “who’s buying who”

4. Move Fast

• Speed outweighs accuracy

• Delay creates uncertainty

• Customers don’t tolerate

disruptions

• The longer it takes the more it

costs

At the time it seemed like we were

going too fast, but for employees

and customers, it must have

seemed like forever.”

Dedicated Teams with 100 day plans

Source: Strategic Rewards™ 1999/2000, Supplemental Survey of Top-Performing Employees

5. Link Pay-outs to create Win Wins

Case Study : Broking Firm

• The broking firm had come very fast, driven by a top notch team who had moved

from well know international broking firms.

• Team structured their pay-outs as part of revenue, and not in equity. Company

therefore owned largely by the family that funded its growth

• Bought by an international I-Bank. Key risk identified was the team attrition.

• Deal structured with a significant portion earmarked for the Team – covering Dealers,

Research, Operations.

• Pay-out structured such that if any one employee left, the total pay-out decreased,

affecting all including those who stayed back.

Cover critical stakeholders and de risk

6. Over-communicate

Top reasons communications were

ineffective

• Inadequate resources

• Too slow

• Inadequate senior management

attention

• Not all groups were communicated

to

• The messages were inconsistent

• Launched too late

• Not well planned

• Not frequent enough

• Ended too early

100

90 90

80

70

60

50

40

30

20

10

0

Why does

this Gap

Exists ??

43

Communication is

Important

Communication is

Successful

Communication is consistently rated the most important factor, yet most

don’t do it well

7. Culture matters

Source: Watson Wyatt Worldwide Study

% of Employees citing type of information gathered during due diligence

Organizational Culture 46%

Workforce potential 49%

HR Policy 56%

Major Shareholders 56%

Management Capability 71%

Financial Aspect 75%

Technology 78%

Market Share 86%

Hard Assets 90%

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

“Culture issues” are rated among the top failure factors, yet rated last in the

type of information gathered during due diligence

8. Structure the chaos

Joint Task Forces to plan

& Execute

Purge the “ Nice To Haves”

Business &

Integration Measures

Dedicate the right

Integration leader & team

resources

Execute the “Have-To-Do’s” extremely well

Use Ruthless Prioritization

Coordinating the

integration

Disciplined project

management & accountability

All integration activities must be coordinated though a program management

approach to ‘structure the chaos’

9. Key Reason for Post Integration Success

Cultural Integration 35%

Expedient integration 41%

Employee Sustainability 44%

Communication 51%

Leadership 73%

0% 10% 20% 30% 40% 50% 60% 70% 80%

…The complexities of acquisitions require bold and decisive leadership…

Accounting challenges in M&A Accounting/ Diligence

Focus on the Nitty gritty

• Deals break at due diligence stage – high percentage

• Too many small issues – lower confidence

– Either lower valuation or

– Break the deal

• Advisable to do a pre due diligence exercise by hiring a professional who

does a legal and financial due diligence

– Clean up the books

– Provide the correct inputs for creating the past and future financials

• Also understand

– The mode of sale – shares, slump sale, merger and impact

– On the tax issues – stamp duty, VAT, Capital gains etc.

• Some of these issues have delayed deals by over 3 months, which is risky

Accounting Issues – House keeping

• A pre due diligence will throw up various house keeping items that need to

be addressed. Some of them are

– Land / Building documentation

• In most cases, there are either duties that have not been paid, or a clear

title is a couple of steps away

• This is normally discovered in financial due diligence, and invariably holds

deals up

– Incomplete company secretarial practices

• Serious lapses in filing of various returns, maintaining regular

– Non payment of statutory dues

• Could be across Gratuity, filing with PF authorities etc.

– Inter se promoter shareholding issues

Accounting Issues – Stocks

• Stocks – an area of serious accounting checks

– Tendency of Indian promoters to park losses in stock

• Shows a higher profit, as well as allows for higher borrowing capabilities

• At time of acquisition, buyer needs to take a commercial call on the

purchase price impact.

• From an accounting perspective if he cleans it up, then the borrowing

capacity changes

– In Retail, to show stocks in transit which actually have been removed or sold for

cash

• Lilliput, where the Private equity firm found out that the stocks being

returned by the stores actually do not exist – had been sold for cash

• Reebok – Adidas : where the opposite happened. Sales shown but which are

lying in 4 godowns.

Accounting Issues – Management Accounts

• Family run unlisted companies accounts don’t tell the correct story

– Pass personal expenses as well as transfer to personal accounts and

avoid tax

– At the time of sale, it is more important to be able to show the actual

profit

– Buyer will be circumspect about these nos.

– Important to build a strong reconciliation between management and

statutory accounts.

Accounting preparation – Projections

1. Create a realistic bottom up financial projection for the next 6 months and next 2.5

years

1. 2 years - this is what the payout will get linked to

2. 6 months - these are the figures the potential buyers also evaluate and build

comfort

2. Realistic assumptions take into account

1. Business cycles

2. Capital expenditure requirements

3. Working capital demands etc.

4. Semi variable nature of overheads

3. Normalizing accounts

1. Correct accounting practices

2. Correct anomalies in current financials in the projections

3. Management accounts which give a truer statement of the financials

Valuation & Pricing – Best Practices I Banker

Understanding how deals are structured

Consider such structured deals a given in most cases

Company Revenue 40 Cr

Expected Valuation 60 Cr

Actual value offered by

acquirer 80 Cr

Structure of payment

Year 0 Year 1 Year 2 Year 3

30 Cr

(Upfront) 10 20 20

Projected Sales 70 100 120

Projected EBIDTA 10.5 20 24

Payment Linked To Projected EBIDTA

Points to note

Critical for the seller to create a demand to ensure best offer

• The Buyer’s Story – Valuation offered is higher than the expectation of the Seller

– The back ended payout is linked to numbers provided by the Seller

• The Seller’s Dilemma – 60% of the deal value to be recovered over the next 3 years

– Of the expected value, he is getting only 50% upfront

• Our Analysis – Expected valuation was a 10x of TTM EBITDA.

– What the buyer is offering is 5X upfront. Instead of another 5X in the future, he

is increasing it to 7X to account for increased risk of performance as well as for

time value of money

So is it a fair deal ?

• Is the multiple fair – it depends

– For some industries, 6-7X is the accepted multiple on the trailing EBITDA, while

in others it would be more the multiple on Revenue

• Is back ending fair – yes it is

– but the number of years should be kept shorter from the seller’s perspective.

• Is the back ended amount fair keeping in mind the structure ? Yes

– The future payments if discounted by 20% to calculate NPV would give an

answer close to the Seller’s expectation of Rs. 30 crores more

• Why is the buyer paying more ?

– Much of the payout will come from the post tax cash flows of the acquired

business itself

– Further, internationally he could have raised at least 4X of EBITDA as loan for this

deal.

• What are the other points that the seller should keep in mind ?

Focus on the fine print

• Sales linkage or Ebitda or a mixed formula ?

• Will the Ebitda get impaired by excessive investment by the Buyer

(relevant for a services business ) ?

• Aggressiveness of the projections

• Sliding scale for payout or a step process ?

• Level of Floor for Variable below which there is no payment ?

• Any caps ?

• Carry forward of underachievement

Understanding the Buyer’s calculation

Price

Core Value

• Discounted cash flows

• Listed company

benchmarks

• Multiples of Ebitda /

Sales/ PAT

• Price to Book Value

• Comparable

Transactions

Synergy sharing

• Cost Rationalization

• Cross Sell

• Enhanced Revenues

• Is shared with the

acquirer

Control Premium

Typically 15%-30% of

Core Valuation

Conceptual example of the Synergy calculation

Fair price --r---r------1

1

1------......._......... .............. t _

Transformation Net costs integration

benem

Average same-period industry consolidation

benefit

Degree.of overpaymg

Captured synergy

Understanding Valuation - Qualitative aspects

• It is a myth that since valuation models are quantitative and valuation

is objective

• It is a matter of the buyer’s perception

– A reflection of his view of the industry

– Reflection of his view on what will be the growth trajectory of the

company

• Importantly is a function of demand and supply

• Finally it is about timing too

– Sell high i.e. when it is doing well

Be realistic about pricing

An example of how you can go wrong

Company Revenue 40 Cr

Expected Valuation

Actual value offered by

60 Cr

acquirer 80 Cr

Ye ar 0 Ye ar 1 Ye ar 2 Ye ar 3

30 Cr

Structure of payment (Upfront) 10 20 20

Projected Sales 70 100 120

Projected EBIDTA 10.5 20 24

Actual EBITDA achieved 7 14 17

Min EBITDA required 7.9 15 18

Payouts 0 0 0

Condition : Future installments –at least 75% of projected EBIDTA.

Total Future Payout = 0

Qualitative aspects

• If it is straight sale, this is not an issue

• However if it is a joint venture or a structured deal, comfort with the

buyer is crucial

• Specially for entrepreneurs who have never worked for /with others !

• More important than wringing the last cent out..

Getting Ready – Hire a banker !

• Understanding what a banker will do

– Help you get ready with the basics Creating the business model

– Create multiple Valuation with the acceptable structure for the Client

– Identify the prospective Buyers/Sellers and create the demand !

– Advise you on how to negotiate and ensure that Client’s positioning is protected

– Drive the transaction to make sure

– Involve lawyers, tax consultants, company secretary etc.

• Complex activity

– Specific knowledge of corporate finance, tax, accounting, legal regulations

– Experience of negotiating and creating demand

• Needs time and focus

– Typically owners underestimate the time that M&As take – could stretch beyond

a year

– Need an external body that prevents the owner from defocusing on business

It’s a specialized job – the Client should focus on his core areas and

outsource this requirement

About Merisis Capital Advisors

• Merisis Capital Advisors is a leading independent investment banking advisory firm

serving the middle market companies and their owners

• Founded by investment professionals each with over 18 years of corporate finance

experience with complementary skills and domain knowledge

• Ability to cater to a wide range of domains, client requirements and customer segments

– Services : Capital Raising & M&A – Domestic & Cross-border

– Capital raise ticket size : Venture Capital funding ($2-5 million) to PE Funding($5-$25

million)

– Experience set :

• Be an advisor to our clients in matters of corporate strategy and institution

building

• Ability to evolve Structured financing

• Differentiators

– Significant connects across the investment ecosystem – Funds and Intermediaries

– Strong Execution and Closure capabilities

– Performance culture fostering meritocracy across the company

• For more information on Team, Deals and Sector coverage, please visit us at

www.merisis.in

Thank You