Due Diligence

for

Mergers & Acquisitions

11/02/2015

-

AGENDA

Why Due Diligence is important for M&A;

Objective of Due Diligence;

Types of Due Diligence Overviews;

When Due Diligence becomes Relevant;

Key Focus Area in Due Diligence;

Due Diligence Process;

Common Due Diligence Issues in India;

Case Study;

Summary;

Conclusion .

DUE DILIGENCE : LEARN FROM

THE PAST, BUT LOOK TOWARDS

THE FUTURE 2

WHY DUE

DILIGENCE IS

IMPORTANT

BEFORE ANY

TRANSACTIONS

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To investigate into the Affairs of Business as a prudent business person

To confirm all material facts related to the Business

To assess the Risks and Opportunities of a proposed transaction.

To reduce the Risk of post-transaction unpleasant surprises

To confirm that the business is what it appears.

Why Due Diligence is Important for M&A….??

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To Create a Trust between two Unrelated Parties

To identify potential deal killers defects in the target and avoid a bad business

transaction.

To gain information that will be useful for

Valuing Assets

Representations & Warranties for Indemnification

Negotiating Price Concessions

Why Due Diligence is Important for M&A….Cont…

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To verify that the transaction complies with investment or acquisition criteria.

To Investigate & Evaluate a Business Opportunity

It Involves an analysis carried out before acquiring a controlling interest in a

company.

DUE DILIGENCE IS NOT THE JUDGEMENT MAKING IT IS JUST BRING OUT ALL FACT TO FORE

Why Due Diligence is Important for M&A….Cont…

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OBJECTIVE

OF DUE

DILIGENCE

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Objective of Due Diligence

To determine compliance with

relevant laws and disclose any

regulatory restrictions on the

proposed transaction

To evaluate the condition of the

physical plant and equipment; as

well as other tangible and

intangible Assets

To ascertain the appropriate

purchase price & and the

method of payment.

To determine details that may

be relevant to the drafting of

the acquisition agreement,

To discover liabilities or risks that

may be deal-breakers

To analyze any potential antitrust

issues that may prohibit the proposed

M&A

To evaluate the legal and

financial risks of the

transaction

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TYPES OF

DUE DILIGENCE

OVERVIEWS

9

Types of Due Diligence Overviews Cont..

Operational Due

Diligence

Operational Due Diligence aims at the assessment of the functional

operation of the Target Company.

BUSINESS DUE

DILIGENCE

Strategic Due

Diligence

Technical Due

Diligence

Strategic Due Diligence tests the strategic rationale behind a

proposed transaction and analyses whether the Deal is commercially

viable, whether the targeted value would be realized

Intellectual Property Due Diligence – Review & diligence of

Intangible Assets like Patent, Copyright, Design, Trademark , Brands

etc. getting greater importance.

Technology Due Diligence – Technology Due Diligence considers

aspects such as current level of technology, Company’s existing

technology, further investment required etc. 10

HR Due Diligence

BUSINESS DUE

DILIGENCE HR Due Diligence aims at People or related issues. Key managers

and scarce talent leave unexpectedly.

Environmental Due

Diligence

Environmental Due Diligence analyses environmental risks and

liabilities associated with an organization .

Information Security

Due Diligence

It is often undertaken during the information technology

procurement to ensure that risk are uncovered.

Types of Due Diligence Overviews Cont..

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Legal Due Diligence

A Legal Due Diligence covers the Legal Aspects of Business

Transaction liabilities of the Target Company, potential legal

pitfalls and other related issues. Legal Due Diligence covers

intra-corporate and intercorporate transactions.

LEGAL DUE

DILIGENCE

Types of Due Diligence Overviews Cont..

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Financial Due Diligence provides peace of minds to the both

Corporate and Financial buyers, by analyzing and validating

all the financial, commercial, operational and strategic

assumption being made.

Financial Due Diligence includes review of accounting

policies , review of internal audit procedure, quality and

sustainability of earning and cash flow, condition and value

of Assets, potential liabilities and tax implication on Deal

Structure.

FINANCIAL DUE

DILIGENCE

Financial Due

Diligence

Types of Due Diligence Overviews Cont..

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WHEN DUE

DILIGENCE BECOMES

RELEVANT???

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Deal Strategy Validation

Value Driver Identification

Identifying black holes

Valuation

Identifying

Deals

Evaluating

DealsExecuting

Deals

Making

Deals

Successful

Harvesting

Deals

• Structuring and Negotiating issues

• Matters to be included in Shareholders /

other agreement

• Representation and warranties /

indemnities involved

• Design tax efficient structures for

acquisitions and disposals

• Planning exit strategies

When does Due Diligence become relevant?

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KEY FOCUS AREA IN

DUE DILIGENCE

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Focuses on historical results to form a view of future and confirm there are no

“black holes”;

Key outputs:

Quality of earnings

Quality of net assets and working capital

Confirms or provides business model assumptions

Identifies risks and possible mitigators, via representations & warranties,

purchase price adjustments and completion reviews

Generates negotiation points to support your offer and refute counter

arguments; Definitions / Business Conduct Issues / Indemnifications

Financial Due Diligence – Cornerstone of

Every Deal

GOAL - Analyze and validate financial, commercial, operational

and strategic assumptions underpinning a Deal;

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Financial Due Diligence typically focuses on….

Review of Internal Control

and MIS systems

Group company transactions and

dependence – this would highlight

Separation / Stand Alone Issues.

Trading Results – segment

wise and identification of

Extraordinary/ exceptional

items, if any.

Gross Margins and

EBITDA analysis.

Management &

Employees and their

Relationship

Specific regulation for business /

industry

Impact of Discontinued

operations.

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Complex tax and regulatory regime in most Asian countries;

Different legal structures and industry segments have different tax risk profiles;

Key outputs:

Identifies tax risks as well as compliance status of Target

Advise on how identified tax exposures can be mitigated

Provides optimal financial and tax structure for the proposed deal

Direct and Indirect Tax Due Diligence

GOAL - Evaluate potential tax implications of the

transaction and tax position of the Target;

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Tax Due Diligence Typically Focuses On..

Status of Direct and Indirect

tax assessments.

Review of audits carried out

by the respective tax

authorities

Review of the claims made by

the tax authorities and the

responses made.

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Typically involves a combination of desk research, interviews with target

management team, key trading partners and industry experts;

Key outputs:

Issues in respect of achievability of business plan projections

Target’s positioning and competitiveness

Target specific market and industry related issues

Identifies strategic value creating opportunities

Highlights Exit risks and opportunities

Market Due Diligence

GOAL - Assist in understanding the condition and

prospects of the market a Company wishes to enter in;

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Covers full scope of business operations from supply chain and logistics to

manufacturing and commercial activities;

Ensures that sufficient work is done on some of the operational assumptions that

are key to the success of a deal;

Key outputs:

Assess operational effectiveness

Identify and quantify opportunities for operational improvement and develop

action plans to deliver against these opportunities

Assess existing management structure and provide insight on personnel related

issues

Operational Due Diligence

GOAL - Gaining a coherent overview of a Target’s

operations

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Particularly important for M&A in the IT services sector;

Key outputs:

Assess existing IT infrastructure and future needs

Provides inputs for planning integration of systems and applications

Highlight key business process issues, such as in purchases & payables cycle,

revenues & receivables cycle

Assess security & controls to ensure data integrity, availability and confidentiality

IT Due Diligence

GOAL - Evaluation of IT security & controls and business

process issues

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Typically covers pension and employee liability valuation, payroll costs validation,

employment termination costs, compensation and benefit alignment costs

Key outputs:

Assess existing levels of employee proficiency against industry standards

Highlight redundancy issues

Assess potential for redeployment of staff

Analyses of industrial relations

Assess employee compensation, including retirement benefits

HR Due Diligence

GOAL - Qualitative evaluation of existing staff including

HR policies

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Buy Side Diligence(For ascertain what buyer are buying )

Sell Side Diligence(Issues on which buyers can negotiate)

v/s

Types of Due Diligence Reviews – Purpose

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Financial analysis to support opinions and conclusions.

Identification of hidden value in the target.

Highlighting post-acquisition / integration / separation issues.

Using expert resources in the target country to identify local risks and issues.

Identifying areas that may impact the exit strategy of the equity provider.

Analysing the sustainability of earnings and cash flows.

Buy side Due Diligence

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Assists the vendor by providing an upfront independent review.

Highlights sale and purchase agreement issues early that may become negotiating

points or areas for warranties/indemnities.

Ensures a level playing field by providing all potential purchasers with objective

information.

Reduces the level of due diligence procedures that potential purchasers need to

perform.

Expedites the deal timetable by avoiding lengthy negotiations and disruption to the

vendor.

Reduces the risk of last minute value erosion and avoid lengthy re-negotiations.

Sell side Due Diligence

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Full Access

Full access to the target management, staff, accounting, financial and legal data.

Limited Access

Limited access to the target management, staff, accounting, financial and legal

data.

No Access

Strictly controlled environment, typically based on publicly available data.

Carve Out

Strictly limited to the part of business proposed to be sold.

Types of Due Diligence Reviews – Access Levels

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Due Diligence

Financial and

Taxation

Operational & Technical

Human Resource

Legal and Contingent Obligation

What should the methodology be to Generate

following key outputs

Attain complete understanding of

the business and the assets

Identify potential risks associated

with the transaction & the

mitigating factors

Identify key deal issues and deal

breakers and determine possible

reductions in the purchase price

Assess integration and other post deal

matters

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DUE

DILIGENCE

PROCESS

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Consider Preliminary

Structure

Visit Data room Review Background

Material

Review Audit Work Paper

Assist with letter of

Intent

Visit Target Company and

Interview Management

Develop workmen and info Request List

Review financial model of

Target Company

Preparation of Report

Finalize Structure

Support Integration Plan

Read and Comment on Sale Agreement

Pre-Fieldwork Fieldwork Post-Fieldwork

Typical Diligence Process

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Cultural AspectsTaxation Aspects

Marketing Information

Litigation Aspects

Basic Information Financial Data

Environmental Impact

Internal Control System

IPR Details

Important Business Agreement

Documents To be checked in Due Diligence

Processes

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COMMON

DILIGENCE

ISSUES IN

INDIA

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Common Diligence Issues in India

Charge backs, rebates

and returns

Inappropriate revenue

recognition

Inadequate reserves and

reversal of reserves

including inventory

Improper cutoff and

rollover impact;

Financial & Restrictive

Covenants in agreements

/ legal documents

Improper cutoff and

rollover impact;

Unsophisticated financial

reporting system

Issues for representation

and warranties from the

buyer

Related party transactions

– stand alone issues

Implications of Regulations,

Taxes & Duties – based on

deal structure

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Some Practical cases

When Dai-Ichi bank of Japan merged with Nippon Kangyo to form the then

biggest bank in the world called Dai-Ichi Kangyo, the two company executives

found even the definition of the word, ‘loan’ differed between the banks!

They had to put out a 200-word glossary explaining the meaning of various

banking terms before they could even start!

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Some Practical cases Cont…

Dai Ichi Sankyo paid $4.6 B for 63% of Ranbaxy A YEAR LATER IT

WROTE DOWN the value of the acquisition by $3.6 B.

REASON: They did not know the depth and extent of Ranbaxy’s woes and full details of

the Food and Drug Administration (FDA) investigation into Ranbaxy. In fact in 2009 FDA

had shut down reviews of all pending or future drug applications from Ranbaxy’s Ponta

Sahib plant. The first-to-file atorvastatin (Generic for Lipitor world’s largest selling drug) was

the greatest attraction for Dai Ichi and that was fraught with many problems.

DAI ICHI HAVE MADE INADQUEATE DUE DILIGENCE STAGE AND RESULT THEY

EARN HUGE LOSS.

DAI ICHI AND RANBAXY DEAL

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Some Practical cases Cont…

HCL AND AXON DEAL

Infosys and HCL bid for Axon in Sep 08, HCL countered Infosys bid of 600 pence

with an aggressive offer of 650 pence;

INFOSYS WITHDREW AND HCL TOOK IT OVER

NOTE: HCL did make the acquisition work by doing all the right things –main one –by

eating the ego!

They reverse merged HCL teams into AXON as AXON was a high performance team and

they were better than HCL –thus HCL Axon was born.

HCL DURING HR DUE DILIGENCE UNDERSTOOD THE FACTS THAT AXON TEAM

HAS HUGE POTENTIAL AND DEAL CREATE SYNERGEY FOR HCL-AXON.

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Identification of “deal breakers”.

Adjustment to “pre-diligence” valuation.

Negotiation support.

Conditions in Share Purchase Agreement (SPA).

Representations and Warranties.

Inputs for post deal action points.

In Summary…Result of the Due Diligence

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Quality of Assets

Quality of Earnings & Cash Flows

Potential Liabilities &

Commitments

Separation / Structuring /

Integration IssuesTax and Other

Regulatory Issues

Other standalone issues

Co-ordination with other advisors and issues identified by them

Industry and market issues

In Summary……Due Diligence Focuses On.

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PARTICULARS DUE DILIGENCE AUDIT

Scope

Includes not only Financial Analysis but also

business plan, sustainability of business plan,

future aspects, corporate and management

structure and legal issues.

Limited To Financial

Analysis

Data Covers future growth prospects in addition to

historical data Based on Historical data

Mandatory Mandatory based on Transaction Mandatory

Assurance Negative assurance i.e. identification of Risks if

any

Positive assurance i.e. True

and fairness of the financial

statement

Type It is required for future decision Post mortem analysis

Nature Varies according to the nature of Transactions Always uniform

Repetitiveness Occasional event Recurring event

Due Diligence V/S Audit

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CONCLUSION

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The goal of DUE DILIGENCE should be

DEAL MAKING

not

KILLING…

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Corporate Professionals Capital Private LimitedD-28, South Extension –I, New Delhi-110 049

Ph: +91.11.40622200; Fax: +91.11.40622201; E: pkvijay@indiacp.com

Pavan Kumar VijayManaging Director

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