The underlying fundamentals of the mergers and acquisitions (M&A) market continue to improve in 2013, driven by the combination of a stabilizing the United States economy, favorable credit terms, open debt markets and elevated levels of cash on corporate balance sheets — all factors that can pave the way for a potential increase in domestic M&A volume this year. Acquisitive organizations planning to capitalize on this favorable and competitive environment will need to continue to adapt how they approach due diligence, by fortifying traditional, defensive due diligence approaches with offensive value-creation strategies that leverage sophisticated methodologies driven by data analytics.
The organizations that can successfully adapt their due diligence approach, utilizing data analytics on both a defensive and offensive level, could potentially allow such investors to limit the potential down-side risks associated with a particular acquisition and, more importantly, increase the long-term value creation associated with their M&A strategy.
Before one can fully embrace the idea that 2013 will see relatively strong deal activity, it’s necessary to examine the recent economic and political landscapes. Over the past few years, economic growth in the U.S. has been constrained by an anemic job market, a stressed housing market, conservative consumer spending, new regulations that have created uncertainty, disagreements among lawmakers around long-term tax and spending policies and foreign economic market pressure.
These general economic challenges intensified cost-cutting initiatives by many companies and significantly curbed M&A appetite among both strategic and financial players across the U.S. and abroad. At the end of 2012, it was evident that M&A activity had surely been depressed in terms of both deal volume and value, which would have been further depressed without fourth-quarter transactions that were pulled forward in light of potential tax rate changes.
Because of previous market volatility, one cannot fault those who remain pessimistic about deal activity this year, even in light of the few mega deals that occurred in the first quarter. However, though it is still difficult to determine exactly what the future holds for the M&A market, the necessary stars may be aligning in order for strategic and financial buyers to begin aggressively considering deals and, ultimately, pull the trigger.
Though the political climate remains complex, the avoidance of the fiscal cliff is a sign of near-term stability. Consumer confidence is returning in the U.S. — with a new high of 76.4 percent as of February 2013, according to Thomson Reuters/University of Michigan’s preliminary index of consumer sentiment. Additionally, U.S. companies continue to report solid financial and operating results, with many S&P 500 companies showing fourth-quarter earnings and sales that topped analyst estimates.
Economic conditions in Europe are still challenging and the ultimate timing of a recovery is still in flux, yet investors are hopeful that this important market is nearing its valley.
As a result of these signs of improvement, there is a general feeling of optimism in the corporate and private equity arenas that deal volume will be on the rise this year, and many organizations see their M&A strategy as a key attribute for creating long-term equity value for their investors. In fact, a recent KPMG LLP study of 300 M&A professionals at U.S. corporations, private equity firms and investment funds revealed optimism that M&A activity will increase in 2013.
Progressive Growth Strategies And Tactics
As a result of the financial crisis, companies switched their focus to cost reductions and decreased investments over the last few years. This has generated cash savings that today collectively totals in excess of $1 trillion. With U.S. Treasuries and interest rates at an all-time low, businesses are now looking for growth opportunities, such as unloading dry powder by taking advantage of deal prospects and divesting struggling or non-core assets. And investors are looking for yield, which has created a strong demand for corporate debt.
Executives want to execute acquisitions that bring revenue and cost synergies to their organization that are aligned with the firm’s long-term growth strategy. In truth, companies should concurrently remain focused on investing in new growth strategies to create desired returns, which includes an investment in capital expenditures as well as the acquisition of new talent.
With one-fifth of the survey respondents expecting to endure at least one divestiture in 2013, selling off non-core assets remains an integral part of the strategy of many corporate organizations and creates opportunities for private equity firms.
In M&A, it has always been more glamorous to buy than to sell. However, divestitures are just as important when it comes to creating value and ensuring the organization’s limited capital and talent is allocated in the products and markets that will maximize their overall long-term equity value and related returns.
Importantly, the vast majority of the executives in the survey expect their deals to have valuations of $250 million or less, and only a small percentage expect billion-dollar deals to dominate this year. The expectation of smaller deals is congruent to conditions in the marketplace today, setting the stage for a surge in middle-market deal momentum; in a delicate economy, smaller deals are easier to finance, integrate and justify to shareholders.
The potential for growth and profitability in new markets and geographies also remains an attractive option as businesses look to refocus their activities. Survey respondents, in particular, are intent on making acquisitions in order to expand geographic reach, enter into new lines of businesses and expand their customer base.
Additionally, emerging markets around the globe are enticing to companies and financial buyers, resulting in competitive play in the M&A market. KPMG research indicates that outside of North America, China and Western Europe were cited as the top areas where companies plan to invest; overall, growing their geographic footprint was the top reason among the survey population for expansion. Within those regions, technology, energy, health care and financial services industries in particular should garner the most activity.
In today’s market, buyers are also looking for profitable operations to add to their portfolio, as survey respondents confirmed when queried about their approach to growth. Additionally, developing distinct product lines and entering into new lines of business can result in the customer base that’s needed for companies to expand their current market share and customer wallet-share.
Achieving Maximum Deal Value From Data-Driven Diligence
M&A due diligence that relies on traditional processes can limit an organization’s ability to adequately determine the value of an entity and appropriately evaluate a potential acquisition’s investment thesis in great depth. Today, due diligence should utilize sophisticated, data-driven methodologies in order to assign the right values to businesses and drive M&A success.
The use of data analytics in an organization’s due diligence approach can assist the investor in identifying, evaluating and specifically quantifying a series of questions and attributes related to the transaction value and investment thesis.
Key examples include: how a target generates its revenues and related profits; what the long-term sustainability and potential risks are associated with the target’s revenues on a prospective basis; and specific quantification of synergies — both positive and negative — for revenues as well as costs.
Historically, organizations have attempted to broadly evaluate and quantify these attributes during diligence. However, with the use of data analytics, organizations can more tightly articulate the above implications, which can reduce the acquisition’s downside risks and, more importantly, evaluate and expand the acquisition’s value-creation strategies.
In recent years, due diligence has become more critical than ever before in ensuring the maximum deal value is achieved. With a degree of volatility currently surrounding the consumer markets, it remains difficult to assess future revenue streams; it has also become necessary to perform more rigorous commercial diligence on the revenue cycle. Boards of directors are also under a microscope and pushing management to spend the time and money on a holistic approach when investigating a target.
A meticulous approach to assessing quality of earnings, people and company culture is also critical. Once the company is bought, capturing synergies and realizing value should happen quickly. A deep understanding of quality of earnings and employee assessment will also ensure buyers develop the right day-one planning efforts, to help capture those synergies immediately.
The purpose of due diligence has always been to decrease risk for both parties involved in the transaction process, determine deal valuation and increase return. Given the lack of information available in a traditional due diligence process, organizations were forced to utilize qualitative approaches to evaluate certain risks and opportunities of a potential investment, serving as a defensive strategy that identifies problems in the target and providing a broad, high-level view of the investment.
However, it is becoming increasingly transparent that data is at the core of successful due diligence and collectively will determine the value of the deal. By focusing due diligence efforts on extracting and analyzing transactional level data instead of only relying on target qualitative feedback and reporting at the management level, acquirers are able to arrive at more accurate and insightful conclusions, ultimately resulting in better decision-making in negotiating and closing the deal.
The survey results reveal the most challenging issues for respondents to contend with during the due diligence process are the assessment or volatility of future revenue streams, the analysis of revenue and cost synergy, the examination of quality of earnings, as well as the assessment of the culture and people. Concerns around these issues can be remedied by approaching due diligence with a progressive, offensive strategy, without abandoning the traditional, yet crucial, review steps.
New Due Diligence Strategies
One way firms are implementing new due diligence strategies is through the use of finely-tuned, sophisticated data toolsets that are unlocking powerful new information in predictive analytics. They are designed to depict financial performance through a business strategy lens, while asking the most critical strategic questions. And recent successful deals are proof that utilizing modernized financial due diligence, with deeper business analytics, is highly valuable to the client’s investment.
In contrast to traditional, qualitative due diligence activities, these powerful software research tools offer a unique, quantitative strategy to create value in the purchase price, and provide companies with a strategic perspective to strengthen judgment, expose risks and identify value-creation opportunities during the transaction process.
Additionally, these platforms have the capabilities to address and analyze specific trends and investment considerations unique to every transaction and industry, and provide valuable analysis related to customers, product lines, locations and cost structures, among other factors.
The core results from employing progressive data tools are the company’s ability to gain confidence in the due diligence outcomes, validate or challenge the initial investment thesis while finding complementary strategies, determine a realistic price on the purchase assets and, ultimately, gain an even more favorable return.
Buyers that approach due diligence holistically through traditional, qualitative methods as well as quantitative toolsets should also undoubtedly have the advantage over their competitors in a bidding situation and maximize the value for all parties involved in the transaction.
Although the current cutting-edge practices of M&A due diligence have changed the way deals transpire, in the future, there will be room to delve deeper into the data and assess potential synergies or disconnects more thoroughly. Due diligence technologies will only become more sophisticated by integrating market research, expanding datasets, incorporating a global viewpoint and providing an automated perspective on the data.
The volatile economic environment has presented significant challenges to the M&A market in recent years. However, a strategic growth approach combined with a progressive due diligence strategy should help companies create the desired value when executing transactions and, ultimately, drive their businesses forward.
As companies look to differentiate themselves in a competitive marketplace, the utilization of the appropriate tools that provide progressive, data-driven due diligence, is changing the way deals are getting done.
Dan Tiemann (([email protected]) is the Americas lead for Transactions & Restructuring for KPMG LLP and Joe Hartman ([email protected]) is a partner in the firm’s Financial Due Diligence practice.