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Comment réussir vos acquisitions dans les pays émergents ? (février 2012)


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Comment réussir vos acquisitions dans les pays émergents ? (février 2012)

  1. 1. Getting on the right side of the delta: A deal-maker’s guide to growth economiesJanuary 2012
  2. 2. Editorial team:John Dwyer, Alastair Rimmer, Nick Page, Richard Skinner, Ward Duvall,and Claire DaviesKey contributors:China: Matthew Phillips and Curt MoldenhauerIndia: N.V. (“Shiv”) Sivakumar and Amit NawkaRussia: Lev Vilyaev and Andrew CannBrazil: Luis Madasi, Alexandre Pierantoni and Mikail OjevanMiddle East & North Africa: Hani Ashkar and Ziad Sarkis (Saudi Arabia),Nitin Khanna (UAE), Maye Ayoub (Egypt) and Antoine Abou Mansour (Lebanon)Sub-Sahara Africa: Simon Venables and Peter McCrystal (South Africa)Eastern Europe: Jonathan Thornton and Charles Bates (Czech Republic)US: Manuel IraolaJapan: Philip Blythe and Matthew WybornUK: Sir John Stuttard, Leonard Sinclair, Yael Selfin , Simon Harris, Maciej Grygiel,Craig McVicar, John Glynn, and Jacqui RivettFrance: John Hadley and Ghislain de La Tour d’ArtaiseCanada: Vanessa IarocciAustralia: Richard Shackcloth and Sean GregoryNetherlands: Johannes Postma
  3. 3. ContentsIntroduction 3Executive summary 4The importance of deals in growth markets 10Avoiding the pitfalls of past deals 141) Lack of transparent financial information – minding the gaps 142) Justifying developing market valuations – getting real 173) Non-compliant business practices – discerning the manageable from the deal breakers 204) Post completion operations issues – integrating and taking control 225) Difficulties with negotiating and contracting – making it to the dotted line 246) Partnering conflicts – reconciling differences and managing great expectations 277) Government interference – managing an additional stakeholder 30Nuances of individual markets 33 Getting on the right side of the delta January 2012 1
  4. 4. 2 PwC
  5. 5. IntroductionDoing deals in growth markets is a topic that features regularly While there are plenty of examples of successful dealsin our client conversations. For many companies doing a deal is in growth markets, the deal makers we interviewedthe best – or only – way of tapping into growth markets, largely acknowledged that deals in growth markets are inherentlybecause it is faster than going-it-alone. And deals in growth riskier. There is a much bigger deviation, or range, of potentialmarkets are not just about low cost manufacturing, access to outcomes. We refer to this range as the delta, and in growthnatural resources, or market access for basic global products. economies, the delta between a good deal and a bad one isDoing a deal in a growth market can also provide buyers with much bigger than in developed markets. If things go well,access to best practice in core operations, innovation investors stand to make a lot of money. But if things gocapabilities and capital. badly, investors can lose big – an average of 50% of their investment in the deals analysed where transparentFor this study, we carried out an assessment of over 200 deals, information was available. And the impact on reputationsincluding publicly announced deals and a broader set of can be considerable, as evidenced by the many high profileprivate deals that PwC has advised on. We interviewed 20 examples of problems that emerge after the ink has dried onsenior deal makers who have bought businesses in growth the sale and purchase to understand the root causes of problems, and howthey overcame the challenges encountered. Collectively, the Growth markets are different, which is why our strongestcompanies they represent have completed over 140 acquisitions recommendation is to build the local machinery needed toin growth markets, with considerable success. In addition, the get a deal done well in advance of executing the first deal.contributors to this study have been involved in hundreds of This and other recommendations resulting from this study willdeals in growth markets. help companies to avoid doing bad deals, to successfully complete on good deals, and to make sure a good deal doesn’tDeals in growth markets remain incredibly challenging. Our turn bad after the deal trophy is on the shelf. In short, theresearch suggests that over 50% of deals that enter detailed study aims to help deal-makers get on the right side of theexternal due diligence in growth markets fail to complete. delta between a bad deal and a good one. Anyone can getWe believe this is materially higher than in developed markets. lucky on one deal, but it takes investment and a rigorousOne key reason for this is that many companies’ boards struggle approach to consistently get it right.with perceived ‘sky high’ valuations in growth markets. John Dwyer Alastair Rimmer PwC Global Head of Deals PwC Global Head of Strategy Getting on the right side of the delta January 2012 3
  6. 6. Executive summary It’s tough, but you’ve got to do it The majority fail to complete, Doing deals in growth markets is a tough and failure can hurt business but not doing those deals, or Our study shows that 50-60% of deals failing to make them work could make that go into external due diligence in the broader business outlook even growth markets fail to complete. tougher. Access to high growth economies, All of these failed deals represent a with large populations, rising affluence considerable opportunity cost – whether and the potential for innovation make a it is letting a good deal get away, or presence in growth markets a necessity for spending management attention, time many companies. Doing deals in growth and money that could have been better markets is a challenge worth taking on. used elsewhere on a good deal. Exploring And challenges abound: negotiations can deals that don’t complete can also damage drag on, and considerable time and credibility with investors. Though deal effort can be spent on a deal that does completion rates are also low elsewhere not complete. Even if a deal does in the world, the cost of failing in a complete, a lot can still go wrong: it can growth market can be much higher due emerge that risks were missed during to the scale of the opportunity lost. due diligence, post-merger operations can be mismanaged, and conflicts with The delta factor for completed partners can arise, ultimately resulting in deals is high costly failure. In addition, once business Even after a deal is sealed, a large managers have had their fingers burnt percentage of deals subsequently result in a particular market, they are often in significant difficulties – and at a very reluctant to return, hence closing off high cost. Where sufficient data was key markets. available in the public domain, we found that post-deal problems cost the buyer on average c. 50% of the original What we mean by growth markets investment. And in half of these cases, In this report, we have taken a broad definition of growth the buyer either lost control or divested markets that consists of the world excluding Western the business at a loss. Post-deal problems Europe, the US, Japan, Canada, Australia and New also bring a number of other intangible Zealand. Obviously, this represents a wide range of costs, foremost among them being economies. The BRICs are in a league of their own, negative investor sentiment and and within the BRICs, each market varies considerably. unrealised deal value. Conversely, if you However, the rest of the E7 (Mexico, Indonesia, and get it right, the upside is great. Turkey), and the next tier of large and growing economies (South Africa, Nigeria, Egypt, South Korea, Vietnam, and Although only a small percentage of the Philippines) also present attractive opportunities. deals that have problems make it into the public domain, there are a much larger number of deals with problems that don’t make it into the press. This includes a group of under-performers that is potentially the most dangerous of all.4 PwC
  7. 7. Figure 1 Assessment of deal issues in growth economies Deals that failed to complete Deals that resulted in issues post-completion Transparency of Transparency of financial information financial information Justifying valuations Justifying valuations The asset Non-compliant Non-compliant business practice business practice Post completion Post completion people issues people issues Negotiation & Negotiation & contracting difficulties contracting difficulties The seller Partnering conflicts Partnering conflicts The government Government interference Government interference 0 10 20 30 40 0 10 20 30 40 % of deals % of deals Source: PwC Analysis database of growth market deals with problems.Investments that under-perform, but not and competition for assets in growth markets, government involvement isso much to justify closure or divestment, markets is stiff. Three other issues often part of partnering. Problems withcan be both difficult to fix and difficult explain another 50% of problems. financial information, such as a USto exit. These investments take up Teams fail to obtain approval from the private equity firm’s recent concernsconsiderable management attention, and government. Financial information is over accounting at an investment in amay prevent the company from pursuing less transparent – there is less of it, children’s apparel company in India, cana more successful strategy in the market. managers are less willing to share it, emerge after a deal completes. FinancialThey’re not dissimilar to the ‘walking and accounting practices are different – information may have been signed offdead’ of the venture capital industry. which make it difficult for buyers to get by an inexperienced auditor, financial comfortable with a deal. Often there are information may not have been signedNearly 40% of deals failed non-compliant business practices (e.g. off at all, or there may be issues that areto complete because of a corruption, labour & tax compliance) not identified by local standard auditingvaluation mismatch which can become deal breakers. procedures. Non-compliant businessDeal risks typically relate to one or more practices are also common problems.of three key elements: the asset itself, 30% of post-deal problems For this reason, FCPA (Foreign Corruptthe seller, or the government. Through concern partnering Practices Act) and Anti-Bribery reviewsour past deal analysis and through The most common problems that are critical. We have identified a numberinterviews, we have identified the most emerge after a deal completes concern of situations where these were notcommon pitfalls both before and after a partnering, causing c. 30% of deal carried out properly and problems weredeal completes. These problems are not problems post deal identified in our later encountered with outside authorities.unique to growth markets. What is survey. Even sophisticated investors can There is also a range of potentialspecific to growth markets are the have problems in this area. High profile operational issues that make it difficultdegree, frequency, and root causes of examples of partnering problems include to integrate and take control of an asset.these problems. Danone disputes with its partner in China, and the TNK-BP joint venture in Russia. By examining a number of deals weAs shown in Figure 1, the most common Beyond partnering, the same issues that traced the root causes of these problemsbarrier to deal completion is an inability prevent deals from completing also to a set of critical differences in practicesto get comfortable with valuations, frequently emerge after a deal completes. and governance between growth marketsexplaining 40% of failed deals in our Direct government interference is a and developed markets. This has led todata set. The magnitude of future growth common problem, and with a prevalence the following set of uncertain, there are few comparables, of state-owned enterprises in many Getting on the right side of the delta January 2012 5
  8. 8. Recommendations 1) Understand the strategic Finally, developing a rationale is hard. There is no silver bullet to increase the rationale early Developing a strategic rationale also chances of success in doing deals in We see a common theme across less takes time: 1-2 years in our experience. growth economies, but drawing on the successful or less experienced companies Often, it requires building up data from experience of successful deal-makers of not developing a strategic rationale for primary sources. Also, interviewees and our own expertise, we have five growth market deals early enough. consistently highlighted the need to recommendations to ensure you are on Companies often only have limited educate the boards and shareholders of the right side of the delta factor. resource charged with developing Western companies. Board members business across a number of markets. and shareholders often hold pre- Their boards wait until a target conceived concerns about growth acquisition has been identified before economies, which may be easily seriously looking at a market. dispelled myths, or easily addressed risks. Our view is that this element of The reason for this is understandable for developing the rationale is not given many companies. It’s difficult to build enough attention. the international deal infrastructure of a multinational company. Due diligence “Doing deals in developing countries will be imperfect and valuations are is a cultural challenge. There is a high, so a strong strategic rationale is need to educate the management in critical to completing a deal. However, mature markets on the necessity to there is also a tendency to under-invest take higher risks in growth markets.” in resources in doing deals in growth economies. Some companies focus on M&A Director, the short-term potential of growth Global Electrical Distributor economies. We see companies that treat growth markets as high risk ventures that could generate a small percentage of 2) Prioritise markets current sales, as opposed to markets that Although there are common themes could generate 30%, 40% or more of across growth economies, each market is global sales. We also see companies that different. This is one reason why local fail to consider strategic considerations capabilities are critical for success. With for a deal like checking the rise of a a requirement for increased investment potential global competitor. in individual markets, there is a case for prioritising markets. This allows the There is also a risk of underestimating company to focus scarce resources on the need for developing a strong fewer markets to increase the chances strategic rationale for a deal. The need to of building scale positions that can develop a strategy for a new market may support future growth. This is particularly sound obvious, but we are surprised that the case for smaller companies, who may our survey suggests that some companies lack the international deal infrastructure go ahead with a deal without addressing of a multinational company. Also, some key questions about the market and of the most effective M&A strategies are competitors. ‘platform strategies’, or making a large initial acquisition to enter a new market and then bolting on smaller acquisitions. This strategy requires greater focus on fewer markets.6 PwC
  9. 9. 3) Go there • Understanding market potential to “I can’t emphasise enough theGrowth markets are different. Reflecting help with valuations; importance of doing on the groundthis, being on the ground was consistently due diligence... If you don’t ask the • Identifying a target short-list toidentified by interviewees as the best question, you don’t get the answer. improve the chances of choosing theway to reduce risks in a number of right partner; and A lot of people discover key risks onareas, including: day one, because they didn’t ask the • Engaging with multiple levels of• Giving stakeholders context to government to increase the chances of right questions.” address their concerns; obtaining approval and to understand Partner, Global Asset Manager• Improving the quality of diligence to potential future changes in the increase the transparency of financial government’s position. information and reduce risks from non-compliant business practices; Figure 2 Views of local PwC contributors Eastern Europe Russia & CIS “Eastern Europe is in some ways becoming closer to a “Very often, small-and medium-sized Russian companies developed rather than a growth market, but corruption in have issues with tax compliance. This can lead to potential businesses related to government contracts is still an issue tax liabilities, especially as an acquisition often triggers a in many Eastern European countries.” review by tax authorities.” “We strongly recommend that an FCPA or similar review “Thorough due diligence can often identify these practices is undertaken to identify any practices ongoing in the and therefore the risks can be quantified. But this takes company that a western buyer cannot continue post deal.” time and patience.” Jonathan Thornton, Partner, Deals Andrew Cann, Partner, Deals China Middle East & “Strong competition from rival North Africa bidders and alternative sources “There are issues specific of funds makes valuations the to individual markets such key issue for China. Based on as living hardships and our data, differences in security risks. expectations around valuations explain nearly 50% of deals “Companies need to start withdrawn after beginning recruiting for key managers external due diligence.” even earlier, and factor in higher costs for key staff.” “Bring your stakeholders on board early on. Spend more Hani Ashkar, Partner, time on the strategic rationale Middle East Deals Leader for the investment. Discuss what approach you’ll take to valuations.” Brazil Sub-Sahara Africa Matthew Phillips, Partner, China Transactions Leader “The regulatory environment, “Government policy is more central particularly for tax and to deals in Africa. There is often a labour, is a complex one. There higher level of political interest and India are high taxes and social perceived interference in deals. Some “Indian companies often have a large charges on payroll, sales and countries can change the rules on tax number of transactions with companies income. Taxes are diverse and or legal parameters quickly.” owned by other family members. Other legislation changes fast.” family members who are not in the forefront “Local knowledge is paramount. “Conduct a phased approach Investors need to visit government often play a significant role in making or to due diligence so you can departments and ambassadors to breaking a deal.” identify the key issues, understand anything which could “Find the real decision makers and start including corruption, and then cause the government to intervene.” talking to them early on.” focus on them.” Simon Venables, Partner, N.V. Sivakumar, Partner, Luis Madasi, Partner, Deals Southern Africa Deals Leader India Deals Leader Getting on the right side of the delta January 2012 7
  10. 10. 4) Put key people in place Identifying people in the organisation or Ultimately, the people involved will recruiting people to fill key positions will most influence whether your deal is take time, but is worth the investment in a success or not. Companies should: any case. • Build a short-list of local advisors including finance, strategy, corporate “By day one, decide on your project finance, law, forensics, and integration or integration manager – a local or specialists. In selecting advisors, local someone who knows the market is knowledge and experience are as best. Get your senior management in important as previous relationships. place and make sure all lines of communication are completely clear.” • Build a deal team of both dedicated Head of M&A, Global Insurer deal leaders and deal ‘moonlighters’, people who can work part-time on a deal to provide specialist input across finance and operations. The deal team should include nationals who are on the ground, and should also include the people that will manage and go into the business post-completion.8 PwC
  11. 11. “When we do deals in emerging 5) Adopt best practice for deal. These choices largely reflectmarkets, we do the normal due approaching deals in growth markets trade-offs between risk and rewarddiligence: financial, tax and legal. Many boards need to accept that a (either speed or upside). These choicesBut that’s not enough for some of ‘normal’ deal approach is not do not have obvious answers, rather they appropriate for a growth market. reflect preferences specific to companies’these assets and some of these places. There is too much ground to cover; cultures and strategies.You have to do more than the normal competition from rival bidders can bedue diligence. Sometimes you have to strong and appear irrational; sellers’ The delta between a good deal and a badbe creative.” expectations are different; and there is one is that much greater in growthAfrica M&A Executive, too much uncertainty over future markets, but we believe it’s possible toStrategic Industry performance. Past deals show that there get on the right side of this delta. are a number of best practice measures Companies can de-risk deals in growth and tips to manage individual risks in economies by recognising these markets“Due diligence needs to be wider in growth markets. as large opportunities that require somegrowth markets to cover things you initial strategic thought, by prioritising How a company applies these measures markets and establishing a presence onwould not normally consider in the will be influenced from the outset by its the ground in those markets, putting keyWest like employee relations, size, culture and risk-appetite. There are local resource in place, and adoptingpolitical risk, and market practices” a number of difficult choices about how best practice for a deal. We believeHead of Corporate Development, to approach deals in growth economies companies that take these steps increaseGlobal Bank – such as how much weight to give to the their chances of doing a good deal and long-term strategic option value of a avoiding bad ones.“It is difficult to use traditionalvaluation methods to come to asingle figure. Having an option value Figure 3is a key way to mitigate this. We use Best practice measures and tipsearn-outs. We like it when people areleft with minority stakes to help Area Measures and tipscrystallize value.” Financial information • Phase diligence: first thorough high-level initial screen, then in-depthPartner, Global Asset Manager • Gather data in a bottom-up manner in priority areas (with exclusivity if possible) Valuation • Conduct additional research to improve comfort with forecasts • Use earn-outs/deferred consideration to align interests of management • Combine long-term strategic option value with conservative DCF (e.g. scenarios, higher discounts) Business practices • Conduct FCPA/Anti-Bribery review • Conduct diligence on key individuals/partners and common issues (tax, labour, related party transactions) • Understand if non-compliant practices can be managed Post-completion • Address critical areas such as governance from day 1 operations issues • Slower pace thereafter Negotiation & contracting • Adapt to local negotiating approaches (e.g. relationship focused, more direct negotiations with stakeholders, engaging a broader group of stakeholders) • Encourage seller to use an experienced advisor • Have a back-up (e.g. negotiate with multiple parties, develop an organic option) Partnering • Avoid 50/50 JVs • Research partner extensively • Discuss exit plans with your partner early Government interference • Run scenarios for changes in government positions Getting on the right side of the delta January 2012 9
  12. 12. The importance of deals in growth markets 92% of CEOs expected growth in You have to be there growth markets are the key drivers of this their Asian operations, 86% Though the activity levels of multinational economic growth. In particular, growth is expected growth in Latin America, companies doing deals in growth markets based on increasing wealth for the circa and 75% and 72% expected growth in 2011 remained subdued in volume 4 billion people who fall into the world’s terms, in value terms 2011 activity poorest socio-economic group, earning in Eastern Europe and Africa surpassed 2006 levels. between $1,000 and $4,000 per year, and respectively. Conversely, only 55% often referred to as ‘the Next 4 billion’. and 48% of CEOs expected growth The key motivation behind both current in North America and Western and future activity is access to large and Acquiring a business is one way – Europe respectively. growing markets. Roughly six billion of and in some countries the only way – PwC 2011 Global CEO Survey the world’s seven billion people live in for foreign companies to access these growth economies.1 PwC forecasts that, at markets. Deals can also provide current market exchange rates, the GDP of multinationals with local capabilities, the E7 (The BRICs plus Mexico, Indonesia manufacturing bases, or access to and Turkey) could surpass that of the G7 resources. They can also be a way of (the US, Japan, Germany, France, the UK, acquiring growth markets rivals that Italy and Canada) as early as 2031. may be tomorrow’s key threat in the Increasing productivity and wealth in global market. 1 World Bank statistics.10 PwC
  13. 13. Figure 4 Deals from North American & Western Europe to growth economies, £bn £bn 200 176 180 161 160 138 140 127 120 106 100 80 66 60 40 20 0 2006 2007 2008 2009 2010 2011 Number of deals 1,900 2,033 2,148 1,406 1,712 1,720 Source: Dealogic, PwC Analysis.Figure 5PwC macro economic outlook – January 2012Source: PwC Economics. Getting on the right side of the delta January 2012 11
  14. 14. It is important to note that deals in Also, capturing growth is likely to require growth markets are not necessarily only local innovation capabilities. Customers about bringing best practice to growth and consumers have different tastes markets. In many cases, companies in across growth markets. With increased growth markets are not constrained by competition for their Yuan, Rupees, legacy investments, so building a Real and Roubles, global products are business from scratch provides an insufficient to gain share. This is even opportunity to learn from the mistakes more so the case for serving the low of the past to establish world class income consumers within the next four operations. The banking industry is a billion. Many of the ground-breaking good example of this, where banks in innovations to serve this market will Brazil and Turkey have developed some come out of growth markets. of the best technology in the world.12 PwC
  15. 15. But deals in growth markets arecostly from many anglesThough the rationale for seeking dealsin growth markets is clear, finding andvetting such deals can be costly andtime-consuming. This upfrontinvestment can make it hard to walkaway if a deal proves to be a bad one. Figure 6But if the potential deal was truly bad, Cost of deal issues as % of total investment or book value for ten public casesthe effort to identify the risks thatmake it a bad deal represent time and %money well spent. Much more money 120will invariably be spent if a bad dealgoes through.Of the problem deals we looked at, 10010 had sufficient public informationavailable to estimate in a robust way thecost of the issues. For these, we foundthat the cost of problems on these“bad” deals averaged around 50% of 80the total investment. While this doesnot represent a statistically significantsample size, it indicates the order ofmagnitude of costs of post-deal problems.Costs consist of divesting the business at 60a loss relative to book value or initialinvestment, fines, and write-downs Average: 49%against book value.In addition, there are also considerable 40indirect, intangible, or personal costs,in terms of share price impact, negativeinvestor reactions, or even individualsserving prison sentences. In many casesthe total investment is written off or sold at 20a loss, meaning diminution of capital andstrategic market position, as well as higherpsychological and reputational risk hurdleswhen seeking to re-enter the market. 0 Beverages Media Forestry Banking Travel Telecoms Banking Beverages Manufacturing Financial ServicesAs the experience captured in our surveyillustrates, 50-60% of deals that enterdue diligence in growth markets fail tocomplete. Comparing publicly announceddeals, deals by developed economycompanies in growth markets fail moreoften than the deals they do in developed Indicates the business was closed/exitedcountries.2 We also believe deals in growthmarkets are more likely to result in Source: Company reports and press articles.problems after completing.Over the next pages, we look at each of themost common pitfalls in turn, consideringtheir root causes and the suggesting waysthat companies of all sizes can mitigatethose risks from pre-deal, throughnegotiation to post-completion. 2 Source: Analysis of Dealogic data comprising deals by Western European and North American multinationals investing in growth economies vs. deals by the same buyer set investing in Western Europe and North America. Getting on the right side of the delta January 2012 13
  16. 16. Avoiding the pitfalls of past deals 1 Lack of transparent Common problems & root causes than in similar companies in the West. financial information – Difficulties understanding financial In the case of a carve-out, building up minding the gaps information in a business often prevent information can be even more difficult. deals from going ahead. But there are a much greater number of examples of Secondly, information can be completed deals that had worse than presented in a different way, because Common problems expected performance or where local accounting policies and practices • Difficulty understanding financial unexpected liabilities emerged because can differ from those in the West, information prevents necessary the true financial position of a business making it difficult to verify financial disclosure was not understood before completing information. Financial accounts are the deal. It is rare for a shareholder to generally in the local language and may • Risks are not given enough weight publicly fall out over the validity of be in a different format. There may be company accounts, but that is what has less discipline around recognising bad been reported in relation to a US private debts, and a desire to avoid bad news can Root causes equity investment in an Indian children’s result in costs building up in the balance • Managers place less emphasis on apparel company.3 Elsewhere, a series of sheet and liabilities not being recognised. financial information, so less is allegations made by analysts and available – e.g. poorer accounting investors of false financial reporting by systems Chinese companies listed on Western exchanges remain unresolved and have • Accounting policies and practices led to regulatory investigations and differ from those in home markets “There are a lot of family-owned market uncertainty.4 – e.g. two sets of books companies who are often disorganized in how they keep • Managers are less willing to A lack of transparency can come in three forms. Firstly, there is less information. information and are understaffed in provide information because of Many businesses are understaffed in key positions. This makes diligence concerns with confidentiality finance and IT and have less developed difficult and lengthy.” • Deal teams obtain insufficient financial reporting systems, because local advice companies in growth markets tend to “They don’t understand what selling have less stringent requirements for practices should be in terms of information than companies in providing information on the Mitigating actions developed markets. Because owner business. They think a two page • Conduct thorough initial review managers and family-owned businesses financial statement is sufficient and are common, there is less need for don’t fully realise the time and effort • Prioritise issues: decide what is financial and management reporting, important in conjunction with required to carry out a full due and there is a greater focus on cash- local advisors diligence process.” rather than accrual- based accounting. • Where possible, obtain exclusivity This will vary by type of business. For South America Investment Manager, and spend time building up key example, public companies generally Global Private Equity Fund data bottom-up have better information than private companies, but even public companies in • Put risks in context to take growth markets have less information calculated risks 3 “Asia fundraising goes on despite fraud allegations”, Financial Times, October 13, 2011 4 “Muddy Waters Claims on China Companies Have Yet to Be Proven,” Bloomberg, December 1, 201114 PwC
  17. 17. A prevalence of local GAAP can make it This would suggest flat or declining sales difficult to present financial information rather than growing sales and that the in a way that is meaningful to foreign seller’s portrayal of the growth of the companies on IFRS or US GAAP. In business was better than reality, which markets such as Brazil, local GAAP is can lead to valuation problems. relatively easy to reconcile to IFRS, but compliance with local GAAP by many Thirdly, even if the information is small and medium-sized enterprises is available, the seller may be unwilling poor. Finally, third party confirmations to share information, because of“In terms of accounting, lots of can be unreliable. concerns with confidentiality.things are not completely clean inbusinesses in Eastern Europe. If it’s One executive that we spoke with about “They also don’t want to providetotally misleading, we won’t do it. a deal in Sub-Saharan Africa provided an information as they see it asBut often, the entire industry in the example of the first problem area. He confidential. There are alsomarket does it a certain way. It indicated that even three years after frequently ‘creative accounting’might technically be a liability, but completing the deal, “the financial decisions and the quality ofin the local context the liability will systems are still appalling”. What the deal accounting and financials is notnever materialize.” team found after completing the deal was the target’s finance team lack of good.”Investment Manager, Global Private basic spreadsheet skills. South America Investment Manager,Equity Fund Global Private Equity Fund There are also extreme examples, as a China-focused deal executive with a“There was nothing malicious. It was global FMCG company we spoke witha lack of experience and insufficient highlighted. “I have been to companiessystems. Their attitude to the that said they have 30% growth, but whenfinancial accounts was not cooking you get there, they have a warehouse full ofthe books, but they were more finished products, and no raw materials.”flexible in representing financialinformation.”“We quantified the impact and asked Case study – Latin Americaourselves, ‘are we willing to take On a deal PwC worked on in Latin America, the team encountered boththis risk?’” inadequate financial information and weak accounting policies. There wereInvestment Manager, European several short comings in accounting procedures and no control testing in thePrivate Equity Fund external audit. Most concerning, the auditors had not signed off on one set of accounts because one month’s financial data had been lost when the company’s server had been moved To help address the inadequate financial information, a PwC team first spent time understanding what was available in the company and to identify critical gaps. A key objective at this stage of the due diligence was to explain what was common to the market and which areas were unique to the company. Subsequently, PwC continued to work with management to build information up from trial balances. They built profit & loss statements by product and region, identified key performance indicators and worked with the management team to alter systems to track these indicators. Getting on the right side of the delta January 2012 15
  18. 18. Mitigating actions from growth markets, there is likely to be In terms of how to overcome these even greater pressure on deal teams. issues, the key theme coming out of both Buyers from other growth markets are our discussions and our experience is often more prepared to do a deal around using local advisors in the without data in key areas, because they diligence teams so the context of the frequently are more focused on the risks involved can be put into focus. strategic rationale for a deal (e.g. access Deal teams will be unlikely to get to markets or raw materials) rather than comfortable with all risks, but the financial rationale. This can put “When you do diligence in emerging understanding context allows deal teams those less exposed to developing markets, you have to roll-up your to take calculated risks. markets at a disadvantage. sleeves and get your hands dirty.” Africa and Southeast Asia M&A By understanding what is normal for On average, there is less transparency Executive, Global Branded an individual market, and what is not, in company accounts in growth markets Drinks Company it is possible to focus on the issues that than in more developed economies and are critical for the business in question. this presents a risk to foreign investors. Given the breadth of issues at play, this However, we do not think it is feasible “The problem is you can’t spend that initial scan may need to be wider than a or even necessary to eliminate all of this diligence in developed markets. risk. What is important is to focus on much time with people during a critical areas and spend the time with diligence because you will scare Once critical areas are identified, it is local advisors to obtain data, bottom-up management.” necessary to take an approach to due if necessary. Exclusivity greatly diligence that is different from that taken facilitates this: there is unlikely to be “You can send in your advisors to in developed economies. Local teams are time or appetite for working with trial help. It came down to PwC doing important for this process. Shared balances in an auction. This makes it hard work on paper ledgers.” language and culture help teams to critical to identify off-market deals, explain the need for specific types of rather than solely relying on a limited Africa M&A Executive, analysis, find solutions to build the data, network of intermediaries and Strategic Industry and understand what the data is saying. corporate finance houses. Another challenge to obtaining exclusivity is that However, in order to do this, significant it exposes the vendor to the risk that the access or exclusivity is needed. To buyer withdraws. To obtain exclusivity, contrast the above case study, another foreign buyers may need to offer some PwC team worked on a separate deal in concessions, for example in terms of time Latin America where the client did not frame, and they must be able to convince have exclusivity. It faced the similar a vendor that they are likely to go ahead difficulties understanding financial with the deal. To do this, it is important information. The PwC team was able to that Board members and senior produce an initial red flag report executives are familiar with doing deals identifying information gaps, but the in growth markets and are bought in client was not able to persuade the target early into the strategic opportunity, to work with PwC to address those gaps. and where possible into the specific deal In the end, the buyer lost out to a rival in question. bidder. With increasing competition for assets from up-and-coming multinationals16 PwC
  19. 19. 2 Justifying developing market valuations – getting real Common problems • Large gaps in expectation between buyer and seller • Worse than expected performance Root causes Common problems Root causes • Uncertainty over future growth: Nearly 40% of the deals we assessed Valuations using traditional techniques market demand, distribution failed to complete because the bidder are difficult because of greater channels, and future competitor was unable to get comfortable with the uncertainty about future revenue actions valuation of the business. The beer growth. The key sources of this industry, with frequent auctions, has uncertainty are future market demand, • Few comparables numerous examples of international distribution channels, and competitor • Competition for assets companies losing deals because of high actions. Valuations may also be higher valuations in growth markets. The because many sellers have strong bidding war over Harbin Brewery in alternatives to doing a deal with a Mitigating actions China is one of the highest profile foreign investor. There are often rival • More research to increase comfort examples over the past decade, but there bidders. Stock markets also offer with projections have been a number of recent auctions as attractive valuations. Finally, many well, for example the Sona Group in companies have access to low cost capital • Structures such as earn-outs Nigeria. These competitive auctions were from local banks. • Combine conservative short-term affected by a number of factors, but Discounted Cash Flow valuations were potentially the key “The risk/return profile is often not (e.g. scenarios, higher discount determinant of who won the bid. For the there. Sellers have inflated price rate) with long-term strategic winners, there is the risk of having expectations. They’re too big to fail option value over-paid, while those that lost the bid in their own territory. They know the now lack a strategic asset. local banks, can get favourable terms, and can roll over loans. They High prices are often predicated on high“There is always someone willing never have to sell. I’ve not seen one growth, but there are cases of lowerto pay the asking price and price distressed seller of a good, sizable than expected growth 12% growth, or more.” For example, several consumer banks Eastern European business.” from Western Europe invested in Russia Investment Manager,“The hard part was getting just ahead of the financial crisis only to Global Private Equity Fundcomfortable. There were no good find subsequent performance was worsehistorical precedents or data. Real than expected. Not simply the result ofestate had only been a real business the financial crisis, the main reason citedin India since 2005, when the doors is actually stronger than expectedwere opened to foreign investment in competition. Barclays has divested itsIndia, and there was not a lot of Russian retail business, and Swedbank isinformation available to help judge in discussions to divest its retail business in Russia after selling its retail bankinghow much cash flow would be unit in the Ukraine in 2011.5generated from these investments.”Director, Global Asset Manager 5 “Swedbank In Russia Retail Talks With Raiffeisen”, Dow Jones News Wires, 4 August 2011. “Barclays announces sale of Russian arm to Igor Kim”, Reuters, 25 October 2011. Getting on the right side of the delta January 2012 17
  20. 20. “One of the pitfalls of doing deals in As with financial information, the main However, taking these actions is unlikely growth markets is getting reliable challenge with valuations is a lack of to provide the board of a global company market and economic data. information. It is difficult to obtain with the same level of comfort as it Understanding historical and accurate historical data on market spend, would be able to obtain in home markets. much less good forecasts for future Uncertainty around future growth, and projected beer consumption is key demand. While most companies are good difficulty in understanding the business’ for valuations. It is difficult to get at short-term cash management, there is financial situation, mean that the data that is reliable, precise and strategic rationale for a deal must generally less long-term planning. specific enough.” Companies may have a one-year budget, be that much stronger to justify Head of M&A, Global Brewer but many are unlikely to have a three- or proceeding with a transaction that might five-year plan. There are fewer otherwise look expensive. As such, some comparable transactions to suggest what flexibility with traditional valuation “It is difficult to make a valuation growth rates other buyers have assumed mechanisms is necessary. We believe based on DCF. Growth hypotheses in recent transactions. what is important is a degree of conservatism in short-term projections, and wacc are more volatile in growth Mitigating actions while separately considering the markets than in developed countries. There are ways to mitigate these risks. strategic rationale for an investment Working capital is difficult to which might therefore justify a much The global brewer we interviewed does predict, as it is not necessarily its own consumer research to underpin higher multiple than in developed followed in the financial reporting.” projections and uses larger than normal markets. Considering the option value contingencies with revenue of an acquisition in conjunction with “PER and other multiple ratios projections. Structuring solutions like a conservative Discounted Cash Flow are difficult to obtain. Multiples/ earn-outs can also share risk and align model is one way to ensure that you are valuations are less often disclosed in the interests of managers and partners. taking into account upside and strategic the BRICs. Companies are not easy to rationale without throwing the compare in terms of growth dynamics.” credibility of underlying assumptions into question. M&A Project Leader, Global Facilities Management Provider Case study – forecasting out of a conflict In one private equity investment in a growth market, the minority private equity investor had developed a conflict with another shareholder. The parties reached an agreement for the private equity investor to buy out the other shareholder’s stake. However, the private equity investor could not justify the valuation, largely because of uncertainty over future growth. PwC was hired to build a detailed model to support long-term forecasts. The resulting growth projections helped to support the valuation, so the private equity fund could buy out the other shareholder.18 PwC
  21. 21. “You need to do as much as possibleto ground the business commercially,but you have to apply more of astrategic lens. You need to be moreflexible about how you think. No onecan tell you what the market willlook like in ten years time. You needto treat it more like an option playdue to the high level of uncertainty.”Africa and Southeast Asia M&AExecutive, Global BrandedDrinks Company The high valuations and risks of The 3-7 year investment horizons of growth markets mean that private most private equity funds can present equity firms must have clear value potential challenges when funds seek propositions to clear their hurdles to help their portfolio companies rates for return on investment. For invest in growth markets. Entry into a example, one value proposition in new market has a long-term strategic China is helping mid-market option value for a company. However, companies prepare for an initial private equity investors may not be public offering. Many of the largest willing to fully value this option private companies in China have because they are unlikely to be able to access to lower cost capital from realise the value at exit. Entry into a banks and public listings, while many new market may not be valuable to a smaller companies are unable to future trade buyer who already has a obtain debt financing and lack the presence in that market. Also, in a financial reporting and governance secondary buyout, a private equity capabilities required for a listing. For fund may not fully value the option these smaller companies, private value if it only impacts profits in the equity can provide much needed long-term. capital while putting in place the systems and controls to prepare the company for a public listing in three to five years. Getting on the right side of the delta January 2012 19
  22. 22. 3 Non-compliant Business Common problems a subsidiary of a global corporation practices – discerning In understanding financial information, or private equity fund. Many of these the manageable from the there are a number of accounting and business practices can present deal breakers information practices in growth markets considerable risks for a foreign buyer. that differ from those in developed Common areas of problems include tax economies. In most cases, these practices and labour compliance, corruption, and are common and innocuous, but some fraud & misappropriation. These problems Common problems reflect a more serious risk. can expose a foreign buyer to potential • Tax compliance – “black cash” reputational damage from bad public transactions In the same vein, there are a number relations, or investigations and fines from of business practices that may be more outside authorities. If rectified while local • Corruption common in a developing economy, competitors continue the practice, the • Fraud & misappropriation and thus present a limited risk for the business may become uncompetitive. business, but would not be acceptable for • Labour practices & compliance Root causes Figure 7 • Less developed/unenforced Business practices that present problems for multinationals business and regulatory Area Description Example environments Tax compliance • Companies often keep two sets • In the Latin American case mentioned of books previously, PwC identified tax liabilities • Less formal governance structures • Low levels of tax compliance that represented 35% of the target’s (both corporate and personal). enterprise value We have come across staff paid in cash in paper envelopes, which Mitigating actions did not go through the accounts to avoid payroll taxes • Spend time on the ground with • For company directors who are also local teams/advisors paid in dividends or shares, this can present a significant risk for the company • Targeted due diligence covering key individuals and common Corruption • Some practices may be acceptable • Within a year of eLandia International under local law or norms (or Inc.’s acquisition of Latin Node Inc., FCPA issues (e.g. tax, labour, corruption) unacceptable but poorly enforced), issues in Honduras had caused it to but fall afoul of international bribery discontinue the target’s operations, and • Understand if the practice can laws incur additional costs relating to the FCPA – Foreign Corrupt Practices Act in the investigation, its attempts at remediation, be managed United States and Latin Node’s bankruptcy6 – Bribery Act in the UK Fraud and • More related party transactions7 than • One high profile example of alleged misappropriation in developed markets although more misappropriation of funds in growth often than not, these are benign markets concerns recent accusations of • However, some will have unrecorded embezzlement in the NASDAQ-listed transactions, fraud (potentially China Medical Technologies8 including false audit evidence such as fake invoices) or misappropriation of funds Labour • If a foreign buyer discovers child • Black empowerment regulations in labour in a business, it poses an South Africa ethical dilemma and a reputational • There are often stricter workers’ rights risk. The child may be the sole bread regulations in former communist countries winner for a household. The foreign • Other markets, such as Brazil, are difficult owner may need to consult with because of extensive labour laws and government and local and regulations international NGOS to find the right solution • Foreign ownership may require the company to comply with new labour laws Others • Range of other risks which may • Melanine milk contamination scandal in present risks for foreign investors, but China in 20089 primarily concern health & safety, and loss of intellectual property 6 “Latin Node Inc.: Undiscovered FCPA Violations Wipe Out an Investment”, Shearman & Sterling, April 15, 2009. 7 A related party transaction is an arrangement between two parties who are joined by a special relationship prior to the deal, for example a shareholder’s company being hired as a supplier. 8 “China Medical shares plunge on fraud allegations”, Reuters, December 6, 2011. 9 “Fonterra puts up $8.4m to provide care in China”, New Zealand Herald, October 11, 2008.20 PwC
  23. 23. “I can’t emphasise enough the Many of the issues we come across in this Once identified, it is possible toimportance of doing on the ground area concern related party transactions. understand if the risk can be managed,due diligence. I was in the office on For example, sales and purchases can be or if it runs throughout the company.Friday and some cash arrived in a made through related party special First and foremost, we recommend that purpose vehicles at below and above companies conduct and FCPA or Anti-brown envelope. We wouldn’t have market rates respectively. This moved Bribery review. In general, we believediscovered that in a normal profits out of the target company (thus that tax compliance can be managed,management Q&A process.” minimising taxes). Related party vehicles either through new policies orPartner, Global Asset Manager can be nearly impossible to trace to the indemnities in the sales & purchases ultimate shareholders, may be agreement. However, indemnities are unregistered for tax purposes, and are often only effective with an element of“There may be corruption, but unless often closed down after a short time deferred consideration. The key tothe business has a high component of frame (e.g. six months). managing fraud and misappropriation isgovernment interaction, then it’s less to understand if any identified Root causes irregularities are benign related partylikely that there are high levels of While multinationals are subject to transactions, or evidence of somethingcorruption in the business, and it strict regulations and standards, many worse. We believe this can best beshould be manageable. If there are growth market companies use less understood by assessing individualhigh levels of government formal governance structures. We transactions, as well as conducting dueinteraction, then we spend a lot of believe buyers can rectify these practices diligence on key managers andtime making sure the business by putting in place specific policies and stakeholders.doesn’t rely on extra payments and improved controls. The key risks arebribes.” failing to complete a deal because of Industries with high levels of business practices that could be government involvement (e.g. mining &South America Investment Manager, corrected, or failing to identify and plan metals, industries where the governmentGlobal Private Equity Fund to rectify inappropriate practices. is a key customer) generally present the greatest risks for corruption. However, if “Partners can have a different corruption is not endemic, then it may be“There is rarely a sufficient level of possible to put in place controls which approach to regulatory compliance.control in place: no statutory audit limit corrupt practices and the risk of In China, some may open storesprocesses, no business continuity running foul of global regulations. first and then ask for planningplanning, etc. It is necessary to permission later.”understand and recognise this and In some cases, it may also be possible toput into place a programme to bring Corporate Development Manager, employ constructive solutions to raisethe business under control over a Asia Pacific Retailer standards. In one example of potential12-15 month period.” child labour, the buyer created an Mitigating actions apprenticeship program with reducedHead of M&A, Global Insurer The key challenge to managing business hours, equal wages, and a training practice-related risks is determining program. Whatever the solution, what can be rectified and what cannot. rectifying these practices can add“If we can cordon off the part of the Spending time on the ground and costs to the operations of a businessbusiness where [there are non- asking targeted questions is often the which local competitors are unlikelycompliant practices] and put in place key to identifying business practice- to incur. But the impact of anya plan to stop the practice – for related risks. rectifying measures on theexample in parts of procurement – competitiveness of the businessthen we will do the deal. On the deal should be considered as part of thewe did, procurement had to be rebuilt valuation of the business, and couldfrom the ground up. However, if there therefore become a deal breaker.are questions around corruption inthe core business, or its operatinglicense, then it’s a deal killer.”Africa M&A Executive,Strategic Industry Getting on the right side of the delta January 2012 21
  24. 24. 4 Post completion Common problems A senior executive in the banking operations issues – There were several instances of people industry acknowledged these same integrating and taking issues post-completion creating language and cultural risks, but also control operational difficulties in the deals we difficulties navigating informal assessed. Given the nature of these governance structures. issues, we believe a large number of these people problems are likely to go “When you buy a company whose Common problems unreported and the actual percentage of staff is local, they have often had no • Wide range of factors causing deals that experience problems in the exposure to an international bank’s worse than expected performance integration and taking control phase is policies and procedures and we have post completion much higher than reported. to impose these upon them. This is a massive cultural shift and people do In a joint venture we advised on in India, the buyer put none of its own employees not appreciate the extent of this. Root causes on the ground in India. Within a few Language barriers only serve to • High requirements of foreign- years, the JV ran into trouble. The make this more difficult.” owned businesses: local operating foreign buyer had complaints around experience, deep business & a lack of transparency, and difficulty “There are also informal social finance expertise, foreign achieving global standards for structures and deferential dealings. language skills, cultural affinity governance, quality and technology. In Africa, we found the head of risk • Different attitudes to management After protracted legal proceedings, was deferring decisions to someone among local staff the international buyer was forced to in the team two notches below him.” surrender its share in the investment. • Living hardships in some markets Head of Corporate Development, One public example of post-deal people Global Bank issues is a major UK industrial group’s Mitigating actions investment in metal fabricating mills in • Getting the right people in place Russia. There were delays launching • Setting the right pace operations and the investment under- (address critical areas from day 1; performed against expectations. slower thereafter) “Bringing people into Russia with good project management skills took us longer than we expected. And so we did not execute our projects... this is our delay. I thought we could do it much quicker. You are dealing with import licenses, you are dealing with approvals from the government and they are helpful, but it takes time. We thought it would be easy. But we have a language barrier.” Group President of Division22 PwC