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CFO Summit XXI-A.Elli M&A
- 1. CFO Summit XXII2011 Navigating the Merger and Acquisitions Minefield to Facilitate a Smooth Integration Alberto Elli VP and Controller Global Finishes Group
- 2. Navigating the Mergersand Acquisitions Minefield to Facilitate a Smooth Integration 1. Exploring the Dos and Don’ts of M&A 2. Selecting the growth method – organic versus inorganic 3. Reviewing the post-merger integration 4. Devising ongoing improvement and disposal During recent years, Mergers and Acquisitions (M&A) have become a valuable tool to help a company grow rapidly without having to create another business entity. But the merger of two companies can create wide ranging problems for CFOs as they have to combine the socio-technical, financial and accounting systems of the merging organization into one newly –combined system. This presentation will focus on:
- 3. Organic or withM&A, the Goal is: Build Shareholder Value
- 4. Maximization of Shareholder Value Shareholder value isthe guiding link among management activities MANAGEMENT’S MISSION Employee & Investor Communications Performance Measurement and Information Systems Financial Policies & Practices Shareholder value management is making all operating, investing and financing decisions according to their impact on value. It means changing the way you think about running your business and creating a culture of concern for value. Strategy Formulation Corporate Development Incentive Compensation Shareholder Value Management
- 5. The principle offinding the highest valued use for all assets guides all acquisition and divestiture decisions Principle: Portfolio Implications: Valuation Condition: Find the Highest Valued Use for All Assets Keep or Potentially Acquire Divest or Avoid Buying Value to You Value to Others> Value to You Value to Others > CREATING VALUE WITH M&A
- 6. Organic GROWTH vs.Acquisitions Leverage existing assets for growth Buy assets and improve for additional value ORGANIC CUSTOMERS SEGMENTS PRODUCTS GEOGRAPHY TECHNOLOGY CUSTOMERS SEGMENTS PRODUCTS GEOGRAPHY TECHNOLOGY ACQUISITION
- 7. However, creating valuein transactions is difficult for buyers Shareholder Returns Average Returns from Acquisitions -20% -10% 0% 10% 20% 30% 40% Target Buyer (initial) Buyer (one year) Buyer (two years)
- 8. Organic vs. Acquisitions… … there are a lot of shades of gray ! 1. Pure Organic growth from existing assets 2. Distribution Agreements 3. Toll Manufacturing and Direct Sales 4. Greenfields on new technology / new geography 5. Bolt-on Acquisitions on existing segments / geography 6. Acquisitions to acquire Technology / Management 7. Acquisitions to enter New Markets 8. Transformational Deals
- 9. Therefore, defining theStrategy is a prerequisite to create Shareholders’ Value • Forget about available acquisition targets at first • Focus on the “Big Idea” • What do you need to drive a compelling, differentiated, and sustainable competitive advantage? • Is an Acquisition the best alternative ?
- 10. Strategic Analysis 1. IndustryAnalysis: Is the industry creating value? 2. Competitive Analysis: How do we compare to the competition? 3. Segmentation: What segments are attractive? 4. Strategic Development: What strategies might enhance our competitive advantage? 5. Valuation: Which strategy creates the most value?
- 11. Acquisitions • Does anacquisition accelerate our ability to deliver our Strategic Plan? • How? Scale Brands - Segment Distribution Management Geography Technology • Can we add value to the business and is the value of the combined entity greater than the sum of the parts? 1 + 1 = 3 … Synergies ?
- 12. To identify andimplement value creating transactions, there are ten questions to answer M&A PROCESS Key Transaction Questions Tools, Frameworks & Analyses 1. How will a transaction help us achieve our goals? Acquisition Strategy 2. Which companies might be good targets? Strategic Fit Search and Screen 3. What type of transaction would make the most sense? M&A vs. Alliance, JV and Minority Interest 4. What synergies might be created? Scale, Scope, Skill Strategic and Financial Due Diligence 5. What is the target worth to us and to other potential bidders? DCF Valuation Multiples and Transaction Analysis 6. How should we assess target performance? Shareholder Value Analyses Economic Profit and Other Analyses 7. What risks are involved? Cost of Capital Analysis Sensitivity, Scenario and Simulation Analysis 8. How should a deal be structured? Assets vs. Stock Purchase Cash vs. Stock Payment Fixed vs. Contingent Payments 9. How should the target be integrated? Absorption vs. Preservation vs. Symbiosis vs. Holding 10. How can we prepare for and implement negotiations? Negotiation Planning and Strategies
- 13. Why M&A Disciplineis important? Studies conducted by McKinsey and KPMG concluded that over 60% of acquisitions failed and that over 80% of acquisitions failed to create value. Acquisitions fail for a number of reasons: •Flawed Strategy •Overpay •Due Diligence failures •Poorly managed integration •Lethal competitive response •Cultural Clash •Poor acquisition process
- 14. Strategy • Company • Group •Division • Segment CEO COO CFO Corp Dev. Div. Pres. Corp. Dev. and / or Div. Pres. / Operating Team Corp. Div. Pres. and Operating Team Div. Pres. / Operating Team Corp. Team Outside Corp. and Division Corp. Dev. w/ • Div. Pres. / OP Team • Legal • Environmental • Tax Strategic Agreement Courtship Negotiation Close Integration Target Identification Post Analysis Board of Directors Approval Senior Management Approval Corp. Dev. and Div. Pres. Board of Directors Review Sherwin-Williams Acquisition Process
- 15. Target Identification • Identifyand screen targets for their fit with the strategy and the ability for the combined entity to build a competitive advantage • Scale • Brand and marketing • Distribution – channel and geography • Operating efficiency • Technology • Think about:
- 16. Once your business’competitive position is known and strategy has been set, characteristics of targets with good strategic fit become evident: Factor Relative Position Synergy Hypothesis Buyer Ideal Target Scale O - We can bring a smaller target economies of scale Operating Efficiency + - We can improve a smaller target’s efficiency Service O + They could help us improve service Product Breadth O O Complimentary product lines would expand both of our product breadth Marketing/ Brand + + Quality brands would strengthen our portfolio Pricing O + Upscale customers could be migrated to our brands Potential Synergies
- 17. The value ofa company will be the highest of its acquisition, current and break up values The Value Spectrum STRATEGY SYNERGIES Break Up Value Current Value Acquisition Value Also known as asset value or liquidation value Assumes that the best strategy for the business is to cease operations Also known as stand-alone value Assumes that the best strategy is the current strategy Also known as value with synergies Includes synergies the firm might be able to create with other businesses
- 18. Several methods canbe applied to value companies, but they are not necessarily equivalent METHODOLOGY CALCULATION FOCUS STRATEGY VALUED Net Assets Assets - Liabilities Value Break-up Current Multiples - Price/Earnings - Price/Cash Flow - Market Value/Book Value - Price/Sales Calculate using current prices: P/E x Earnings P/CF x Cash Flow Market/Book x Book Value P/Sales x Sales Price Current Transaction Multiples - Premium to market value - Premium to book value - Acquisition Multiples (Shares x Price ) + a premium Book Value + a premium Calculate using acquisition prices: P/E x Earnings P/CF x Cash Flow Market/Book x Book Value P/Sales x Sales Price Synergistic DCF Cash flows forecasted under the current strategy discounted at the weighted average cost of capital Value Current DCF with synergies Cash flows forecasted using synergistic strategy discounted at weighted average cost of capital Value Synergistic PRICE VS. VALUE Common Valuation Methods
- 19. DCF is theprimary tool for valuing synergies because it links decisions to their impacts on value DECISIONS Operating Margin Taxes Working Capital Capital Expenditure Cost of Capital Market Size Market Share Sales Mix Retail Prices Staffing Levels Wage Rates Raw Material Prices Tax Effective Structures Accounts Receivable Accounts Payable Contract Terms Plant Life Replacement Equipment Maintenance Scale of Operations Cost of Equity Cost of Debt Leverage VALUE DRIVERSMICRO DRIVERS Cash Profit Investment Required to Support Operations Discount Rate Cash Flows from Operations Shareholder Value DETERMINANTS OF VALUE Revenues Operating Investing Financing DISCOUNTED CASH FLOW FRAMEWORK
- 20. The DCF frameworkdiscounts free operating cash flows to estimate a company's value DISCOUNTED CASH FLOW FRAMEWORK (C) Forecast Period Residual Period + + = - = 2006 2007 2008 2009 2010 2011 - - - - - - - - Residual Value CF CF CF CF CF1 2 3 4 5 (A) (B) (D) (E) Present Value of Free Oper. Cash Flow Present Value of Residual Value Non Operating Assets Enterprise Value Market Value of Debt and other Obligations Shareholder Value
- 21. Why DCF? • DCFremains the favorite of many practitioners and academics because it relies sole on the flow of cash in and out of the business, rather than on account-based earnings. • DCF makes evident when cash will be returned from every each acquisition.
- 22. Due Diligence -Definition • Thorough investigation of the business, personnel, legal, financial and tax state of a potential acquisition • Significant commitment of time, resources and money by both Sherwin-Williams and seller • Process managed by Corporate Development but support from Operating Team and Corporate Staff is critical
- 23. Due Diligence -Process • Must maintain momentum from the Initial Offer agreement to complete transaction • Due diligence request list can be intimidating to the seller … take the time to explain and help. • Kick-off meetings with internal team and target critical to timely and successful process • Target timing is 12 to 16 weeks but this can vary significantly depending on the acquisition • Employment agreements and employee engagement must be carefully managed
- 24. Why is DueDiligence Important? • Important decision point: Yes/No on the acquisition –> Search for “Deal Breakers” • Verify sellers representations made at the time deal was struck • Impacts pricing considerations/valuation model • Facilitates contract (required representations and warranties; schedules) • Highlights necessary consents and approvals • “Unofficial” start to integration process –> great opportunity to interact with target’s people -> ask for Management or Expert meetings
- 25. Due Diligence Areasof Focus • Environmental • Legal/Litigation • Tax • Pension (legacy costs) • Working Capital (overdues and slow-moving) • Compensation and Benefits • Foreign Corrupt Practices Act (FCPA)
- 26. Integration is oneof the least glamorous, yet most important phases of the acquisition process • The Critical Success Factors noted in your Strategic Agreement/Approval presentations and financially detailed in your valuation/proforma should guide your integration process. • Integration starts during the courtship phase, well before the deal is completed • Each acquisition is different and requires its own unique integration approach • Integration is process that requires active management Integration Phase
- 27. Lessons Learned (1)… Top Management view: 1. Maintain focus: new distribution, new technology, new markets 2. Stick to a model process (discipline) 3. Set IRR Targets: Domestic: …% International: …% (+risk premium) 4. Improve division top line and profitability 5. Manage cash and its return 6. Accuracy and integrity of financial statements 7. Detailed focus on integration and synergies 8. Size matters (…think larger…) 9. Post analysis 10. Stay aggressive and build targets’ pipeline
- 28. Lessons Learned (2)…Divisional Management view: 1. The business model drives the right acquisition’s price. 2. To enter in new markets is multiple times more resources’ consuming than strengthen our position in existing countries (bolt-on). 3. Dimension matters (sales and/or market share). 4. In targeting acquisitions, integration ability and substantial synergies are key decision points. 5. A target must be profitable: we are not in the turnaround business (?) 6. Spend time to assess the country risks and competitors’ strengths .
- 29. Lessons Learned (3): Pre-Deal • Bring more intelligence to the process. Assess current capabilities and resources needed at the very beginning. • Reinforce guidelines on communication with the press • Don’t be scared by the complexity. Ask for alternatives • Take advantage of your local team in the existing geography. • Develop second-best to take care of day-to-day operations when your first line gets deeply involved in a sizable deal. • Discuss tax implications at the very beginning (Asset vs. Stock deals). • Look at formulas for price sharing and to minimize cash upfront, ( like earn-out formulas or significant hold-backs)
- 30. Lessons Learned (4):Integration • Have your own fully dedicated gatekeeper and a thorough Project Management Plan • Assign dedicated financial people from day zero. • Create taskforces and checklists (better on-line). However, do not expect to get by with off-the-shelf checklists • Implement ASAP your Policies and Procedures. • Training on FCPA (and f/up on any due diligence findings) is one of the most important element to set the right tone on compliance
- 31. Lessons Learned (5):Pro-forma year-one • Not to the point of “sand-bagging” but a jump start is really needed to create morale and confidence on both sides. • Be prudent. Work on “what-if” scenarios • Consider salary integration issues (equalization / retention / different benefits or perqs). • Estimate extra taskforce / temporary management • Be realistic with environmental costs, as well as Health and Safety (multinational standards are very high!) • IT integration is always very costly (do not underestimate network and communication costs -> security) .
- 32. Lessons Learned (6): The Way Forward • Create a repository/common database to share relevant information on lessons learned about due diligence, valuation, integration … • Monitor how you are improving Profitability and Market Share through the right balance between M&A vs. Organic Growth . • Measure if acquisitions are delivering proforma (and returning cash invested); keep “measurable” as long as possible also bolts-on acquisitions. • Create specific Divisional Corporate Development Teams to keep the M&A process alive and to build pipeline of targets. • Coordinate Divisional CD with Corporate CD with open communication and full sharing of pipeline!
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- 34. Impact of DueDiligence on Valuation • Verify sellers representations made at the time LOI was signed (i.e.. sales, profits, GM, pricing, etc.) • Confirm viability of synergy/dissynergy assumptions • Input liabilities/assets not originally included in the original valuation model (i.e.. current liabilities that might transfer with the business, compliance/remediation costs) • Update estimated transaction costs Gain a clear understanding of the value of the business going into negotiating the SPA
- 35. The five primarycomponents of value in an acquisition are “stand-alone” value, and four types of synergies Stand-Alone Value Synergies Buyer Creates within Target Synergies Target Creates within Buyer Dis-Synergies Buyer would Face Buyer’s Defensive Synergies Total Value to Buyer The amount of the potential buyer’s stand-alone value lost if the target is not acquired The reduction in value caused by combining two businesses The value of all improvements to the buyer’s operations The value of all improvements to the target’s operations The value of the target as a “stand-alone” entity under its currently anticipated strategy 1. 2. 3. 4. 5. + + + + = VALUING SYNERGIES
- 36. Acquisitions can createvalue by creating synergies that affect revenues, costs or investment • Cross-sell to new markets/customers • Create more attractive full-line product range • Improve sales/marketing effectiveness through new capabilities • Gain/secure distribution channel for existing products • Gain first mover advantage • Technology or technical capability (credibility, new products) • Vertical integration benefits VALUING SYNERGIES Synergies Higher Revenues Lower Costs Lower Capital Requirements • Gain scale benefits • Access new process technology capabilities • Eliminate need for expensive research and development • Spread fixed overhead costs • Scope economies • Optimization • Leverage/utilize excess capacity, eliminating need for plant investment • Access new capabilities in working capital management
- 37. Synergies are commonlygenerated in three basic ways Selected Examples Selected Issues/Considerations Scale “Get Bigger” Leveraging fixed or semi-variable costs Distribution leverage Supplier leverage Benefits can be “competed away” in an active bidding process Scale economies may be overtaken by scale complexities Does the target operate in the same strategic “segment”? Scope “Get Broader” Product/service expansion Geographic expansion Vertical integration Channel expansion Does vertical integration reduce costs or increase effectiveness? Do customers value a broad product line? Will they pay a premium or favor you over narrower line competitors? Are customers intent on purchasing nationally or globally? Is demand shifting across channels? Skill “Get Better” R&D capabilities Product developing skill Manufacturing skill Marketing skill Is acquisition the best approach to access/apply the skill? Do you/they really have the skill in sufficient quantity? What costs or barriers exist to applying the skill? SYNERGIES
- 38. Some synergies takelonger to achieve than others TIMING Short Term Medium Term Long Term Staff reductions Cutting variable costs Access to assets Technology leverage Supplier efficiencies Customer acquisition Geographic expansion Channel expansion Combine distribution Cross-selling Production economies Skill transfer Sales force integration International coordination Joint R&D Vertical integration Common Synergy Timing* *Illustrative only
- 39. Avoid the “sevendeadly sins” of synergy identification and evaluation 1. Over-estimating the amount (or underestimating the timing) of total synergies 2. Confusing total synergies with unique synergies 3. Assuming that synergies created within your operations can necessarily be saved for your shareholders 4. Forgetting to look for synergies created within the target and within our operations 5. Forgetting to identify and value dis-synergies 6. Over-estimating defensive synergies 7. Pursuing targets without a clear understanding of whether they are worth more or less to you than other bidders COMMON ERRORS
- 40. Business Environment Vision Strategy Processes Structure Culture Performance Results FeedbackLoops The Business All “Business Decisions” are Tested for “Compatibility” Among the Framework Components Possessing true Domain Knowledge Provider of Global Coatings Business Solutions Clearly defined Customers, Brands and Channels Segmentation Achieving Best-in-Class Process Excellence Having Motivated, Skilled People in the Right Jobs Operating in a Culture of Disciplined People, Disciplined Thought & Disciplined Action; open dialog Accountable for the targeted Business Results Coatings Business Management Framework
- 41. Elements of SuccessfulAcquisitions • Clear objectives and criteria • Well selected candidates • Correct strategy formulation • Product/market dynamics • Assessment of synergies • Proper valuation • Establish “walk away” price with synergies • Integration teams • Value-lined targets and timetables • Monitoring and incentives Can you make an acquisition candidate more valuable? Can you quickly gain the benefits? Will you create value for your shareholders? Do you know exactly what you are buying? Right Strategy Right Information Right Price Right Implementation Elements Key QuestionsPurpose