Business deals in volatile environment

1. 1
Corporate Strategy Board
M&A Focus
Doing Deals in a Volatile Environment
How to Modify the Deal Process for the Current M&A Climate
Key Questions Addressed
• What is the current business climate for doing
deals?
• How big an issue is volatility as a complicating
factor in trying to do deals at this time?
• Where is the deal process most likely to break
down in a volatile or uncertain environment?
• What emerging process fixes are corporate
dealmakers considering or implementing?
Overview
On September 3rd, 5th, and 8th, 2008, the Corporate
Strategy Board conducted small group discussions
with a total of 15 Corporate Development Executives
on the challenges associated with doing deals in a
volatile environment. This document outlines the
topics discussed, the data presented, and an
overview of the key insights that surfaced from
executives at each point in the discussion.
Discussion Moderator: Seth Verry
Document Author: Ross Katz

2. 2
Executive Summary of the Discussions
With private equity sidelined in the past 12 months, buying
opportunities for corporate dealmakers have improved. Indeed,
corporate deal-making on a transaction volume (not value) basis
has actually gone up. But the current environment of volatility is
complicating what could otherwise be a very productive period,
with a bit of a "one-two punch” for corporate dealmakers.
First, the deal market itself is in a transitional period: coming
down the from the deal-making peak of 2007, buyers and sellers
are exhibiting mismatched expectations for price, with buyers
hoping for bargains and sellers holding out hope for strong
pricing. Earnouts, as a way to bridge these gaps, have become
the “necessary evil” of the current environment. As appropriate
as these devices are, they are extremely difficult to use in
practice.
Second, the extreme volatility of the macro-economy and capital
markets has several implications for the deal process. For
instance, contract "adjustments" are more likely to be required
between announcement and close as conditions change rapidly.
Thus, deal executives should pay more attention to Material
Adverse Change clauses and the other contract devices that
buyers (and to a lesser extent sellers) can use to protect
themselves from many aspects of volatility. The larger issue is
the impact of uncertainty on deal approvals: confidence in
valuation models takes a hit, and management teams become
conservative and less willing to consider bold commitments of
capital. Leading dealmakers are considering valuation
techniques that better deal with uncertainty, but they are also
finding that the real solution here has less to do with technical
valuation and much more to do with reframing the business case
– and sometimes the deal structure – to align with the current
bunker mentality of management teams.
Table of Contents
I. Summary of the Current Deal Environment
• Volatility Complicates Dealmaking……….3
• Strategic Dealmaking Remains Strong…..4
• Prices are Down Yet Still Relatively High..5
• Drivers of Continued Corporate
Dealmaking...............................................6
• The One-Two Punch of Volatility………….7
II. Challenges of the Current Environment
• Where Volatility Affects the Deal Process..8
• M&A Challenges to Dealmaking in
Volatility……………………………………...9
• Key Challenges to Dealmaking in
Volatility……………………………………..10
III. Valuation
• Valuation Overview………………………...11
• The Right Tools for the Right Time………12
IV. Negotiations
• Deal Structure Overview………….............13
• Pick Your Poison: Available Structural
Provisions……………………………………14
V. Management Conservatism
• Management Conservatism Overview…....15
• Combating Management Conservatism…..16
• The Power of a Good Story: Cargill’s M&A
Gameboard………………..……………........17

3. 3
Summary of the Current Economic Climate
Worldwide, deal volume has declined across
industries, but this is a misleading outlook for the
corporate dealmaker. Corporate M&A has grown 6%
since this time last year, indicating that Corp Dev
executives have continued to seek acquisitions as
private equity has moved to the sidelines. PE deal
volume is down 25% on last year (see page 4).
Meanwhile, prices have declined slightly, but not
significantly enough to reflect an opportunity for
bargain hunting (see page 5). Most industries are
still above their 10-year average EBITDA multiples,
with notable exceptions (for instance, real estate).
We believe this reflects a structural shift
occurring in the corporate M&A market. Acquisitions
are being more widely used as vehicles for
corporate strategy. This trend reflects the “open
innovation” movement, the growing use of
acquisition as a channel to customer solutions, and
the growing acceptance of adjacency market entry
as a valid corporate strategy. In addition, corporate
development groups are being staffed to more
effectively execute these strategies (see page 6).
We contend that current economic volatility is
impacting strategic M&A processes through two
primary forces:
• The “Transitional” Market for Deals: Seller’s
expectations have not yet returned to an
equilibrium that might catalyze a spike in
corporate bargain-hunting .
• Broader Macroeconomic Volatility: Volatility- in
equity markets, debt markets, and input
markets- renders the underlying assumptions
of deals difficult to trust (see page 7).
Volatility Complicates Dealmaking
Questions for Group Discussion
1. Does this capture the core dynamics of the deal
environment you are seeing?
2. How big an issue is volatility as a complicating
factor in trying to do deals at this time?
3. Which aspect of the overall volatility presents the
greatest challenge:
• the overall macroeconomic volatility
• the transitional nature of the market for
deals
Summary of Group Responses
Executives broadly agreed with our characterization of
the market, citing a mismatch between buyer and seller
expectations, unpredictable deal flow, fewer auctions,
less debt financing, longer negotiation time frames, and
management conservatism as the major complicating
factors of volatility. Both macroeconomic volatility and the
transitional marketplace contribute to these challenges.
Section #1: Summary of Current Deal Environment

4. 4
Overall Worldwide M&A Volume
Number of Transactions By Quarter
Transaction Volume by Buyer Type
% Change from Previous Year
Source: Thomson Datastream.
Strategic Deal Making Remains Strong
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
9,000
10,000
Q
1
2002
Q
2
2002
Q
3
2002
Q
4
2002
Q
1
2003
Q
2
2003
Q
3
2003
Q
4
2003
Q
1
2004
Q
2
2004
Q
3
2004
Q
4
2004
Q
1
2005
Q
2
2005
Q
3
2005
Q
4
2005
Q
1
2006
Q
2
2006
Q
3
2006
Q
4
2006
Q
1
2007
Q
2
2007
Q
3
2007
Q
4
2007
Q
1
2008
Q
2
2008
Strategic Private Equity
Source: Dealogic.
-25%
6%
On a Volume Basis, Deal Making by Corporate Buyers is Actually Up This Year
Section #1: Summary of Current Deal Environment

5. 5
Prices Are Down Yet Still Relatively High
0
2
4
6
8
10
12
14
Q1
2002
Q3
2002
Q1
2003
Q3
2003
Q1
2004
Q3
2004
Q1
2005
Q3
2005
Q1
2006
Q3
2006
Q1
2007
Q3
2007
Q1
2008
Q3TD
2008
6.3, Q4 2002
11.9, Q1 2008
EBITDA Multiples Have Corrected but Remain Far From Bargain Territory
9.7, Q3 2008
*Source: Thomson Datastream.
Median EBITDA Multiples*
By Quarter
Section #1: Summary of Current Deal Environment

6. 6
• Structural shift in the role that deals play in several ways:
– Acquisitions as means of product development via “open
innovation”
– Continued use of deals (and partnerships) to deliver on
“solutions” strategies
– Legitimization of “adjacent” growth strategies – often achieved
via deals
• Growing basic competence and staffing of Corp Dev groups
• Significant change in the market’s reaction to deals –more positive
than its used to be (McKinsey research)
• Kicker?: in a volatile economy deals can advance objectives more
rapidly plus signal management’s confidence in the strategy
• Bottom line: as long as there are strategies to advance, there will be
deals getting done
Drivers of Continued Corporate Deal Making
Several Structural Changes May Explain Why Corporate Buying Isn’t Slowing Down
Section #1: Summary of Current Deal Environment

7. 7
The One-Two Punch of Volatility
• The “transitional” nature of the market for deals
– sticky seller expectations for price yet impatient buyers looking for
bargains (akin to real estate)
– unclear when/if we reach a new equilibrium
– multitude of variables at play
• exchange rate impact on cross-border bargain hunting
• when PE comes off the sidelines
• pace of financial market recovery
• potential for post-election regulatory changes
• The broader context of macroeconomic volatility
– an unprecedented period in modern economic history
– wide range of indicators well outside of historical ranges
• oil, exchange rates, food prices, many commodities, real estate
– corporate planners having to rethink the planning process
– the focus of our Executive Workshop series this year
Corporate Dealmakers Are Dealing With Two Broad Dimensions of Uncertainty
Section #1: Summary of Current Deal Environment

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Corporate Strategy Board View
Based on our one-on-one conversations with
members, we contended that all aspects of the deal
process were affected by volatility. We captured these
issues through representative quotations on page 9.
We also synthesized those conversations into a map
of the deal-making process with corresponding
challenges for each phase, page 10.
Questions for Discussion
1. Which element of the deal process is most
stressed by the current environment of
uncertainty? And how?
2. What can be done to address the challenge?
• Process fixes you considering or
implementing
• Ideas you have heard about that pique your
interest
• Ideas you would like to test among this
group of peers
Where Volatility Affects the Deal Process
Summary of Group Responses
Participating executives expressed the greatest concern
with the following three aspects of deal-making:
Valuation: Volatility is undermining the assumptions which
are normally included in valuation models, causing
executives to consider alternative methods of valuation,
such as real options.
Negotiations & Deal Structure: In the current environment,
executives are encountering a mismatch between buyer and
seller price expectations. One executive observed that
sellers were expecting 30-40% premiums on their 52-week
highs rather than the currently depressed market value.
Several cited this mismatch as the most complicating factor
in the current economic environment. Mismatched price
expectations are lengthening the time frames between LOI
and close. Longer negotiation time frames are leading to
revisited deal terms. One executive believed these time
frames to be 30-40% longer than normal. Volatility during the
lengthened negotiation period perpetuates more revision
and uncertainty of deal terms up to the time of agreement.
Management Approval: Volatility is causing leadership
teams to become increasingly conservative about engaging
in acquisitions.
We introduced research and views on each of these areas,
and discussed them at length, as outlined on pages 11-17.
Section #2: Challenges of Current Environment

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M&A Challenges of the Current Environment
Representative Quotes from Research Interviews
“The latest challenge is overvalued companies that prefer not
to sell instead of dropping their ask price to reasonable levels.”
“Outside of the auction context, I am wondering how often
potential buyers are characterized as being overly aggressive
(e.g., taking too buyer friendly an approach on contract
terms)….Does the current environment influence initial
positioning in any significant way on this subject?”
“One of the challenges the volatile environment presents is to
make "Adjustments" to the earlier agreed (but not closed)
terms, when the environment was rosier then what it is now.
What kind of adjustments can be made and what clauses
can/need be incorporated in agreements to this effect (from
Buyer and Seller perspective) .”
Section #2: Challenges of Current Environment

10. 10
Limits of
DCF Method
• Standard
techniques not well
suited to the high
levels of
uncertainty in
critical inputs
Mismatched
Expectations
• Difficult to
reconcile price
expectations of
buyers and sellers.
Terms Revisited
• Buyers seeking
to renegotiate as
conditions change
Management
Conservatism
• Understandable
management bias
to “keep the
powder dry” during
current volatility
Potential
Synergies
Rendered Invalid
• Mid-cycle
integration efforts
needing drastic
redirection as
initial planning
assumptions prove
to be incorrect
Deal
Stage
Unpredictable
Deal Flow
• Deal flow
becomes
unpredictable (or
diminished) as
sellers revisit their
intent to sell
Valuation Negotiations Approval Integration
Prospecting
Process
Challenge
Valuation, Negotiations, and Approval are Most Challenging During Volatility
Key Challenges to Dealmaking in Volatility
Section #2: Challenges of Current Environment

11. 11
Valuation Overview
Corporate Strategy Board View
The current environment of uncertainty requires
dealmakers to consider alternative methods of
valuation, such as decision trees or real options. The
matrix of valuation techniques outlined on page 12
illustrates that some valuation methodologies are
more naturally suited to different types and levels of
uncertainty. This matrix comes from a past CSB
research on the global energy company Shell, which
faces relatively high degrees of project- and market-
based uncertainty in many of its initiatives.
Questions for Discussion
1. What challenges have you encountered when
valuing companies in the current environment?
2. Are you utilizing different methods of valuation?
• Real Options?
• Decision Tree?
• Other?
Summary of Group Discussion
Participating executives agreed that uncertainty in the
current environment undermines the assumptions of
discounted cash flow and other valuation models.
Triangulation is Preferred: Dealmakers are considering
more complicated valuation tools, such as real options
analysis, to better model the uncertainty of the economic
environment. However, experienced participants
advocated for using multiple valuation models to
triangulate the value of a company rather than trying to
accurately create one model for all of the uncertainties
involved.
Stronger Attention to Sensitivity Analysis: During
valuation, participants expressed the need to be more
conservative with inputs and conduct a robust analysis of
the assumptions underlying a valuation. This helps
discover which valuations may be less sturdy in the
current economic climate.
Section #3: Valuation

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The Right Tools for the Right Time
Shell Leverages Different Valuation Tools to Address Different Types of Uncertainty
Section #3: Valuation

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Deal Structure Overview
Corporate Strategy Board View
Corporate dealmakers have a wealth of
structural devices for reconciling divergent
price expectations and mitigating risk (see
page 14). The challenges is that the tools that
theoretically have the most potency – earnouts
and MAC clauses – are arguably the most
difficult to use in practice.
Questions for the Group
1. Are you altering deal terms to reconcile
price and mitigate risk?
2. Which of the tools, presented on page
14, are you using?
3. What challenges have you encountered
when utilizing these tools?
Overview of Group Responses
Participating executives agreed that structural tools were appealing when
trying to reconcile price and mitigate risk, but they disagreed about the
effectiveness of those tools. In particular, participants had valuable
discussion about these options:
Earnouts: Participating executives expressed divergent perspectives on
the use of earnouts to bridge the gap between buyer and seller price
points. Earnouts can be exceedingly complicated. One executive
described a meeting in which a parabolic formula was proposed to
determine the amount of an earnout. She laughed at the prospect,
“Lawyers are not mathematicians.” It would be difficult for an M&A lawyer
to describe complex earnout schemes in a contract, let alone make them
enforceable. Therefore, some executives explicitly avoid earnouts. Other
executives expressed more comfort with utilizing them. These executives
emphasized the need to keep them simple and explicitly align buyer and
seller interests.
Material Adverse Change (MAC) Clauses: For acquisitions of public
entities (where a time lag exists between agreement and close), volatility
is causing dealmakers to more closely consider the usage and structure
of MAC clauses. There is some disagreement about whether these
clauses can be worded to be neither too narrow nor too broad, such that
they can be enforced.
Closing Conditions: Warranties and Indemnities are being more
strongly considered and debated to protect buyers during the longer
timeframes between agreement and close. Participants expressed
difficulty with evaluating the terms to put in a deal outside of an auction
and deciding on the posture with which to approach negotiations.
Section #4: Negotiations

14. 14
Negotiation Integration
Closing
LOI Announcement Close
• Material Adverse
Change (MAC)
Clauses
• Termination Fees
• Lock Up
• Go Shop
• Other Affirmative &
Negative Covenants
• Earnouts
• Representations
• Warranties
• Hold-Backs
• Indemnifications
• Purchase Price
Adjustments
• Excluded Assets
Pick Your Poison
Buyers Have a Wealth of Structural Devices for Managing Uncertainty
Discussion Question:
What of these tools are
you now using to
manage risk?
Section #4: Negotiations

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Management Conservatism Overview
Overview of Group Responses
Participants made these recommendations for overcoming
management conservatism in a volatile environment:
Focus More Strongly on Strategy and Types of Synergies:
Participants consistently agreed that the volatile environment called
for even closer attention to how acquisitions fit with overall corporate
strategy. Synergies should be closely examined to ensure that they
can be delivered following integration. In addition, participating
executives are doing more granular market analyses to determine
which markets are desirable. This tactic ensures the deal stands up
to criticism and ensures that key stakeholders are invested.
Find Desperate Buyers in Your Organization: One executive
expressed the need to find desperate business heads to fund and
support acquisitions. Desperate buyers tend to have more sound
strategic logic and the commitment necessary to ensure that
integration occurs quickly and smoothly.
Pick Your Battles: Participants agreed that executives should
cautiously choose the acquisitions which are worth lobbying
management to undertake. As discussed above, organizational
commitment and alignment can be the most important factors in
determining acquisition success.
Get Capital Out of the Equation: Conservatism has put stringent
capital constraints on dealmakers’ purchasing resources. When
combined with exorbitant prices, many dealmakers are becoming
more open to alternative deal structures-such as alliances, licensing,
or option agreements- to make deals happen.
Corporate Strategy Board View
There are at least three broad strategies for
combating management conservatism when
it comes to doing deals: 1) demonstrating
the value of acting now, 2) reducing the cost
of action, and 3) showcasing the risks of
waiting. The following slide outlines these
strategies along with representative tactics
for pursuing them. Linking proposed deals to
the strategy is the clearest tactic; it’s also
something that many dealmakers believes
they do well when in fact they do not. Page
16 presents Cargill’s M&A Gameboard, a
tool Cargill uses to visually represent how
each acquisition fits into its overall strategy.
Questions for Discussion
1. Which tactics have you used to combat
management conservatism?
2. Which tactics have been most
successful?
Section #4: Management Conservatism

16. 16
Combating Management Conservatism
Strategies - and Representative Tactics - for Securing Management’s Approval
Strategies Representative Tactics
Demonstrate the
Value of Acting Now
Link the deal to the strategy
Leverage tools that visually link depict how deals done today set up
sequential moves that meaningfully advance critical strategies (example:
Cargill’s M&A Gameboard and associated CSB PowePoint tool)
Showcase the (positive) empirical record
Leverage recent CSB work on ‘Winning in the Turns,’ or BCG’s work on
doing deals during downturns; both analyses suggest that bold decisions
(such as deals), have a greater chance of creating competitive advantage
in uncertain or difficult times.
Reduce the Cost of
Action
Take capital out of the equation
Pursue a joint venture, for example, or secure “first right of refusal” for the
target while conducting further analysis.
Showcase the Risks
of Waiting
Make the cost of inaction visceral and real
Use war-gaming techniques to show how existing or new competitors could
seize the opportunity missed by not doing the deal yourself.
Source: Jeff Gell, Jens Kengelbach, Alexander Roos, “The Return of the Strategist –
Creating Value with M&A in Downturns,” The Boston Consulting Group (May 2008)
Section #4: Management Conservatism

17. 17
The Power of a Good Story
Cargill Uses its ‘Gameboard’ to Show How Each Deal Fits into a Coherent Strategy
Link to Excel-Based Tool to Create Your Own Gameboard
Link to Case Study for Further Detail on How Cargill Created and Uses the Gameboard
Section #4: Management Conservatism

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