Buyer Stress Test

Due diligence has taken on greater importance as buyers today are that much more cautious when it comes to dedicating precious capital to an acquisition. The conditions have also forced buyers to take a harder look in the mirror to determine whether or not their business can handle a deal.

“Many companies put a lot of time into understanding the business of their target, but it’s always stapled on to the financial forecast of their own business,” Jeff Gell, a managing director and partner at Boston Consulting Group, says.

BCG, in October, issued research that included a buyer's checklist. The report, "Be Daring When Others Are Fearful," discussed things buyers need to look at ahead of a deal and various ways they can optimize their valuations, whether it's through revisiting their dividend policy or improving their credit ratings.

William R. Kucera, an M&A partner at Mayer Brown LLP, said the current financial situation of many buyers has left management with little margin for error in assessing transactions. “In better times, they might get a do-over or two if things don’t work out,” he said.

Kucera adds that "a threshold question" even seasoned buyers are asking is: "Are we yet in a position to get back into the M&A game?”

Companies may spot value in the market, but even good deals can sink a company if they haven't stress tested their own business for every scenario that could await.

Gell warns that for all of the due diligence performed on a target company, if a buyer’s core business suffers after an acquisition, the management will face angry shareholders that come out against the deal. This will happen even if the company’s losses had nothing to do with the transaction. “Investors often aren’t smart enough to realize when you underperform, they will just think you overpaid for the acquisition,” he says, adding that he has seen situations in which the management team is replaced because the base business underperforms.

The inward facing due diligence can look at a lot of things. Gell recommends taking the initiative to identify a reasonable range of events, including unlikely and uncomfortable circumstances as opposed to just the predictable situations. Buyers should know ahead of time the financial implications of a deal for each situation and understand the kind of fallout each scenario may have.

In the recent past, a number of deals probably would not have seen the light of day had the buyers taken a closer look at their own position. Dow Chemical's acquisition of Rohm & Haas or Bank of America's Merrill Lynch acquisition are two deals that might come immediately to mind.

To Gell, who would not discuss specific transactions, internal due diligence can be just as important for acquirers as efforts focused on the target. “It’s a matter of going in eyes wide open, as opposed to eyes wide shut,” he says.

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