Financial due diligence, including the well-known quality of earnings analysis, has been an ingrained practice for many years. Corporations and private equity firms generally do not close a deal without performing this type of analysis at a certain level. However, more and more emphasis has been placed in recent years on the value enhancement elements of deals, namely the identification, quantification, and evaluation of synergy and cost savings opportunities during diligence.
“The need for this type of analysis has always been there, but given the typically tight timeframe of a deal process, buyers and sellers traditionally haven’t spent enough time developing a thoughtful savings or cost takeout plan. With time, mature buyers have come to appreciate the tremendous benefits associated with this facet of diligence, and there is an increasing demand in the market right now,” says George Theocharopoulos, a director in transaction advisory services at RSM US.
Due to the competitive, high-multiple deal environment, private equity firms are extremely value-focused, which is a key reason behind this increasing demand for synergies and cost savings diligence.
“Our clients quite often develop their own ideas on the potential upside whether from improvements and enhancements they can make to a target’s operating model or from a merger between the target and existing portfolio companies. We can evaluate if their plan would create the value they are anticipating and offer recommendations on the alternatives that might deliver the best results, based on data and our many years of experience on advising businesses,” says Kartik Sundar Raj, a partner in transaction advisory services at RSM US.
Some investors prefer to have third parties validate the cost savings and synergies that are identified as it bolsters their ability to receive lender financing.
“Lenders place reliance on the third party in validating the value enhancements being proposed. An objective review of the underlying support and proposed outcomes enhances visibility into the magnitude of potential savings or lack thereof providing investors and lenders with additional valuable data,” says Scott Barcroft, a director in transaction advisory services at RSM US.
The synergy and cost savings assessments have become critically important for those contemplating complex acquisitions and modeling savings through operationally driven synergies.
“The analysis is always valuable as it allows buyers to establish the right valuations on the target company while minimizing any post-close pitfalls from experiences not aligning to pre-deal expectations.” says Barcroft.
A few of the areas where RSM typically encounters cost savings and is able to unlock value include:
Technology
Buyers typically want to understand if they can simplify the operating environment or integrate it with an existing business and not be hampered by legacy operating systems. Often times buyers want to be able to move to a single ERP, CRM system or core operating platform. Our analysis delivers insight into what would be possible with the existing technology, quantifies the pro forma run rate costs, estimates the one-time expenditures associated with integration, and provides perspective on what approach would make the most sense given the investment thesis.
Headcount
When two companies merge, there is usually a duplication of roles and responsibilities especially on the back-office and support functions.
That said, headcount is not always easy to reduce. There are quite a few cases where headcount synergies can be more complex to implement. Reviewing relevant workloads in conjunction with other aspects such as quality, safety, and customer satisfaction as well evaluating opportunities for automation, reduction of manual tasks, and process improvements, are only some of the key considerations that need to be assessed. There is no one-size-fits-all approach, and headcount changes are in quite a few cases not as simple as they might seem.
Third-party-spend
Third-party spend also provides significant opportunity for value creation when companies merge. Comparing the relationships, pricing, and terms for each company’s material costs, insurance premiums, outside counsel, transportation providers, and professional services partners (such as audit, tax, and consulting partners to name a few), will typically uncover savings opportunities from best price arrangements, maximizing rebates, increased scale, and / or simplification of the combined business. At the same time, it takes thought and insight to unwind these relationships smoothly and without negative implications to the top and bottom lines or the overall risk profile of the combined business.
Despite there being some common threads, no two synergy and cost savings analyses are the same given how different each investor’s strategy and objectives might be. That said, there is almost always value to be uncovered. In a short period of time, this type of analysis can look to evaluate some of key business aspects (or operating areas) and compare them with a client’s portfolio companies and / or with leading practices based on our experience, assess the one-time cost required to achieve the savings, and help a client understand the true value that could be extracted.