Commentary & Analysis
Deconstructing Deals That Didn't Happen (Part 2)
Some M&A transactions in the printing industry fall apart before they reach the signing stage. Other deals, however, come undone after the ink is dry, and often for reasons that should have been obvious all along. New Direction Partners looks at how to stay out of the latter trap.
By Patrick Henry
Published: July 19, 2011
In Part 1 of this article, Paul Reilly and Peter Schaefer of New Direction Partners (NDP) analyzed why some M&A transactions in the printing industry fall apart before they reach the signing stage. Other deals, however, come undone after the ink is dry, and often for reasons that should have been obvious all along. It proves, say Reilly and Schaefer that there is no substitute for meticulous fact-finding at every stage of negotiations and due diligence.
Needless to say, this applies with double force to reviewing the financials. If the devil is in the details, there had better be no nonsense in the numbers-because if they contain any ambiguities about the seller's true valuation, the disconnect is certain to make itself known sooner or later.
Reilly recalls one recent case in which the seller's claim to have excellent pricing didn't pan out after the deal was done. The buyer, finding pricing to be lower by 10%, is still struggling to understand why there should be such a gap between pre-closing estimate and post-sale performance. In any event, says Reilly, the deal "is not reaching expectations, because the value-added has dropped so low."
The takeaways are that the due diligence leading up to the deal must be thorough, and that the seller should be careful not to overstate profitability. "Otherwise, it could come back and bite you," Reilly says.
Some Opposites Don't Attract
Harder but no less urgent to assess correctly is the potential impact of differences in business culture. The harm that this kind of confict can do to a deal should never be underestimated, Schaefer says. If cultural friction exists, it typically becomes apparent only when the deal is near to closing. Failure to acknowledge and address it at that point, says Schaefer, "makes integration very, very difficult."
What if company A is a low-cost producer with an attitude toward customer care that's analogous to Henry Ford's stance on customer choice ("You can have a car of any color you want, as long as it's black")?. What if Company B's mantra is, "Customer satisfaction at all costs?" Schaefer knows the answer: "You put those two companies in the same building-disaster," he says.
Another way to gauge differences in company culture, he says, is to look at how the respective managements handle (or are handled by) their salespeople. At some companies, sales teams write their own rules. At others, sales force management is more disciplined and prescriptive. Approaches as divergent as these will be hard to reconcile after the deal is closed, Schaefer says.
Never forget the unpredictable, sometimes illogical human element that comes into play in the structuring of every deal, counsels Reilly. Emotional involvement and the desire to reach a successful conclusion can cloud judgment. Additionally, the speed with which some deals takes place can lead to carelessness in due diligence.
Declare Your Intentions
But whatever the emotional climate, says Schaefer, it's vital for all parties to be candid about what they are thinking and feeling at every stage of negotiation. He cites one deal that, when it closed, represented a "fantastic acquisition" in which it was understood the president of the selling company would remain committed to the merged entity. But, two weeks later, this executive threw the deal into consternation by abruptly resigning. Schaefer's advice to others in similar situations: "Be up front, out loud about what your intentions are, post closing."
This story, says Reilly, serves as a reminder that at many companies, there is one person on whose presence success chiefy depends, and that if this person leaves the company in the aftermath of a deal, the consequences may be alarming.
He recalls a transaction in which the EBITDA was favorable, the market was strong, and the president of the selling company was full of assurances that his hand-picked replacement would be as good at running the business as he had been. The successor, unfortunately, did not live up to his advance billing, and the company's EBITDA profit margin dropped from 20% to 10% in a year. This is why, says Reilly, wise buyers will insist on having the seller's prime mover remain on the job for a sufficient interim period-six months, say, or however it will take to achieve an orderly transition.
Something else to handle with care during the transition is customer service, which should experience no interruptions or changes while everything else is falling into place. If operations are to be transferred from one plant to another, Reilly recommends dedicating someone to the logistics: "The process of planning and executing a move is a full-time-job," he says.
An ever-present risk in M&As is that key salespeople or accounts will depart after the deal is announced. The simplest preventive measure, Reilly says, is to let sales representatives and customer personnel know what is going on well in advance of closing. Reilly acknowledges that sellers may be reluctant to let buyers approach their customers in this way, but he insists that transparency is the best means of preserving their business after the deal is done.
Are Non-Competes Non-Starters?
Companies entering into M&As sometimes try to hedge against sales defections through non-compete agreements that prohibit departing sales employees from soliciting their former accounts on behalf of other companies. These agreements, however, do not always hold up in court when litigated.
As a countermeasure, Reilly suggests compensating salespeople bound by non-competes with stock in the merged company. Courts, he explains, may regard payment in stock as valid remuneration for a pledge not to compete in the event that the salesperson takes his or her leave, blunting arguments that the non-compete has deprived the ex-employee of the ability to make a living.
Finally, unpleasant though it may be to acknowledge, out-and-out dishonesty has to be counted among the things that can sabotage a done deal.
A case in point, says Reilly, was a transaction in which the seller was a private equity firm that deliberately misstated the quality of management in the company being sold. Eventually, it came to light not only that management was inadequate, but that the private bankers had spoken openly about it during one of their board meetings. The outcome, according to Reilly, was the seller's payment of a $2 million penalty to the buyer whose trust it had abused.
The moral? To Reilly and Schaefer, it's plain: always act in good faith when pursuing an M&A, but always get the facts. Insisting on transparency protects both parties against ugly-headed things that can rear themselves after it's too late to do anything about them.