Jeff Haxer: Commercial Due Diligence in Healthcare

For both corporate acquirers and private equity investors, the key to a successful transaction is effective commercial due diligence. Jeff Haxer, a partner with Bain's Healthcare practice, discusses a few lessons that corporate acquirers can learn from PE investors.

Read the Bain Brief: Global Healthcare Private Equity and Corporate M&A Report 2017

Read the transcript below.

JEFF HAXER: We do more private equity due diligence than anybody in the world. And we started to do more and more work with our pharma companies to understand how do they approach corporate due diligence. And we've noticed there's some differences. Both start off with the intention of, how can we buy this asset and make more money as a result? But somewhere along the way, they have diverging paths that they approach the problem slightly differently. And the first thing we noticed that was a big difference between private equity funds and corporate BD funds is private equity funds take a much, much more stringent view of the deal thesis. And corporate BD groups often will start with a critical deal thesis but will lose their way along the path of doing due diligence.

And so we've come up with the four C's. And the first C in writing a good thesis is that it has to be confirmable. You have to be able to prove or disprove it. And if you can't prove or disprove it, it's not good enough. The whole point of a deal thesis is to say, "What do I have to believe to make more money with this asset?" And if you can't prove or disprove it, it doesn't count. The second C is that it has to be chronicled, you have to write it down. And the reason is, you need people to look at it and react to it and say, "I understand it" or "I don't understand it." The third C is that there has to be consensus. And this doesn't mean everybody has to believe that it will happen. It means that everybody has to believe that that is what has to happen for this deal to make sense.

And then the last C is that it closes the gap. This means that it has to exist for a reason. There's a reason that you're buying this asset. It either drives revenue synergies or it helps you with cost synergies. Or it gets you into a market that you couldn't get in on your own. There has to be a reason why you're pursuing this asset.

The next piece is the market itself. And what we found out is private equity funds are much more likely and happy to say, "I don't know anything about this market." And therefore, they'll take a critical lens to it. How does this market work? Who's the winners, who's the losers, what are the trends?

Oftentimes, a corporation will look at it and say, "Well, I'm already in that market, and therefore I understand it. And so I'm going to take my understanding based upon the business unit that I already have in that market, and I'm going to project that that's what's going to matter to this asset that I'm buying." And they often won't take a critical lens to that market. And oftentimes, it's not the asset that will make or break the deal, it's the market. And if you miss the market trends, the asset's not going to outperform in that market.

The next piece that corporate funds will sometimes do is they'll get blinded by the synergies. They'll see a big shiny number early on and say, "We can take 10% of our cost structure out." And they put that down in the deal thesis, and they never come back to it. And the time they come back to it is after they bought the asset, and they plug it into their budgets and they find out—whoa, we can't make that. So you need to routinely scrub these synergy estimates that you have to make sure that they're going to work as you know more about the asset.

The last piece, and this is critical, is private equity funds are looking for a reason not to do the deal. And what we find is oftentimes corporate BD funds are looking for confirmation of why they should do this deal. And that we can sometimes call deal fever. So be very careful about having deal fever.

BD groups within a corporation exist to do deals. Their incentives are to get the deal done. The private equity group exists to do deals that can help to make money, not just to do the deal. And so they're more than happy to exit, walk away from a deal and move on to the next one, whereas a corporate BD fund looks at it and says, "Man, this is a great deal. I've got to make this work." And the longer they stay in the process, the more likely they are to succumb to deal fever.

So to wrap it up, corporate due diligence is very critical to making sure that you execute deals that make more money for you. And both corporations and private equity funds do commercial due diligence. But there's a lot that corporate BD funds can learn from private equity funds as they go along the way.

Read the Bain Brief: Global Healthcare Private Equity and Corporate M&A Report 2017