Jakarta Post

When to walk away from a business deal

As important as recognizing the right investment is recognizing the wrong one.

By Suvir Varma and Satish Shankar

First published on septiembre 06, 2006
min read


Some of Indonesia's largest companies, such as PT Bumi Resources, PT Energi Mega Persada and PT Adam Skyconnection Airlines, are eying potential acquisitions and assessing where and how to invest. But as important as recognizing the right investment is recognizing the wrong one—because due diligence turns up systemic weaknesses in the business or the price is just too high. The question too many companies forget to ask is not "How to close the deal?" but "When to walk away?" The truth is that making the right call about acquisitions, for buyers and sellers, is a challenge that more and more executives face, and it is getting harder. When Bain & Company recently surveyed 250 senior managers with merger and acquisition responsibilities, half said their due diligence process had overlooked major problems, and half also found that targets had been dressed up to look better for deals. Two-thirds said their approach routinely overestimated the synergies available from acquisitions. Overall, only 30 percent of executives were satisfied with their due diligence processes. A third acknowledged they hadn't walked away from deals despite nagging doubts. What can companies do to address these common shortcomings? For starters, they can rid themselves of their "going in" assumptions. Private equity firms like TPG tell us their acquirers' advantage lies in being industry outsiders: they force themselves to ask basic questions about how an acquisition truly will make money for investors. Indeed, such coldly realistic calculations lie beneath a rising tide of private equity-backed mergers and acquisitions across Asia. Last year, private equity investors accounted for about 11 percent of all merger and acquisition activity, with more than US$120 billion in capital under management across the region. Top corporate buyers take a similarly rigorous approach: "When I see an expensive deal, and they say it was a 'strategic' deal," says Craig Tall, vice chair of corporate development at U.S. financial services company Washington Mutual, "It's a code for me that somebody paid too much." Due diligence starts with verifying the cost economics of the proposed deal. Buyers must ask such questions as: Do the target's competitors have cost advantages? Why is the target performing above or below expectations? To arrive at a business's true stand-alone value, all accounting idiosyncrasies must be stripped away. Often, the only way to do that is to look beyond the reported numbers by sending a due diligence team into the field. But focusing these efforts is important. China Mobile got left at the altar earlier this month by its takeover target, Millicom. By some accounts China Mobile's exhaustive approach to due diligence fostered concerns at Millicom that, along with pricing issues, helped scupper the deal. Successful acquirers focus on creating a detailed picture of their target's customers. They begin by drawing a map of the target's market—its size, its growth rate and how it breaks down by geography, product and customer segment. It's just as important to examine the capabilities of competitors. For example, in the bid of one global food company to buy an overseas maker of fruit flavorings that we will call FruitCo, the acquirer found that while FruitCo boasted considerable global scale, the key competitors were national: local factors turned out to be the more relevant driver of costs. That was because the economics of transportation and purchasing made the global sourcing of fruit—a major cost component—unfeasible. And advanced processing technologies were enabling FruitCo's competitors to achieve competitive economics at the country level. The acquirer came to recognize that, "What we thought we knew turned out to be wrong." Indeed, successful acquirers know that the ultimate goal of due diligence is to determine a walk-away price. And for this price to have meaning, successful deal makers must be willing to walk away, just as Millicom did last week; and just as HSBC did last year, from a deal to buy Korea First Bank that ultimately went to Standard Chartered. In the end, effective due diligence is about balancing opportunity with informed skepticism. It's about testing every assumption and questioning every belief. It's about not falling into the trap of thinking you'll be able to fix problems after the fact. By then, it's usually too late. Suvir Varma is a partner with Bain & Company and leads the firm's Southeast Asia Private Equity Practice. Satish Shankar, also a partner, heads Bain's Southeast Asia Consumer Good Practice.

Some of Indonesia's largest companies, such as PT Bumi Resources, PT Energi Mega Persada and PT Adam Skyconnection Airlines, are eying potential acquisitions and assessing where and how to invest.

But as important as recognizing the right investment is recognizing the wrong one—because due diligence turns up systemic weaknesses in the business or the price is just too high. The question too many companies forget to ask is not "How to close the deal?" but "When to walk away?"

The truth is that making the right call about acquisitions, for buyers and sellers, is a challenge that more and more executives face, and it is getting harder. When Bain & Company recently surveyed 250 senior managers with merger and acquisition responsibilities, half said their due diligence process had overlooked major problems, and half also found that targets had been dressed up to look better for deals.

Two-thirds said their approach routinely overestimated the synergies available from acquisitions. Overall, only 30 percent of executives were satisfied with their due diligence processes. A third acknowledged they hadn't walked away from deals despite nagging doubts.

What can companies do to address these common shortcomings? For starters, they can rid themselves of their "going in" assumptions. Private equity firms like TPG tell us their acquirers' advantage lies in being industry outsiders: they force themselves to ask basic questions about how an acquisition truly will make money for investors.

Indeed, such coldly realistic calculations lie beneath a rising tide of private equity-backed mergers and acquisitions across Asia. Last year, private equity investors accounted for about 11 percent of all merger and acquisition activity, with more than US$120 billion in capital under management across the region.

Top corporate buyers take a similarly rigorous approach: "When I see an expensive deal, and they say it was a 'strategic' deal," says Craig Tall, vice chair of corporate development at U.S. financial services company Washington Mutual, "It's a code for me that somebody paid too much."

Due diligence starts with verifying the cost economics of the proposed deal. Buyers must ask such questions as: Do the target's competitors have cost advantages? Why is the target performing above or below expectations? To arrive at a business's true stand-alone value, all accounting idiosyncrasies must be stripped away. Often, the only way to do that is to look beyond the reported numbers by sending a due diligence team into the field.

But focusing these efforts is important. China Mobile got left at the altar earlier this month by its takeover target, Millicom. By some accounts China Mobile's exhaustive approach to due diligence fostered concerns at Millicom that, along with pricing issues, helped scupper the deal.

Successful acquirers focus on creating a detailed picture of their target's customers. They begin by drawing a map of the target's market—its size, its growth rate and how it breaks down by geography, product and customer segment.

It's just as important to examine the capabilities of competitors. For example, in the bid of one global food company to buy an overseas maker of fruit flavorings that we will call FruitCo, the acquirer found that while FruitCo boasted considerable global scale, the key competitors were national: local factors turned out to be the more relevant driver of costs.

That was because the economics of transportation and purchasing made the global sourcing of fruit—a major cost component—unfeasible. And advanced processing technologies were enabling FruitCo's competitors to achieve competitive economics at the country level. The acquirer came to recognize that, "What we thought we knew turned out to be wrong."

Indeed, successful acquirers know that the ultimate goal of due diligence is to determine a walk-away price. And for this price to have meaning, successful deal makers must be willing to walk away, just as Millicom did last week; and just as HSBC did last year, from a deal to buy Korea First Bank that ultimately went to Standard Chartered.

In the end, effective due diligence is about balancing opportunity with informed skepticism. It's about testing every assumption and questioning every belief. It's about not falling into the trap of thinking you'll be able to fix problems after the fact. By then, it's usually too late.

Suvir Varma is a partner with Bain & Company and leads the firm's Southeast Asia Private Equity Practice. Satish Shankar, also a partner, heads Bain's Southeast Asia Consumer Good Practice.