I recently had the opportunity to visit Tom Pannell, Managing Director in the investigative and risk advisory practice at K2 Integrity, on the current M&A and deal-making scene. We examined it from both a national and an international point of view.
Pannell noted that the market initially experienced a major slump with the outbreak of the pandemic. Most of the businesses were driven by economic problems. This was the clearest scene in the consolidation within the energy industry. However, in the second half of 2020, things turned back to the way they were in 2019. Pannell said, “You would never expect so much activity in the second half of the year, but a lot of large companies and private equity funds have huge sums of money and are trying to put it to use. People didn’t spend that much. You’ve probably invested it in places and given PE funds an extra boost. “This has resulted in the market being“ extremely competitive ”right now. It also means that depending on the asset class you are buying, valuations can be very high. Companies that have shown that they can move to a remote workforce during this time and stay competitive can “really take a premium from the deal market”.
Conversely, companies that were negatively affected by the pandemic could be “offered at fire sale prices”. The bottom line is that multiple ends of the spectrum are at play at the same time. Pannell said, “You see industries like technology and digital players with huge premiums and very high multiples. and other sectors that are more in need, such as retail, which causes low multiples. Pannell also said, “There will be an increased risk of fraud. What worries me most from a deal standpoint is the fraudulent financial reporting where you’re trying to improve your results to show that the pandemic didn’t affect you as much. You are still a valuable target. “
In May 2021, the market will be at a point where there is a lot of catching up to do. This could literally lead to an “explosion of deals if we move into the summer and things relax a little.” This situation presents new or potentially different challenges related to the inability to make site visits or face-to-face interviews with key executives of a destination. Data analysis is always critical and large amounts of information are available electronically. It is usually “swimming in data in the data room”. It is important to make sure that you have the correct information to analyze. But even with the financial statements, test balances, sales registers, customer master files and other information, you need to test and search selected samples and push management to get the information and read the books and records of a support person for the transaction.
With a multitude of enforcement actions such as corruption and anti-corruption measures, trade sanctions and data protection, other types of due diligence are now required in the context of mergers and acquisitions. You need to deal with corporate culture, cybersecurity, export controls, and a host of other areas that have traditionally been done through personal due diligence.
I asked Pannell, how do you feel about the priority of these other non-financial issues? He noted that you want to “take a step back and look at your deal. What is the track record of your goal in these areas? Are there any red flags or any operational questions you may have? What is the full scope of the operations? Look at your customers, what are they doing, what are they selling? Where do you sell it? How do you sell it? Are they using dealers and third parties, are they selling to governments? Things like this. “
We finished with a look at SPACs (Special Purpose Acquisition Company). Pannell began: “In the past, most SPAC transactions viewed warrants as an equity instrument, but recently the Securities and Exchange Commission (SEC) announced that they could in fact constitute a liability. From a fair value accounting perspective, this can affect the overall view of the balance sheet and how you account for gains and losses on that liability when you account for it at fair value. This is a complicated area right now that is receiving a lot of attention from the investor community and those who are just doing SPAC business. “
International mergers and acquisitions involve both different and increased risks. If an organization hits a multinational global deal, it is likely a fairly sophisticated buyer. However, the ultimate risk of the transaction will inform what you are doing. Since the risk can be both variable and increased, “I think careful consideration is key and let the target’s profile determine the activities you will be doing. Look at the target’s trail and see what they actually do. If it’s a little different than what you do as an acquirer, they may present a slightly different risk than you are used to. “Some of these could include who the target is selling to, where the customer is and what their business is like. Does the goal have us a distributor model? Do you use third party sales agents and are customers of foreign governments?
Another area for investigation and verification is a destination’s supply chain. Pannell said, “You really need to understand your supply chain and know where the underlying goods are made all the way through to the end customer.” This means that an acquirer needs to really understand the risks surrounding the underlying supply chain and what this can bring. However, a physical look at their facilities may also be required to determine what problems may arise during a physical inspection. Another area that is currently receiving a lot of attention is the fight against money laundering (AML). An acquirer must review the target’s AML program. This is especially true for banks and other financial institutions that are expanding their global presence. Pannell said, “You want to look into your AML compliance programs. You should look at governance. Finally, you will study the customer due diligence policies and procedures and controls, as well as KYC. “
A new area for background checks in international transactions is national security. The United States Foreign Investment Committee (CFIUS) became much better known under the previous administration. This importance will remain in the new administration. Pannell pointed to the failed attempt by Chinese company Alibaba to buy MoneyGram as a key example.
We turned to some of Pannell’s thoughts on culture. Why it is so important and why it can be such a challenge in an international acquisition context to get it right. Pannell believes, “Culture is crucial. Mainly because from the perspective of the cultural norm, people don’t always do business the same way. Doing business in the US is very different from doing business in Sub-Saharan Africa. Africa is very different from business in Asia. Considering common practices is an integral part of due diligence in a global business. “
From an anti-corruption and business ethics perspective, you need to review the entire compliance program. Is it a paper program and / or are they putting it into practice? They need to review their policies and procedures, try to understand the tone from above, there is a code of conduct and general tone for ethical behavior. These are all important questions that you need to get to grips with the due diligence process before making a purchase. Pannell finds that one key is training a goal that he called “really, really important”. Things like you as a trainer and who is being trained are not just critical issues but can be important indicators of an organization’s culture.