| With the pound stronger against
the dollar than it has been in nearly 12 years, you
cannot blame some UK companies for thinking that this
is an opportune time for making acquisitions in the
US.
While UK/US deal activity rose modestly in the past
six months, the increase was sharper on the sell side
than on the buy side, as companies seized the opportunity
to dispose of problematic US holdings.
Sainsbury's plc sold Shaw’s – the second-largest
supermarket chain in New England – to Albertson’s,
anticipating that WalMart’s push into food might
ultimately threaten its traditional supermarkets. And
Cable & Wireless sold its US Internet transfer and
hosting business to Gore Technologies for about 10%
of the price paid for these assets five years ago.
On the buy side, notable acquisitions by UK firms reflect
extensions of long-established US expansion strategies.
For example, the Royal Bank of Scotland recently completed
its acquisition of the credit card portfolio of People’s
Bank for $2.3 bn.
Historically, the correlation between UK/US deal activity
and the strength of the pound has been weak, and with
good reason: companies that think strategically have
to consider a host of factors when making an acquisition
or divestiture in the US, and are not likely to base
their decisions exclusively on short-term currency fluctuations.
This is especially true in today’s global market
where entire industries can migrate to markets where
the quality of human capital is high and the cost far
lower than in the US or other developed countries.
In this environment, perhaps the most important question
a British buyer can ask is this: does my US acquisition
candidate have something – a customer base, brand
name, technology or other intellectual property –
that a competitor cannot easily lure or copy or outsource?
Without one of these, it is not likely to retain its
value in today’s market, where many products are
fungible. Traditional financial, tax and legal due diligence,
while critical, cannot answer this question. This requires
an additional level of analysis during diligence that
assesses four forces that drive the future performance
and long-term viability of the target:
- The threat of new market entrants
- Degree of rivalry among existing
competitors
- The threat of substitution –
either of the entire product or its components
- The bargaining power of suppliers
and customers.
Let’s consider how a company
would go about obtaining this information and how it
would complement traditional financial due diligence.
A British firm had an opportunity to buy a US consumer
products manufacturer with a recognised brand name at
what appeared to be an attractive price. Financial diligence
revealed that while the company was capable of meeting
its sales projections, offshore competitors would put
pressure on profits within five years.
The UK firm’s diligence team
advised it to conduct commercial diligence before making
a go/no go decision. The team began by looking at trends
in worldwide sources of supply for the target’s
product, and who had pricing power within the industry
supply chain.
The team soon learned that while the target’s
brand name gave it some advantage in the US, this was
not sufficient to stem inroads by offshore manufacturers
who could offer a quality product at a much lower price.
In short, the target could meet its volume forecasts
only by selling at an unsustainable price that compromised
profits. Even if the target immediately began moving
its manufacturing operations overseas, its survival
as a US company was threatened as the industry’s
“tipping point” had already been reached.
During the time it would take to get an offshore manufacturing
operation running, the target’s competitors were
likely to solidify their position in the US, while its
own market position would erode further, making a reversal
of fortune unlikely. Needless to say, the prospective
UK buyer walked away.
Commercial diligence uses
strategic analysis tools to assess internal and external
factors that could affect a target’s ability to
execute its strategy and meet future performanceexpectations.
It also provides a market and strategic lens that clarifies
the image of a target gleaned through traditional financial
due diligence. Basically, commercial diligence analyses
three things:
- Market structure and dynamics
– This involves using primary and secondary
research to analyse the target’s industry at
the market and sub-market level, going as deep as
buyer needs and available data will allow. It focuses
on segmenting the market, analysing the industry value
and supply chains, and measuring the margin pool available
to a target, given its level of industry participation.
Since the attractiveness of a target, like the one
described in the example above, can be affected by
power shifts and structural changes within its industry,
a key deliverable of any commercial diligence project
is laying out scenarios where this is likely to occur,
and gauging how these scenarios are likely to affect
the target.
- The competitive landscape
– While most buyers have intelligence on a known
set of competitors, they may not have defined the
competitive environment broadly enough, or grouped
competitors by strategy or customer loyalty. By using
interviews with customers, competitors, trade sources
and other knowledgeable third parties to supplement
a target’s quantitative data, commercial diligence
can help a prospective buyer develop a realistic framework
to use in assessing the likely moves and strategic
threats posed by the target’s major competitors.
- Customer relationships
– Before a UK firm buys a US company, it must
understand US customer service standards within the
target’s industry, as these may differ from
those in the UK. It is only within this context that
the buyer can assess the quality and durability of
the target’s customer relationships, or identify
ways to enhance them. Analysing customer relationships
is a sensitive process that has its limits. Although
customers usually will not reveal their strategic
sourcing plans, they often make subtle references
that give a buyer useful insights. For example, a
company revealed that it had over-bought an acquisition
candidate’s products because it expected a run-up
in sales in response to a promotion. But the sales
fell short of expectations, and the customer planned
to cut future orders and ask for extended payment
terms. Finding this out during diligence could help
a buyer negotiate better terms. Learning it after
a deal closes might lead to a covenant negotiation
with the bank!
The message for UK companies eying US targets is clear:
to avoid missing commercial factors that could undermine
your long term strategic goals, be sure to supplement
financial due diligence on a target with market, competitor
and customer analyses.
This will help validate the business case for making
a US acquisition, and help determine whether the target
in hand offers the best vehicle for winning in the US
market. Colin McKay is the global leader of PricewaterhouseCoopers’
Transaction Services practice.
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