Due Diligence in M&A By Prof. Samie
JSW CIC Energy Deal Fails After eight months of hectic negotiations and due diligence, in June 2011 Indian power firm JSW Energy's plans to acquire Canadian coal miner CIC Energy Corp failed. The $422 million proposed deal was called off after it failed to fructify within the required deadline of May 31. The Canadian company now intends to open its data room for other potential suitors, however it is open to further talks with JSW on a nonexclusive basis. One of the prime reasons for the deal failure due diligence.
What is Due Diligence Due Diligence is the process by which business, legal and financial information is collected about a company involved in a corporate transaction. In the M&A process, Due diligence is an activity whereby an acquirer does an exhaustive study on the target and tries to ensure that the right price is being paid for the target. A target s primary objective is a successful sale at the highest possible price. The acquirer s objective is to determine whether to purchase the target, and at what price. Due Diligence is all about the seller providing all required information to the buyer for analysis. A proper due diligence can help buying companies avoid unpleasant surprises post merger.
Two Phases of Due Diligence The Due Diligence process can be divided into two phases : Phase 1 Due Diligence before the offer Phase 2 Due Diligence after the offer is made Phase 1 Due Diligence involves reviewing publicly available information. This is done on the pitching side of M&A. Phase I Due Diligence is initiated once a target company has been selected. The main objective is to identify various synergy values that can be realized through a merger or acquisition with the target Company. Phase 2 Due Diligence is a more exhaustive review of all possible information of the target company. This is done on the finalizing side of M&A. Phase 2 Due Diligence happens once the negotiations between the two parties have started.
Phase 2 Due Diligence Due diligence for a buyer Due diligence for a seller Data room inspection Review of private documents Assess and analyze information Evaluate risks and potential returns and prices Structure transaction and terms Set up Data Room Prioritize letters of intent Create short list of potential buyers Set deadline for offers Provide assistance in data room
Steps in Due Diligence The process of Due Diligence comprises of the following steps: Planning Phase Data Collection Phase Data Analysis Phase Report Finalization Phase Due Diligence Reporting
Where is all the information? A physical data room (PDR) is a secure room and is the most important tool in the due diligence process and serves the same function for a seller s company as does the display case for a commercial establishment a place to display one s goods for sale. The buyer will therefore send its team of experts, primarily lawyers and investment bankers, to verify their known information about the target with the contents of the data room and to gather new information. The PDR is a physical location, typically a secure room provided by the seller, where all information regarding the target is temporarily maintained for viewing by potential buyers. In a PDR, information is made available in the form of files and documents placed in binders, folders and boxes.
Virtual Data Room At the start of the new millennium, a transformation occurred with the M&A transaction due diligence process when the first Virtual Data Room (VDR) was set up and used in place of a PDR. A virtual data room (VDR) is essentially an Internet site with limited controlled access, using a secure log-on supplied by the vendor/authority which can be disabled at any time by the vendor/authority if a bidder withdraws) to which the bidders and their advisers are given access via the internet. The major difference between a PDR and a VDR is in the area of access. Access to a PDR is typically sequential, while access to a VDR is exclusively parallel. VDR is specially cost efficient in Cross Border M&A. Using a PDR, only one buyer team may access the information in a data room (unless multiple data rooms are set up at added expense and effort) while multiple buyer teams may access the same data at the same time through a VDR.
What do we look for.. Regulatory Records: Filings with the market regulator, reports filed with various governmental agencies, licenses, permits, decrees, etc. Tax Records: Tax returns for at least the last 5 years, working papers, schedules, correspondence, etc. Debt Records: Loan agreements, mortgages, lease contracts, etc. Miscellaneous Agreements: Joint venture agreements, marketing contracts, purchase contracts, agreements with Directors, agreements with consultants, contract forms, etc. Target Company Property Records: Title insurance policies, legal descriptions, site evaluations, appraisals, trademarks, etc. Financial Records: Financial statements for at least the past 5 years, legal council letters, budgets, asset schedules, etc. Corporate Records: Articles of incorporation, by laws, minutes of meetings, shareholder list, etc. Employment Records: Labor contracts, employee listing with salaries, pension records, bonus plans, personnel policies, etc.
UTI GTB Failed Merger Ketan Parekh or KP as he was popularly known was a central character in the failed GTB-UTI merger. Investigation reveals that Ketan Parekh used funding from GTB bank to inflate share prices for instance HFCL share price went upto Rs. 2500 in early 2000 s (Rs. 15 in 2011). Same modus operandi was used to inflate the prices of GTB to get a favorable swap ratio on its merger with UTI bank share price of GTB shot from Rs. 70 to Rs. 117 in three weeks just before the merger. UTI was accused of not performing the necessary due diligence on NPA s of GTB - According to estimates, GTB had net Non-performing assets of as high as 19 per cent of the net advances at the time of its merger with OBC.
UTI, GTB and Due Diligence Mr Nayak, as the head of UTI Bank and especially because he stood to gain personally from the merger, should have got a due diligence of the proposal conducted, Joint Parliamentary Committee. The then UTI chairman PS Subramanyam and the then UTI Bank chairman and managing director PJ Nayak (who stood to gain personally from the merger) are substantially responsible for the lack of transparency in UTI and the UTI Bank s decision making process and the failure to conduct a due diligence exercise, Joint Parliamentary Committee Report. The UTI could not have been unaware of the sharp spurt in GTB stock. Perhaps, the prospect of becoming the largest player prompted it to go for the merger. But once the possibility of price manipulation came to the fore, the merger was sure to be called off-- either by the banks themselves or by the RBI. GTB had tried to make the best of what was becoming a messy situation. There were indications from the Finance Ministry that the merger was low on the priority list. Perhaps, there was a subtle understanding that the bank would back off on its own Business Daily
Due Diligence in India After the GTB-UTI debacle, the Joint Parliamentary Committee report made recommended Due Diligence to be a mandatory part of the M&A process. RBI has made it mandatory for banks to perform Due Diligence in the M&A process in the banking industry. SEBI has made it mandatory for merchant bankers to fill a Due Diligence Certificate while proceeding with a M&A deal. The merchant banker shall ensure that the contents of the public announcement of offer as well as the letter of offer are true, fair and adequate and based on reliable sources, quoting the source wherever necessary. The merchant banker shall ensure compliance of the Regulations and any other laws or rules as may be applicable in this regard.