Thought Leaders I

Due Diligence: Sometimes a Successful Acquisition Requires Walking Through Some Muck

To do due diligence on an acquisition, sometimes you have to walk through a lot of muck. Zehavit Cohen, a partner in Apax Partners in Israel, toured through hundreds of dairy farms before purchasing Tnuva, Israel’s leading dairy and food producer. The company, which began as a cooperative, was built around more than 600 farming communities. During four and a half months of due diligence, Cohen went to every community. “Each one insisted that I visit their cow farm,” she says during a recent session of Creating Value Through Financial Management, where she discussed mergers and acquisitions.

There is no substitute for this on-the-ground knowledge of the company before acquisition. The added time spent with members of the entire community helped Apax clinch the deal during a competitive bidding process.

But most important, the detailed knowledge of the operation and cost structures helped to shape a business case for making improvements that could increase profits. Since each partner is personally responsible for ensuring the success of the acquisitions they lead, Cohen needed to be certain she could deliver the expected returns.

Successful Acquisitions

Apax buys companies, manages them, and exits in five to seven years. Through careful acquisitions and execution, Apax has achieved a high IRR on its investments over the past 15 years, including the recent downturn.

“In today’s world, growth is difficult to achieve organically,” Cohen says. “You have to acquire companies. Part of M&A is to go and do due diligence, using models and valuations to come up with projections. Unfortunately, once people buy the companies, they forget about all the models, and run companies based on earnings per share and next year’s accounting figures. Private equity firms manage based on basic stuff, which is cash flow.”

Most financial statements don’t have a lot of value for managers running a company, says Cohen. “The Cash Flow Statement is the most important statement we have. We want to maximize cash. All of the rest of the statements are not that relevant. The target of the company is to maximize shareholder value, which means maximizing cash flow over time. Let’s manage the real thing, not accounting.”

• Hire change agents: Successful acquisitions require strong management, particularly executives who can serve as “change agents.” Given this focus, Cohen says they typically bring in some new managers. During due diligence, they carefully assess the capabilities of top managers and they receive a weekly report from consultants on top managers.
  
  “Before we do a closing, we know who is going to manage the company,” she says. They look for current managers who say: “If I could only run the company, here is what I would do,” she says. “You want people who can keep their feet on the ground, but their heads should be in the sky.”
  
  
• Use value drivers to concentrate attention: To keep managers focused on the important things, it is vital to narrow them down to a few measures. “Don’t ask people to manage ten things at a time,” Cohen says. “Come up with two to four. Each manager has two to four value drivers.
  
  
• Don’t be blinded by ‘synergy’ and ‘strategy’: Keep the focus on cash and returns, Cohen says. “It seems that when you talk about ‘synergies,’ you are able to spend as much money as you like. The other word is ‘strategic.’ You are able to spend as much as you want because it is ‘strategic.’ These are the two most dangerous words in management. You meet with companies who discuss their vision but not what they are doing. And if the synergies and strategies do not materialize to cash – forget about it. When people talk about vision and there are no concrete numbers and concrete steps, it is dangerous. How do we get there?

Relentless Execution

In the 1980s M&A boom, investors bought low and sold high, making money through shrewd financing. “People think you make money in acquisitions by financial engineering,” she says. “Not today. You make money by managing. Most money is made through EBITDA [Earnings Before Interest, Taxes, Depreciation, and Amortization] and EBITDA growth.”

Apax has a relentless focus on making operating improvements. Before the deal for Tnuva, they had identified 326 quick wins, from changes in servicing equipment (which reduced plant shutdowns) to changes in handling payables. They then move to longer-term value creation projects such as M&A.

While Apax intends to own the companies for a medium term period, the focus is on increasing long value. “If I sell a company in five years, I want the buyer to see the next 15 years at an even higher value,” she says.

• Mergers and Acquisitions
• Creating Value Through Financial Management
• Strategic Thinking for Competitive Advantage