LEAN EQUITY TRANSACTIONS.

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1 LEAN EQUITY TRANSACTIONS

2 BACKGROUND The economic outlook across the Middle East has evolved radically over the last four years, due not only to the shock caused by falling oil prices but also by a changing political climate. This shock has given rise to a spiral of austerity, with most fiscal balances within the region transitioning from surplus to deficit. As a result, governments of the Gulf Cooperating Countries (GCC) are now trying to re-balance their public finances, marking down capital expenditures, lowering public sector salaries and finding ways to generate additional revenues. In addition to this, factors such as shifting demographics, increasing life expectancy, rising levels of urbanisation and an increasing female share of the labour market are exerting ever more pressure on the GCC s historically state-focused economic systems. CHALLENGES Today, governments of the GCC are facing unprecedented challenges. They need to assure the supply of the funds and resources necessary to sustain new demographic demands such as increased welfare expenditures and rising demand for investment in education, infrastructure and other sectors. These challenges entail the need to switch over to a stronger market economy and attract external funds and resources from both foreign and local investors. The basic milestones for the region s economic systems are now therefore: Increase the level of competitiveness within both private and public sectors through increased productivity of core businesses; Develop a platform of local business leadership and introduce new managerial and technical skills in both the private and public sectors; Attract investment into innovativing technologies; Attract resources quickly to address an immediate need for investment in infrastructure and education. These challenging milestones have led many GCC governments to re-appraise their visions and national transformation plans. Today, these plans prefigure a path of privatisation projects, stimulation of the sector consolidation of mature businesses and development of venture capital operations, with the aim of raising funds for new innovating technologies. The current outlook foresees a short-term resurgence of the Equity Market across the region. With it, the expected growth of equity transactions brings a strong need for accurate Operational Due Diligence to avoid equities being undervalued. 1

3 FOCUS AREAS The due diligence phase of every equity transaction covers multiple aspects of business administration, from financial and fiscal to legal and accounting considerations. Due to the increased importance of securing expected Return On Investment, from both the seller s and buyer s perspective, a new type of due diligence has imposed itself in recent years - Operational Due Diligence (ODD). Operational Due Diligence concerns all of the activities and processes of the core business of a company or business entity. The ODD s objectives are: 1. Validate the assumptions made in a business plan or feasibility study used by both the seller and the buyer to justify the purpose of the transaction; 2. Test the forecasted future cashflows both positive and negative; 3. Plan short-term countermeasures to quickly recover hidden losses and uncover hidden treasures by way of quick implementation projects. AREAS OF WASTE OFTEN IDENTIFIED IN EQUITY TRANSACTION PROCESSES SALE/DIVISION The seller of a target business usually performs a feasibility study before issuing an information memorandum to potential buyers. In this phase, one of the major concerns of the seller is to understand the maximum value that can be recovered from the sale of the business, especially after the implementation of any pre-deal restructuring projects. Failing to do so entails a very real risk of leaving value on the table after the deal, thereby recovering less financial resources than expected from the transaction. IPO - INITIAL PUBLIC OFFERINGS After its commencement, the seller of a share of stock through an Initial Public Offering (IPO) performs a due diligence with the financial institutions participating in the offering. Even under these circumstances, the seller needs to understand the best feasible price range that can be offered during the subscription phase in order to avoid losing value in the transaction. ACQUISITION/MERGER During the due diligence phase, the buyer has the opportunity to check the health condition of the target business - not only by accessing undisclosed documentation in a data room, but also by way of visits to both administrative and production sites. One of the biggest risks the buyer faces during this phase is relying completely on the opinions and forecasts of local management. Doing so risks missing opportunities - not only of allocating to the business plan proper contingencies that could be used during the negotiation phase to establish the best price, but also of discovering areas of hidden potential that can be exploited in any post-deal implementation plans. Missing this opportunity usually leads to a fall in the expected Net Present Value of the investment. 2

4 LEAN SOLUTIONS Applying Lean to the Operational Due Diligence process will give a buyer or seller an edge in the negotiation, enabling them not only to achieve the best possible price, but also to make decisions based on complete and correct data, obtained bottom-up from their own resources. An Operational Due Diligence is usually carried out by advisors using a top-down approach, relying predominantly on management data and forecasts. Conversely, the Lean approach starts from the bottom, from the gemba - the Japanese term for workplace, where both value and waste are created. Only through careful observation of the places where activities actually happen is it possible to get a deep understanding of both the potentials and the risk areas of any given business. At Four Principles, we have developed a specific methodology for Operational Due Diligence, based on our expertise in the application of Lean Principles. This methodology fits perfectly with the expectations of customers, financial advisors indeed all of the main stakeholders involved in the transaction ANALYSIS OF TARGET DEVELOPMENT OF A POTENTIAL SCENARIO EFFECT ON FINANCIAL KPIS AGGREGATION IN REPORTS & ADVISORY Is the business plan valid? What are the benefits of a streamlined future-state? What is the effect on financial KPIs? How to proceed? Identifying risks & potentials and giving recommendations Our Lean solutions (see Figure 1) for ODD provide a very powerful tool for buyers and sellers of businesses, enabling them to get a deeper understanding, based on reality, of how the business is currently doing and - more importantly - of what needs to be implemented to increase its specific value. 3

5 TANGIBLE IMPROVEMENTS The application of ODD with the gemba approach has enabled buyers and sellers to enter and pursue the negotiation phase with an enhanced level of awareness. From the buyer s perspective, Lean ODDs have, in many instances, enabled improvements of between +10% and +25% in expected Net Present Value (NPV) or expected Internal Rate of Return (IRR). INDUSTRIAL GOODS In two different plants of a target company producing chrome plated steel bars, a series of very specific audits detected quick wins in the Overall Equipment Effectiveness of the company s chroming equipment. This analysis revealed the opportunity to recover production capacity this was then addressed with an implementation plan which resulted in the reduction from 12 to 10 chroming manufacturing lines. These restructuring efforts increased the buyer s expected IRR by 18%. CONSUMER GOODS Structured visits, performed as part of an Operational Due Diligence in an assembly / packaging plant of a target company producing assembled furniture, led to the identification of a potential 22% increase of assembly line productivity. This was then recovered through the implementation of Lean One-Piece-Flow and Takt principles. Moreover, these visits enabled the identification of a risk area in the buyer s business plan, based on an overestimation of the packaging lines production capacity. The resulting recommendations enabled a negotiated reduction in the purchase price by 10%. Together with the execution of a post-deal restructuring plan, this reduction led to a 14% increase in the investment s Net Present Value. 4

6 Should you be interested to know more about our Lean services regarding this topic, then please contact us: Tel info@fourprinciples.com Dubai, UAE Office Address Dubai Media City Building 8 Office 212 P.O. Box Dubai, UAE 5