Financial due diligence, including the well-established quality of earnings analysis, has been an ingrained practice for many years. Corporations and private equity firms generally do not close a deal without performing this type of analysis at a certain level. However, in recent years, more and more emphasis has been placed on the value enhancement elements of due diligence, namely the identification, quantification and evaluation of synergy and cost savings opportunities.
The need for this type of analysis has always been there, but given the typically tight timeframe of most deals, buyers and sellers traditionally haven’t spent enough time in developing a thoughtful savings or cost takeout plan. With time, mature buyers have come to appreciate the tremendous benefits associated with this facet of diligence, and there is an increasing demand for it in the market right now.
Due to the competitive, high-multiples deal environment, private equity firms are extremely value-focused, which is a key reason behind this increasing demand for synergy and cost savings diligence.
Organizations will often develop their own thoughts and ideas on potential upsides of deals; these positives may come from improvements and enhancements they believe they can make to a target’s operating model, or due to a merger being contemplated of the target with one of their portfolio companies. Based on data and our many years of experience in advising transactions and businesses, RSM US LLP can evaluate if a plan would create the sort of value an acquiring company is anticipating and offer recommendations on the alternatives that might deliver the best results.
Some investors prefer to have third parties validate potential cost savings and synergies as this bolsters their ability to secure lender financing. Lenders, in turn, place reliance on a third party’s ability to validate the value enhancements being proposed. An objective review of the underlying support and proposed outcomes enhances visibility into the magnitude of potential savings or lack thereof; this valuable additional data is appreciated by investors and lenders alike.
Synergy and cost savings assessments have become especially important for those contemplating complex acquisitions. Modeling savings through operationally driven synergies is always valuable as it allows buyers to establish the right valuations on target companies while minimizing any post-close pitfalls from experiences not aligning to pre-deal expectations.
A few of the areas in which RSM typically encounters cost savings and hidden value include:
Buyers typically want to understand if they can simplify the operating environment or integrate it with an existing business and not be hampered by legacy operating systems. Often buyers want to be able to move to a single enterprise resource planning or customer relationship management system or core operating platform. Our analysis provides insight into what would be possible with the existing technology, quantifies the pro forma run rate costs, estimates the one-time expenditures associated with integration, and provides insight into what approach would make the most sense given the investment thesis.
When two companies merge, there is usually a duplication of roles and responsibilities, especially in back-office and support functions.
That said, head count is not always easy to reduce. There are quite a few situations in which head count synergies can be quite complex to implement. Considering relevant workloads in conjunction with other aspects such as quality, safety, and customer satisfaction, as well as evaluating opportunities for automation, reduction of manual tasks, and process improvements, are important considerations that need to be assessed. There is no one-size-fits-all approach, and head count changes are in quite a few cases not as simple as they might seem.
Third-party spend also provides a significant opportunity for value creation when companies merge. Comparing the relationships, pricing, and terms for each company’s material costs, insurance premiums, outside counsel, transportation providers, and professional services partners (such as audit, tax, and consulting partners), to name just a few, will typically uncover savings opportunities. These may include renegotiating pricing arrangements, maximizing rebates, increasing scale, and simplifying the combined business. At the same time, it takes thought and insight to unwind these relationships smoothly and without negative implications to the top and bottom lines or the overall risk profile of the combined business.
Despite there being some common threads, no two synergy and cost savings analyses are the same given how different each investor’s strategy and objectives might be. That said, there is almost always value to be uncovered. In a short period, we can evaluate some key business aspects (or operating areas) and compare them with your portfolio company or companies and with leading practices, and then assess the one-time cost required to achieve savings and help you understand the true value to be extracted through a deal.