Due Diligence - Sellers

While diligence is ostensibly the buyer’s process, it typically is a bigger deal to the seller, who should take pains to manage the process closely. This is because wide-open diligence poses any number of problems to sellers:

- Disclosing sensitive information (often to a bitter competitor)
- Consuming management time
- Dragging on without end

As a seller, you’re highly motivated to limit the scope of review and the time buyers have to review the information. You don’t want to waste time and resources turning everything over, particularly if you know the documents are of marginal utility to the other side. It helps to try to think like the buyer and anticipate which of your information would be most useful to them, even if it’s not exactly what they’ve asked for.

You also don’t want to make your executives available for endless meetings and diligence sessions with buyers. Savvy buyers know that such meetings are not typically very helpful, particularly with public companies, and will be fine with keeping them brief. With others, you will need to set limits on availability, and be sure that the questions are appropriate for the senior exec involved. There’s nothing like seeing a slack-jawed head of marketing getting grilled about the intricacies of last year’s advertising budget . . .

And then, of course, there is the sensitive stuff. What’s important here is to keep things in perspective. Yes, it can get the hackles up to see your competitor rifling through your secrets. On the other hand, not everything marked “confidential” is worthy of considering thusly. Use this simple test: If your competitor doesn’t buy you, and violates the NDA and tries to use the info against you, what’s the worst they can do? For the vast majority of so-called "confidential" info the answer is: Precious little. Share freely if it’s painless to do so. For the truly sensitive stuff, consider providing it later in the diligence process once things have turned serious. You can even redact or simply tell the buyer it’s too sensitive to share (this last move is best used with care, as it can easily blow trivial documents far out of proportion to their meaning in the context of the deal).

Finally, while buyers would be content doing diligence 'till the cows come home, sellers are wise to put time limits on the process. The amount of time will depend on number of bidders and deal leverage, but setting boundaries is key. Naturally, you will not want to let diligence push on past signing unless it is limited to specific integration matters (and isn't set up as a closing condition).

There are far more intricies to how sellers handle the diligence process, from document copying to using multi-party diligence to further an auction process. I'll try to cover some of those in later posts.

Due Diligence - Buyers

Questions percolate in about the diligence process, so I thought I'd post some thoughts on various aspects of the process from the differing perspective of buyers and sellers. Today, the buyers:

As a buyer, your primary goal in diligence is simple:

Verify that the asset you are buying is essentially what you think it is.

However, buyers often run their diligence in ways that, at best, cost them money and time, and at worst ruin their deals. The two primary mistakes are using a cookie- cutter approach to diligence and over-reliance on outside help.

If an acquiror applies a standard diligence approach to all deals, it will inevitably be overdoing its diligence on many deals. A screaming deal - either due to price or strategic need - demands a very different level of diligence than a deal that is in the margins financially and for which there are strategic alternatives.

In the latter case, you'll want to go through everything at some level of detail, because even small hiccups could push your marginal deal into the red. In the former case, you should just be doing what I like to call "nuclear" due diligence - take a high level pass and make sure there is no radioactive waste: Subsidiary asbestos mining companies, crooked accounting - you get the idea. Subjecting such a deal to a rigorous diligence process is simply a waste of time and resources. Worse, since it is such a great deal, the delay inherent in doing such detailed work - and the annoyance it causes your target - may open a window for an interloping buyer to push you out of the way. If you went shopping for a new TV or computer last Friday, you would have seen this principle at work at Best Buy and Circuit City stores across the land: Not a lot of consultive selling; just a mad scramble to get the limited-quantity deals.

Relying over-much on outside accountants, consultants and lawyers complicates problem number 1. Diligence is in many ways an ass-covering exercise for those involved. In the absence of very clear guidance, even internal people will overdo diligence out of concern for missing something. External professionals will be even worse. Their incentives - financially, professionally and with respect to potential liability - are all aligned on the side of doing exhaustive diligence. As a buyer, you need to make sure they understand very clearly what your goals are for diligence in each case. Are you looking only for unexploded bombs, or for any accumulation of small liabilities? As is the case in many strategic deals, time to deal execution is often far more important than doing a complete diligence work-up.

As a buyer, it is important that you have a senior person running the diligence process so that the personalities can be controlled and the process tailored to the needs of the specific deal.

One final thought for buyers is the difference between valuation and integration diligence. In strategic deals involving significant integration issues, you need to do some high-level diligence on the integration process: Verify software platform versions, people issues, etc. However, the specifics of the integration process are unlikely to matter in verifying value or deciding whether the deal is go/no go. The tricky part is that your operating people will want to get into the specifics right away, because they are responsible for delivering the post-merger results. And of course, it's critical that integration happen quickly and smoothly so deal synergies can be fully realized. One approach that often works - particularly if you've been reasonable with valuation diligence up front - is to negotiate in the definitive docs a process for integration-related diligence between signing and closing. Such diligence won't be a closing condition, and it will be limited to integration-related information, but it can meet your need for speed in the stage up to signing while still getting the detail your ops folks need to start integration as quickly as possible.

More on Mining Deals

Check out The Deal for an in-depth look at the mining company M&A saga I've been posting about all year. The article, which obviously went to print more than a week ago, ends by speculating that Phelps Dodge might be an acquisition target. Indeed.

Google AdSense

With Google shares cresting the $500 mark, I thought I'd help out and add AdSense to my blog. I'm interested in seeing howly closely the AdSense program can hew to the target audience. This is a narrowly-focused blog - will it elicit ads for diligence and financial services or garden tools?

A Classic Rediscovered

I recently read Sloan Wilson's The Man in the Gray Flannel Suit. The book has often been described simply as a critique of corporate conformity, but that's far from apt. While it is in ways a period piece, its themes of balancing corporate ambition and family responsibilities should resonate with any of us corporate tools.

Our hero, Tom Rath, has even more than that to contend with: As the book opens, poor Tom strives to answer the following inane question on a job application: "The most significant fact about me is . . ."

It's a shock, then, when he considers the following response:

"It was the unreal sounding, probably irrelevant but quite accurate fact that he had killed seventeen men."

So Tom's got to climb the corporate ladder, find time for family and come to terms with his wartime experiences. Five years ago that would have seemed difficult to relate to; not so much now as our Iraq veterans return to the workplace

More Mining Consolidation

Readers of Corporate Tool will recall my fondness for the flurry of transactions this year in the mining sector, which has seen an unprecedented level of consolidation and hotly-contested deals. Those who followed this summer's trials and travails will recall the following:

1. Inco and Phelps Dodge agree to merge, with Inco acquiring Falconbridge as part of what is to be a 3-way deal.

2. Falconbridge is not to be had so easily, ultimately succumbing to Xstrata after a protracted bidding war.

3. Inco, reeling from its loss in the Falconbridge bidding, breaks off its agreement with Phelps Dodge and falls into the arms of CVRD - but not without extracting a nice premium in yet another bidding war.

This morning comes the news that Phelps Dodge, unable to bulk up as planned, has sold to Freeport-McMoRan for $26B. This represents a 33% premium on top of what has already been a nice run-up on the back of record copper prices; Phelps shares were at an all-time high before the deal was announced. A nice time to sell, and this summer's series of interloping offers obviously led Freeport to lob in what is sure to be a knockout proposal (further boosted by being two-thirds cash).

Besides the valuations and the bidding intrigue in all these deals, what's fascinating is the speed with which consolidation is causing even old-line companies in an old-line industry to lock up: Phelps has been an independent enterprise since the 1830's!

Techno-Slavery

I received a number of messages re my last post, and just at a time when my own work/life balance has precluded spending any time thinking about blogging. One common thread in the e-mail has the importance of using workplace technology as a tool for enriching one's life, rather than letting it enslave you.

Take mobile phones - I've had one since 1993, and it's hard for me to imagine a bigger productivity booster than having near-ubiquitous voice contact wherever I want it. At the time I got my first phone (an analog beast installed in my car), I had a debate with one of the other lawyers in my firm about whether it was a good idea to have a phone. He was a free-spirited surfer dude, and he sneered at mobile phones as "electronic dog collars" . . . until the day a few months later when he made a two-and-a-half-hour drive to a deposition that was cancelled ten minutes after he left the building. What I stressed then, and did again when talking to my father years later when he was dithering about getting his first phone, is that the damn things come with an "off" button for those times when you don't want to be reached.

With technology like mobile phones, e-mail and, indeed, portable broadband, the issue is more about boundaries than the technology itself. Technology is only going to enslave you to the degree you let it. And if you're able to use it to work more efficiently or shift work around so you can have a more flexible day, it's downright freeing.

Of course, even solid boundaries can't save you from the problems of "bleeding edge" technologies - those things that seem to hold the promise of making our working lives easier but consume more time than they save by clumsy interfaces, too much maintenance or lack of reliability (think voice recognition software, most PDAs and all-in-one message services). I'll take a pass on the "gee whiz" stuff unless in can make my life better right out of the box.

Work-Life Balance

Not to keep pushing Fortune, but once again I've got to point out their work - the latest issue, besides having a terrific in-depth piece on the fall of Milberg Weiss (hee, hee), has an illuminating "How I Work" portrait of Sun CEO Jonathan Schwartz (sorry; no link). I really like this feature - it's interesting how successful business people seem to have so many different ways of structuring their time.

One constant, however, seems to be a lack of balance between work and family time. This is a theme you see almost every month, whether it's Toyota's former chairman lamenting the lack of time spent with his children while they were growing up or PepsiCo's CEO flatly stating that balance doesn't exist for her. For anyone who has spent time around CEOs and other senior management types, this isn't shocking. Whether it's the job or the people who usually occupy it (or a little of both), obsessiveness seems to come with the territory. Unsurprisingly, Schwartz expresses a similar sentiment, but with a twist: "There is no line between personal life and professional life, especially if you care a lot about what you do. I used to really resent that, and then it became really freeing."

Freeing? That seems weird at first, but look at how Schwartz works - not cloistered in an office, but on the move, able to connect with employees and customers wherever broadband is available. If your work and life are interconnected, it's not so much about balance as it is about flow: Making the moves between personal, family and work activities as frictionless as possible. With broadband wherever you go, this integration becomes much easier. I'm guessing this is what Schwartz is getting at - the freeing feeling that you no longer need to sit at a desk all day; that's it's OK to spend a couple hours with your kids in the evening, knowing that you can shift some of your work to after their bedtime. This is a far more liberating attitude than the oft-heard complaint that technology is intrusive, pushing work into places it shouldn't be.

Obviously this doesn't work for all jobs, but for many corporate types it should. I've tried to work that way since as far back as the pre-broadband days, and I welcome any technology that makes it easier for me to be successful while still having a personal life. We all need time in the office to collaborate and connect, and we need to spend a certain amount of time every day getting our work accomplished. What's no longer true is that we need to do it all in one place or all in one chunk of time during the day. That is freeing.

Hiring CEOs - Damage Control at Best?

Got around to reading Justin Fox's intriguing Fortune article on measuring CEO performance. Interesting timing, as I've had a number of recent discussions with company leaders about what, precisely, a CEO is supposed to be doing. Some focus on operations, others on strategy; some sit in their offices all day, others are out meeting customers and business partners. However, the bigger the company and the more diffuse its products and customers, the narrower the scope that the CEO can directly impact. In fact, pretty much the only area a large-company CEO can affect overnight is the corporate structure and culture. Sadly, changes in those areas have disparate impacts: Positive changes will yield incremental benefits that take time to accrue into meaningful results; negative changes will stink the place up right away as talented employees flee and morale plummets.

What this means is that a great large-company CEO can have a small positive impact on a company, while a boob in the same role can cause utter havoc. Amidst the rush to hire superstar CEOs, it's sobering to think that a board's most important consideration is ensuring they get someone who won't screw the place up.

DOJ Tries Constraining Second Requests

This is welcome news that DOJ is trying to put some limits around how it handles second requests for information in large mergers. The biggest issue in second requests is the sheer number of documents that need to be provided to DOJ. When I ran the process for relying to DOJ's second request in the sale of AT&T Wireless, we ended up turning over 10 million pages of documents - and that was the smallest number provided by the 4 parties (SBC, BellSouth, Cingular, AWE) in the merger. We upended the offices of dozens of employees, and for a two-month stretch commandeered a large conference room and filled it with scanners that busily hummed away night and day collecting the documents. I doubt that the mountains of documents dumped on DOJ's door during that process could possibly have been reviewed in any meaningful way, rendering the document portion of the second request more of a costly compliance exercise than anything else.

It's unfortunate, because DOJ has an important job to do in reviewing mergers, but the tools it wields are the blunt instruments of litigation. Any merger of substantial size is going to be subjected to a second request, and thus put through the time and expense of a paper response that must follow the broad rules of discovery in litigation but that is unlikely to be useful in most cases. I suspect that DOJ's economic analyses and the parties' responses to interrogatories (and perhaps certain electronic discovery) are far more determinative to DOJ's decisions on blocking mergers and negotiating consent decrees than any documents provided. Ideally, DOJ would find a way to limit or stage document production while finding ways to more closely hone in on the critical review issues in each merger. Anything that moved this process away from the binary intractability of litigation - at least in all but the most extreme cases - would be welcome indeed.

Private Equity Collusion

Quick post in NYT Dealbook today regarding the latest prosecutorial muscle-flexing against corporate America; this time a DOJ inquiry into the possibility that private equity outfits are colluding to keep prices low.

I'm sure DOJ's investigators have thought about this a lot more than I have, but it doesn't seem to pass the smell test. Private equity is playing in bigger and bigger deals, and prices as a multiple of EBITDA (or any other measure you choose) keep rising. This hardly seems an environment colored by collusion.

Yes, as Dealbook points out, average premiums in $1B+ deals (those where consortia of PE firms are likelier to submit club proposals) are smaller at 16.5% than the 27.4% fetched by sellers in the $100M - $1B price range. But bigger companies are typically associated with mature markets, lower growth, etc. - all factors that keep a damper on the mark-up paid.

In fact, PE firms cobbling together clubs to compete for big game - bigger, at least, than any of the constituent members could take down solo - would seem to enhance, rather than detract from, competition. Finally, there's the issue of market harm - $1B+ companies are not clueless naifs being forced to take cut-rate prices. Beyond their sophistication, these companies have alternatives in strategic buyers and, of course, continuing to run independently.

If DOJ really has a bone to pick with PE, perhaps its energies would be better spent looking at all of those dividend recaps . . .

HP Board Leaks and the Trust Issue

James Surowiecki has another typically excellent article on the need for trust in making good corporate decisions. Trust among colleagues allows for vigorous debate without the participants feeling like they are being personally attacked or put at risk for airing their views. As we know - but don't see often enough in the corporate world - open, unfettered discussion of alternatives leads to the best decisions.

By all accounts, the HP board was not a model of decision-making prowess to begin with. However, as Surowiecki points out, the HP leaks, overshadowed as they might be by a bungled and overreaching investigation, further diminished that capacity.

Facebook and YouTube

I've said before that Facebook should take the money and scamper, if indeed Yahoo is willing to pony up $900MM large. My biggest concern is that while Facebook may be different in many ways than MySpace, it's not really a competitor. I'm not sure it can reach beyond its niche, and it runs a very real risk of being swamped under as MySpace's youthful devotees start entering college. I just don't see enough upside versus risk for Facebook to justify scorning mountains of the good stuff.

YouTube, apparently in play at $1.6B mark from Google, is a different story. This company is comparable to MySpace in reach, and even more so in possibility. YouTube has, seemingly overnight, built an unbelievable brand. There's a lot of hand-wringing over YouTube and copyright issues, but it's all noise - I guarantee those issues will be in the margins, if not forgotten, within a year. Besides all the kooky stuff, smart media companies have begun seizing on YouTube as a distribution source, and who knows what the company could pull off with the heft of a major partner? All in all, it's not at all shocking to see the price this high. While YouTube's sub-30-year-old leaders will most likely sell, unlike Facebook I wouldn't fault them for holding out and continuing to grow the business.

Fortune on the Guidant Deal

Good in-depth report in Fortune on the Guidant - BSX deal. It's a good thing the medical devices industry offers the potential for companies to experience "bursty" growth, as BSX has got a long road back from what is being described as the "biggest M&S blunder since AOL/Time Warner." J&J's recent lawsuit now looks more like the pouring of salt on BSX's wounds than anything else.

J&J Sues Over Guidant Loss

Readers will recall my many posts (start here and work forward) during the Johnson & Johnson - Guidant saga, which was a textbook example of the perils of being overly aggressive with enforcing material adverse change (MAC) clauses in deals. The deal progressed thusly:

- J&J bought Guidant, then backed out during the pre-closing period, citing the MAC clause over a product recall and SEC investigation at Guidant.
- Using this leverage, J&J extracted a reduced deal price from Guidant.
- This elicited interest from other firms, inciting a (post- deal signing) bidding war.
- Interloper Boston Scientific won out, acquiring Guidant for $2B+ more than J&J's original deal price, including a $705MM break-up fee to J&J.

Today, many months later, J&J has sued BSX for $5.5 billion. This figure presumably represents the lost deal value and the many expenses J&J incurred throughout the process. Curious to see what kind of evidence they have, as at first blush this looks like a loser. It's also - of course - a self-inflicted problem, as J&J could have avoided all of this unpleasantness by sticking with its original deal, despite Guidant's temporary setbacks. If J&J really wanted Guidant this badly, they should have kept the long view when the wheels were falling off last winter.

Facebook - Yahoo

Facebook is reportedly close to selling itself to Yahoo for about $1B. Although this is less than the $2B valuation Facebook was crowing about a few months back, it seems a shockingly high valuation for a property that could be reduced to irrelevancy by MySpace or whatever the next big thing in social networking turns out to be.

It's truism in dealmaking that once you've decided you want to do the deal, you need to get the ink on paper as quickly as possible. Until that happens, too many things outside of your control can cause the deal to fall apart. You'd think this concern would ring especially true for a company like Facebook, whose potential competitors have no barriers to entry and whose popularity is dependent upon the fickle tastes of people under the age of 25. Yet the WSJ reports that Facebook founder Mark Zuckerberg couldn't even be bothered to take phone calls over the weekend as negotiations wore on, due to his girlfriend being in town. Others think the company should take its time, hire bankers and get an auction going.

There are times to stretch things out, and perhaps the people at Facebook still think $2B (or close to it) is an attainable goal. It isn't. If they get an auction going they may find little interest. Now isn't the time to worry about leaving a few dollars on the table - I'd like to see the young Mr. Zuckerberg take the life-changing $1B deal rather than risk holding out for more.

HP Board Shenanigans

With my blog locked up, I haven't been able to comment on the boardroom mess over at HP, but I'll leave it at this - I am not surprised in the least that HP's Board chair pursued a take-no-prisoners investigation of boardroom leaks that included sussing out the phone records of Board members, HP employees and even several reporters. Hubris is an ugly thing.

What's disappointing is the lack of media perspective on the fact that a senior Director of a major American company was leaking confidential company information in the first place. Such disclosures are most likely violations of a Director's fiduciary duty and confidentiality agreements, have a corrosive effect on the workings of the Board, and do a disservice to the company and its shareholders. Sadly, this tale of corporate governance in breach doesn't make the juicy copy of a ham-handed pat-down by HP's investigators.

Blogger in Beta

Corporate Tool has spent the last several weeks in limbo, attempting the epic migration to Blogger in Beta. Like unfortunate immigrants in the past, the erstwhile blog encountered obstacles along the way, and became "stuck" between here and there, unable to accept posts or even receive visitors. My thanks go out to Google's Chris Sacca, who led me out of the wilderness and back to old standard Blogger. I'll try the journey again in a few weeks once these kinks get worked out.

Wal-Mart: Half-Off the Evil

Living in the middle of the Seattle metro area, I’d have to go out of my way to find a Wal-Mart. I suspect this distance from an actual Wal-Mart Supercenter is something I have in common with the vast majority of people who wring their hands over the impacts of Wal-Mart on everything from family businesses to the health care system to the labor movement.

About five years ago, I had an experience with Wal-Mart that led me to believe that the truth of its impact is far more complex. I was buying a cellular operation for AT&T Wireless on Kauai, and everything seemed to come back to Wal-Mart: Where’s the best place to keep distribution? Where should we advertise? What should we give employees as thank-yous (Wal-Mart gift cards)? Kauai may be an island paradise, but many who live there struggle to make ends meet. The conveniently located Wal-Mart turns out to be the hub of commerce for full-time residents.

While there’s little question that a Wal-Mart opening down the street is bad news for you if you’re running a convenience store, how good is it for the customers who’ve been buying your limited selection of overpriced goods? A recent article looked into this and came up with some surprising conclusions about the sheer size of the benefit to consumers of Wal-Mart’s low prices. One could quibble with the assumption that Wal-Mart’s prices are really 8% lower across the board, and commentators in the past have concluded that Wal-Mart is a sophisticated user of loss leaders and keeps many prices high. However, there’s no question that the prices and selection offered by Wal-Mart represent a major improvement for the consumers in the markets they enter.

At the same time I read the study above, I was reading Dan Baum’s otherwise excellent New Yorker article on the trials and travails of New Orleans’ Ninth Ward and was struck by this comment:

“. . . the city got a federal grant in the nineteen-nineties to raze the St. Thomas housing project, which occupied a prime spot near the Mississippi River, and replace it with mixed-income housing and resident-owned shops. . . . the result, River Garden, is a collection of simple, attractive attached houses that stood up well to Katrina. Somewhere along the way, though, the number of subsidized units fell by more than two thirds; the idea of resident management disappeared; and the small resident-owned stores became a two-hundred-thousand-square-foot Wal-Mart.”

To the residents who otherwise would have run these businesses, this is a failure. But what about the local residents who now have a reliable and inexpensive place to shop? Areas around housing projects aren’t know for having the shopping and service options a Wal-Mart brings to town. Check out the Wal-Mart “store finder” for stores near you. They are consistently in lower income and/or rural areas. Yes, the Bentonville behemoth may not be a role model for employee satisfaction or supplier relations, but like most large systems its impacts are many and varied. For many folks a new Wal-Mart coming to town is – or should be - a cause for celebration.

Wodehouse on Mergers

On vacation in sunny Central Oregon last week, I read a classic from one of my favorite writers, P.G. Wodehouse - Jeeves in the Morning. Few others can brighten one's mood like Wodehouse, particularly any of his stories involving Bertie Wooster and Jeeves. The Britishisms practically beg to be read aloud for maximum comic effect.

Jeeves in the Morning, written late in Wodehouse's life, is classic Wooster, bumbling his way into one increasingly dire situation after another - insulting his rich uncle, inadvertently getting engaged, burning his rented cottage, etc. It also features an M&A angle: The principal situation from which all of the ancillary troubles spin is Bertie's attempt (on Jeeve's suggestion, of course) to set up a clandestine meeting for merger discussions between his uncle's Pink Funnel steamship line and its American competitor, the Clam Line. Great stuff.