The Art of Deal Making

With this first post in the New Year, I thought I would touch on a topic which has been revolving in my mind for quite a while, and which has been incubating since Boustead announced their Bio-Treat and Big Box deals. I would readily admit that the main content for this post comes from observations and analytical thoughts stemming from the failed investment in Big Box, as well as the investment decision for Bio-Treat. These two events, coupled with my own personal experiences in negotiating and observing how deals are made, compelled me to write something on this in order to start a fruitful and engaging discussion.

Deal-making is the process by which top management such as CEOs and Managing Directors engage in (sometimes) long, protracted discussions and negotiations with third-parties on potential M&A deals. As readers would already know, some of the really large mega-deals involving mergers (such as the SGX-ASX “merger”) and acquisitions (of which there were a few reverse take-overs announced in 2010) were a result of long and intensive negotiations and a lot of give-and-take on both sides. Though some may wonder if the deals actually did turn out to be earnings and yield accretive to shareholders, one should not question the amount of effort and hard work put in by the Management Team to secure these deals.

Deal-making normally starts with casual introductions through a network of business associates, probably over a meal or drinks. These introductions are made usually with a mutual business associate introducing both parties, whereby he acts as a catalyst to facilitate the initial exchange. Subsequent business discussions will be left to the individuals to arrange and the role of the introducer is simply to introduce and provide a summary of what each party is doing (e.g. engaging in what business, looking for what kinds of opportunities etc.). This emphasizes the importance of having good business networks in order to snare potentially juicy deals, and it also helps if you are someone who is well-liked by the business community and is viewed as a successful and down to earth entrepreneur. Going back to FF Wong’s case, he is indeed someone who is affable and will attract others who may wish to conduct deals with him; which also opens him up to a lot more opportunities as compared to those who have to go out and actively seek partners.

The difficult part of deal-making is then the stage of negotiations, for it often involves a huge amount of paperwork, spreadsheets, forecasts and face-to-face interactions. This is the part where each party summons its troops to prepare detailed analyses on the feasibility of partaking in the deal, and each side will also conduct its respective due diligence. Normally, this will involve aspects such as obtaining the Company’s instant info (from ACRA), checking the shareholders and directors (to determine that it is not a fly-by-night company), procuring financial statements and MD&A (if any) and making notes on the potential deal and the rates of return and payback periods.

Due diligence also has several aspects to it – financial, legal and physical. Using the Boustead/Bio-Treat example, physical due diligence will refer to the actual sighting of the asset(s) in question, to make sure they are in existence. In Boustead’s case it was to send down some staff to China to ensure the water treatment plants as stated are actually there. For REIT acquisitions, this involves actual sighting of the buildings to be acquired to ensure they are physically standing and in good condition. Legal due diligence consists of engaging lawyers to review the agreements and contracts relating to the deal to ensure there are no loopholes and points which can be exploited by the other party; and also to draft suitable correspondences to ensure there is no undue liability for each party. Legal due diligence also involves getting the lawyers to inspect all relevant certificates, licenses, patents and other legal documents to determine their authenticity. If the acquisition is foreign (e.g. for Bio-Treat’s case, it is in China), then Chinese lawyers will probably have to be engaged as they are familiar with Chinese laws and regulations governing asset acquisition, and also the paperwork required to effect the deal. Up to this stage, the costs are also quite significant as it involves flying people to China and engaging lawyers in both countries to deal with all the outstanding issues.

Financial due diligence is probably the most important aspect of the deal, and can actually make or break it. This process can be long and protracted as revisions may need to be made on assumptions, and terms and conditions may also change in light of new news or as a result of negotiations. Generally, the financial aspects which are considered important will include ROE, payback period and IRR (Internal Rate of Return). There will be detailed spreadsheets done to simulate the operational aspects of the acquired company or assets and this will be used as the basis for decision-making. Note that all these may require specialized personnel who are knowledgeable about the industry or assets in order to come up with a realistic projection. Hence, more money needs to be spent to hire such professionals to provide an opinion. At this stage, the Company may have its in-house team to do the projections or it may engage consultants to evaluate the deal. Needless to say, consultants are always more expensive than having an in-house team, though sometimes the results are often rather similar!

In light of the above, it is not difficult to see why companies can spend close to S$1 million just conducting the due diligence itself, as Boustead did mention during one of its audiocasts for a failed acquisition target. The problem is that even after incurring all these costs, the deal may not materialize due to problems discovered. Some companies may not even admit to these and still bash ahead as they felt that they have sunk so much into the due diligence that it does not make sense to abandon the project now. A more realistic and wise move would be to exit while the deal has not been hammered out yet, as Boustead had done, rather than take on a bad deal just because of emotional reasons.

So, as can be observed from the above, deal-making is not an easy process and can consume copious amounts of time, manpower and resources. I blogged about this to allow readers to better appreciate what goes on in the “back office” of such deals, rather than just focusing on the glossy news releases which companies put out on SGXNet. The PR companies and spin doctors will do their job of promoting the deal and making it sound attractive, but as investors, I believe we have to assess such deals with a pinch of salt and an objective mind. There have been cases where the institutional imperative has kicked in and a lousy M&A deal was “packaged” to look attractive. So I guess, ultimately, it boils down to “Caveat Emptor” for investors who decide to purchase shares of a Company which is either undergoing an M&A, or is contemplating a major one.

Interestingly, just as I am writing this, GLP (Global Logistics Properties) just announced the purchase of a 53% stake in China’s Airport City Development Co Ltd, paying S$485 million in a 30% cash, 70% shares ratio.