Business Daily from THE HINDU group of publications
Saturday, Oct 21, 2006
Corporate - Interview
Columns - Detaxfication
`Contingent liabilities' against tax litigation, a potential deal breaker
MR VIJAY IYER, Partner, Deloitte Haskins & Sells, Mumbai
Due diligence is what is keeping many companies busy, before M&A (merger and acquisition) talks either break up or end with a done-deal shake-of-hands. For example, Tata's due diligence before making the final bid for Corus. Saraswat Co-operative Bank is conducting due diligence on Pune-based Suvarna Sahakari Bank. And Rashtriya Chemicals and Fertilizers Ltd is engaged in a due diligence at MFL.
The phrase due diligence, for starters, is "the process of investigation, performed by investors, into the details of a potential investment, such as an examination of operations and management and the verification of material facts," as www.investorwords.com defines.
"With more and more Indian corporates looking at the M&A route to strategise, re-organise and grow their business, the awareness of the M&A lifecycle and in particular the due diligence component therein has substantially increased resulting in the due diligence process becoming more structured and effective," says Mr Vijay Iyer, Partner, Deloitte Haskins & Sells, Mumbai. Here is his take on a few questions from Business Line.
How has due diligence evolved over time in India?
It has evolved from being a mere verification of the seller's past financial information to conducting a comprehensive analysis of the deal's strategic logic and the buyer's ability to realise value from it. With experts available in India for, perhaps, all aspects of due diligence, such as financial, accounting, tax, legal and human resource, international best practices, are being deployed in the process.
Also, with more and more sophisticated players coming into India, particularly the larger PEI (private equity investment) houses, and with Indian corporates now aggressively pursuing acquisitions abroad, M&A players are exposed to global best practices and expect these to be used in India as well.
Any differences between the global best practices of due diligence and the practices here?
In India, sellers may not be entirely aware of the due diligence process, what it entails in terms of quality and depth of information required and the extent of the management's involvement.
At times, Indian business houses, particularly family-owned business, have limited documented formal management information systems and keep only minimum information as required to comply with law and the tax authorities. This presents challenges during the due diligence process in performing a fair analysis, as the level of transparency is low.
There is also a general lack of understanding among international buyers of Indian cultural differences, and a lack of familiarity of local business rules. Therefore, the due diligence process must have a built-in flexibility that captures these differences.
What explains deal failure despite due diligence?
The most important is culture clash, that is, irreconcilable differences in management and operating styles. Another major reason is overestimation of synergies from acquisition.
Failure may also result when due diligence is a mere verification of financial statements without critically looking at what the deal will actually bring in and whether the buyer is going to be able to exploit this value. Conducting too much due diligence is at times a reason for failure, particularly when the buyer is too aggressive on his due diligence demands without appreciating cultural differences and the local environment. In such instances, the seller could just walk away from the deal and maybe even go to another buyer at a lower price who is more reasonable and structured in his due diligence demands.
Deals may fail when, during the process, members of the buyer team convince themselves that the acquisition has to be made irrespective of logic, common sense or prudence and then proceed with the transaction, leaving aside all issues.
Can there be instances when one can overrule the red flags that due diligence brings to light, and go ahead with a deal?
Tough question. In today's environment buyers go ahead with a deal even though they have some nagging doubts about it. Maybe one could go ahead with a deal (though not sure if entirely advisable) when such red flags can be clearly assessed and the risk associated clearly quantifiable and addressed.
In India, the issue of `contingent liabilities', particularly against tax litigation, sometimes becomes a potential deal breaker with international buyers not entirely understanding this issue. Greater understanding of tax nuances and the potential risk thereafter at times enable the buyer to accept this and proceed with the transaction.
But this involves understanding the extended time duration that normally elapses before resolution of tax litigation and the potential uncertainty of any definitive resolution with changes in judicial rulings and potential retrospective amendments to tax laws. On the other side of the coin, sellers at times do take an aggressive position on tax litigation showing them as mere contingent liabilities without providing for such issues, though the likeliness of the company succeeding would be remote.
What, according to you, are the top five key factors in due diligence?
Not in any particular order of priority, the following may be some of the top factors:
Close interaction between buyer and seller teams getting acquainted with the management teams, understanding how they operate, level of commitment to the business, assessment of their behaviour in terms of the response time and quality of responses to queries.
Timing is essential. Conduct the exercise early enough too late in the process and the buyer team would have already `made up its mind' to go ahead with the deal given the extent of effort already spent on negotiating the terms and on the project. Apart from correct timing, spending adequate time and effort to complete an effective analysis is important.
Having experts performing due diligence. More importantly, they must be aware of the interdependency of their disciplines and know how to work as a unified team `no tunnel visions'.
Focus on quality of earnings and cash flows identifying financial trends, highlighting issues not encompassed in the financial statements.
Recognising synergies, but also considering the downside risk.
Being prepared to walk away from the deal when deal breakers are identified to know the walk-away price and terms.
In an M&A transaction, other critical factors that need to be kept in mind when conducting due diligence are:
Clear assessment of what is being bought with the economies expected to be generated investigating competition, customers, costs and capabilities.
Identifying the target standalone value.
Identifying the synergies that can be exploited but more importantly, the speed, time period and the extent of investment involved to exploit these synergies.
Identifying integration issues.
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