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ExampleA client became a valuable private company, but publicinvestors were reluctant to invest and its IPO failedresulting in a 85% value impairment for Softbank the mainfinancial sponsor. So what happened?Fundamentally, our client engages in “rent arbitrage” bysigning long-term leases, generally 15 years, at one rateand subleasing the space to SMEs and Enterprise membersat with shorter durations. While the cost per desk is lowerfor the member, the aggregate rent it receives is higher forthe space due to the density. This practice obviously createsa duration mismatch which leaves our client exposed tomarket fluctuations in the event of a downturn. The shortduration of the subleases leaves our client exposed to therisk that tenants might abandon the space on short notice,leaving them liable for the master lease obligation. They arealso exposed to the credit risk of the SME subleases.A significant advantage of our client’s business model is thefact that even though tenants are crammed into smallerspaces, they pay lower costs overall for their spaceservices. The lower rent expense to the tenant is one of thesignificant drivers of their business model.However, the downside to the business model is that it isexpensive. The cost of providing the space services issignificantly higher than those incurred under the traditionaloffice format. There is also the higher cost of the physicalimprovements to the space to provide our clients “look”.Industry estimates indicate that the aggregate has to be inthe range of twice the market rate for the entire subleasedspace to cover the increased operational costs and the noneconomic space of the community areas.So, does the business model make economic sense whencompared to the traditional office market analytics? TheCompany has been losing money at the same rate ofincreasing its top line revenues. Our client has never beenprofitable but its founder (and ex-CEO) points to Amazonand the years it took for them to cross over intoprofitability.12 2020 Deloitte The NetherlandsOur client focusses on different metrics to track theirperformance. The first important metric it tracks is new“membership” (desks rented) growth. This concept is akinto the concept of “eyeballs” or “clicks” tech companies useon the theory that the more views one receives, theincreased probability of a sale. Indeed, its founder hasanalogized the business to a tech company in corporatepresentations due to their extraordinary membershipgrowth.It has been claimed by the company the model is “assetlight” as they are providing a “service” more akin to UBERor Airbnb. With membership growth it believes they willachieve scale and become the dominant global presence inthe co-working space sector. It believes its brand willbecome the default choice for global Enterprises requiringmultiple locations and make the buildings it occupies morevaluable.However, unlike Uber or Airbnb, our client has assets, lotsof them. Its leases are assets, 15 billion and their rentalobligations are liabilities, 18 billion. But these areoffsetting. More importantly, the company has 7 billionof property and equipment. These are the desks, thechairs, the copy machines, the barista equipment, etc.Uber and Airbnb do not have the corporate overhead ourclient does. Uber, in particular, has independent contractordrivers and Airbnb does not own the properties where theyfacilitate rentals. In contrast our client has thousands ofemployees providing numerous services. They haveemployees on-site and at their corporate headquartersdirecting new acquisitions, overseeing the new tenantimprovements, and managing the actual operations at theirfacilities. It is really difficult, and time and employeeintensive, to provide consistent and exemplary service toone’s clients. Ask any hotel manager. While not technically“assets”, their people represent a significant expense notfound in the typical “tech” company.Operational Due Diligence could have revealed the trueeconomics of the business and the flaws in reported kpi’s.Furthermore ODD would have provided investors withguidance regarding a more rational value creation plan.

2. How companies createvalue through M&A 2020 Deloitte The Netherlands13

2. How companies create value through M&AFrom the acquirer’s point of view, a transaction can lead to value creation through:1. Stand-aloneperformanceimprovement2. Realisation ofsynergies betweenthe acquirer and thetarget3. Acquisition of aTarget at a lowerprice than its intrinsicvalue14 2020 Deloitte The Netherlands

1. Stand-alone performance improvementFinancialvalue driversValue generated through stand-alone performanceimprovement initiatives is an avenue typically exploitedby private equity, but which is also applicable tostrategic buyers. Improving the acquired company’sperformance beyond the existing management’sbusiness plan requires a holistic approach, covering allfour financial value drivers of equity value (see graph),as well as finding the balance between short-termactions and long-term value drivers, to secure thecompany’s future.Equity valueNOPLATmarginInvestedcapitalMedium and long-term value creationThe medium to long-term initiatives typically generatesignificant returns, but are more difficult to capture. In orderto secure the organisational health on the long-term themore fundamental changes in the company’s operatingmodel need to be aligned with the long-term strategy.EnhancedpricingCategorymanagementSales e driversGrowth rateShort-term value creationTypical first year of ownership initiatives to improve theperformance of the business and generate access cashto fund more structural improvements are: enhancedpricing and sales force incentives to push the topline,cost base rationalization, improved inventory turns andshorter average DSO as well as re-financing options toreduce the cost of debt. In particular our private equityclients use financial disciplines and proven tooling tosecure these benefits.Short-term Medium-termvalue drivers value Off-shoringTaxefficiencyDigitizationNWC turnAssetutilizationIncreaseleverageCost ofcapitalStrategichealth: (re)definecorebusiness Newproductsnewmarkets Asset lightbusinessmodelsOrganizational healthImproveterms ofdebtDeciding on the sequence of initiatives, as well as the riskprofile, is a key responsibility of the deal team as part of theOperational Due Diligence process. 2020 Deloitte The Netherlands15

2. Realisation of synergies between the acquirer and the targetTo correctly select, price, and integrate acquisitions anunderstanding of the strategic rationale of the plannedacquisition is required. The best way to do that is tothink of the target in terms of customer valueproposition, profit formula, resources and processes.Broadly speaking, there are two strategic reasons tomerge companies. The most common one is to boostthe acquirers current performance in terms ofcapabilities and products, which helps to hold on to apremium position, on the one hand, or to cut costs, onthe other.Under the right circumstances, only resources can beextracted from an acquired company and plugged intothe parent’s business model to boost the acquirersperformance. Resource focused deals are called“leverage my business model” (LBM) acquisitions. Inorder to grow the business, a company can buy anotherfirm’s business model, operate it separately, and use itas a platform for transformative growth. We call that a“reinvent my business model” (RBM) acquisition.The second reason to acquire a company is toaccelerate growth by entering a new market, or to learnfrom the acquired company and reinvent the parentbusiness model (Christensen, 2011). See also the M&Astrategic gameboard below and the two strategicreasons marked in two grades of blue.NewM&A Strategic objectives gameboardExtend Geographic FootprintRBM Enter new geographicmarketsContent For New Segments Acquire requisitetechnologies/capabilitiesMarkets Acquire new products to reach customersin existing geographiesCapture Market Share Maintain market leadership/dominatesegmentBuildon strengths(customer &channelrelationships)Existing Take advantage of fragmented industry toroll-up the tailRBMComplementary Capabilities Gain competencies in keyoperational/technological areas Access to alternative distributionchannels or move forward in the valuechainLBMExistingCapabilities/ProductsDeals which aim to boost the acquirers current performance by cutting costs or hold on premium positionsDeals to accelerate growth by entering new markets or reinvent parents business model16 2020 Deloitte The NetherlandsRBMNew

“Leverage my business model” (LBM) examplesWhen ASML, the lithography machine builder, acquiredHMI, the market leader in wafer inspection technology,it captured nice cross selling synergies, and securedvital technological know-how and the dedication of theHMI engineers for ASML’s continued quest intoproducing more patterns on silicon at nanoscale, tomaintain ASML’s leading market position.The market consolidation strategy the Dutch grocery retailerJumbo embarked on in 2009, by acquiring Super de Boer,and later on C1000 and Emté, demonstrates the power ofM&A in markets where fixed costs are important (forgrocery retailing: store rent, transportation, distributioncentre costs, marketing and branding).“Reinvent my business model” (RBM) exampleOil majors like Shell and Total are considering to enterthe power utility market, to disrupt their existing oilbased business models and to ride the wave ofelectrification.DealtypeLBMRBMStrategic reasonODD Focus areaAcquiring resources to Unicity of technologycommand premiumand ability topricesmaintain critical staffAcquiring resources to Compatibility oflower costresources (input andprocesses)Accelerating growthby entering a newmarketQuality of product andmarket positionagainst peersConclusionsCompanies turn to acquisitions to meet goals theycannot achieve internally. But there is no magic inbuying another company: Companies can do acquisitions that allow them tocommand higher prices, but only in the same waythat they could have raised prices all along, byimproving products that are not yet good enoughfor the majority of their customers Companies can do acquisitions to cut costs by usingexcess capacity in their resources and processes toserve new customers, but again, only in the sameway that they could have by finding new customersor increasing capacity on their own Companies can do acquisitions to acquire newbusiness models to serve as platforms fortransformative growth, which they could havedeveloped in-houseAt the end of the day, the decision to acquire is aquestion of whether it is faster and more economicalto buy something that you could, given enough timeand resources, make yourself. With mergers you buytime. But you only buy time when you are, post deal,able to maintain the know-how, resources or businessmodel the target company is offering. The scope of anODD should therefore focus on assessing if theseresources, know-how or business model exists andcan be maintained post dealFurthermore the scope of an ODD investigation shouldbe geared to test the investment thesis and thereforea deep understanding of how shareholder value can becreated with the envisaged transaction is required.Stand-alone and or via synergies.Acquiring to learn and Unicity of businessreinvent parentmodel and ability tobusiness modelpreserve 2020 Deloitte The Netherlands17

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3. How to strike abalance between risksand opportunities 2020 Deloitte The Netherlands19

3. How to strike a balance between risks and opportunitiesAs discussed in earlier chapters, the objective of thecommon types of due diligence is to protect value andbring deal risks back within an acceptable range. Thiscan be considered a “play not to lose” focus. Based onmany stories of failed mergers, and declining post dealearnings due to uncovered corporate missteps, risks areconsidered a negative that must be managed.Although true, this is just one side of a two-sided coin.Risks, such as the luring introduction of a disruptivetechnology or an aging population also provide businessopportunities, which can be turned into a competitiveedge. In fact, companies prosper by taking risks, andlose money by failing to manage them.Balancing risks and opportunitiesBeing able to see risks and opportunities simultaneouslyis similar to perceiving both the vase and the two facesin the optical game alongside.Developing the capability to recognize both risks andopportunities requires a change in the due diligencemindset and the types of analysis to be performed.Regardless of whether an acquirer is focused onprotecting deal value or winning the deal, a structuredapproach in mapping, quantifying and managing dealrisks and opportunities is a prerequisite of good dealmaking. Finding the balance between risks andopportunities, or the opposites of each other, follows alogic order:1. Identifying risks and opportunities;2. Manage risks and opportunities;3. Evaluate risks and opportunities.20 2020 Deloitte The Netherlands1. Identifying risks and opportunitiesRisks are often placed into four categories: strategic,operational, reporting and compliance. Risks vary fromdeal to deal and can be identified in different ways (e.g.learning from the past, learning from others, marketscanning, scenario planning, etc).Opportunities are typically grouped into two categories.Opportunities within the organization, such as supplychain optimization options and an improved serviceoffering, and opportunities beyond the organization(e.g. shifts in customer behaviour or changinglegislation).

2. Manage risks and opportunities3. Evaluate risks and opportunitiesDuring the due diligence phase deal teams develop acomprehensive inventory of the key risks, and an initialview of the opportunities. What is often missing is astructured approach in assessing the size of the risksand opportunities, as well as the identification ofavailable risk mitigating actions.As part of the deal process acquirers have multipleoptions to mitigate risks, such as risk sharing (e.g.agree on a joint venture structure, rather than a fullshare purchase), transferring risks (e.g. via RW&IInsurance) or reducing risks, by becoming more agile inresponding to risks (e.g. ringfence or separate high riskactivities from the combined group).Risk appetite is generally defined as the amount of riskexposure, or potential adverse impact from an event,that an organization is willing to accept. Once the riskappetite threshold (also termed the risk tolerance) hasbeen reached, deal mechanics can be negotiated tobring the exposure level back within the acceptedrange, thus matching risk exposure with risk appetite.Risk appetite can also be described as intelligent risktaking, coupled with disciplined risk management.Of particular relevance in understanding, measuring,and managing opportunities and risks is the capabilityto quantify their potential benefits and impacts. Oftenwhen risks are well managed, opportunities that initiallyappeared too risky become more attractive. In addition,experienced acquirers know that a greater riskidentification and mitigation capacity is instrumental incapturing opportunities that target management orrivalling bidders cannot capture.ConclusionsSeeking for upsides on top of target management’sbusiness plan can be a necessity to win the deal. Weearlier framed this as “due diligence to win”. A duediligence to win has the explicit goal of uncoveringvalue upsides, not seen by others, to safely bid morefor the target company. When our clients are in a “duediligence to win” mode, they accept that they need toinvest in changes in technology, products, andbusiness models beyond what target managementbelieves is achievable. These changes come withadditional deal implementation risks.Traditional methods can usually be applied to assess thepotential benefits of opportunities (e.g. assessing theincreased market share that can be captured orcalculating the likely profit from increased economies ofscale). Measuring of risks can be done in five steps:a.Quantify risk impact magnitudeb.Assess probability that risks affects the companyc.Quantify this impact on the combined group(Magnitude) x (Probability)d.Analyze the cost/benefit of taking action to mitigateriske.Prioritize risks in a ranking, to understand whichrisks are most critical 2020 Deloitte The Netherlands21

4. Fitting OperationalDue Diligence into theoverall M&A process23 2020 Deloitte The Netherlands

4. Fitting Operational Due Diligence into the overall M&A processThe term “due diligence” is used by lawyers to indicatethe period between signing the Letter of Intent (LOI)and signing the draft SPA. In practice due diligencestarts at the first minute that buyers are considering atransaction.screening. Based on target screening a LOI is signed,which drives Phase 2: Execute the deal, including duediligence, resulting in a Signed Purchase Agreement(SPA). The SPA drives Phase 3: Execute the deal anddeliver promised returns.In this chapter the M&A process is described end-toend. It starts with Phase 1: Identify the right deal,which consists of M&A strategy development and targetIn describing the 3 phases it will be apparent that ODDshould be embedded throughout the M&A process.Execute the dealsuccessfullyIdentify the right dealDeliver the promisedreturnsStrategy paperStrategy (1st phase of value creation planning)Short listGo/No-Go 1.Deal makingInvestmentmemoLOIDue DiligenceGo-no/go 2.SigningClosingPreliminaryDDOperations (2nd phase of value creation ation blueprint Day-1 red 2020 Deloitte The Netherlands24

Phase 1: Identify the right dealODD in phase 2Predeal efforts are focused on identifying the right deal.This typically starts with a strategy paper, which drivesdiscussions on the portfolio, gaps in the portfolio, andstrategies to close the gaps, through either organic orinorganic growth.ODD plays a key role in this phase. In testingmanagement’s business plan robustness, underlyingassumptions will be validated, and the match with theacquirer strategy will be evaluated. In doing so, upsidesand risks to the business plan may be identified, as wellas further substantiation of to be achieved synergies.The identif

Operational Due Diligence is a bespoke, continuous and iterative process of formulating and testing the investment thesis, in order to co-create an actionable value creation plan. Operational Due Diligence is primarily forward looking and opportunity focused, it therefore complements the risk oriented types