How to Conduct Due Diligence – When You Can’t
Remote Sensing® can provide the risk/reward confidence needed
to succeed in a transaction
to succeed in a transaction
By George Pilko, Chairman
How do you find out about a company you’re thinking of acquiring when you don’t want them to know? Pilko & Associates first presented Remote Sensing® in a Grey Paper in December 2002 as a way of conducting due diligence under the radar screen. Since we introduced the program, we have carried out six to eight Remote Sensing® studies every year, on deals ranging from $100 million to $10 billion.
We see Remote Sensing® growing in importance as boards of directors become more concerned about their corporate governance responsibility. Outside directors and other observers have seen and reported examples of the long-term value destruction that happens when an acquisition is not properly integrated; and they are taking EHS governance much more seriously, recognizing the importance of asking the right questions before approving a major transaction. The hitch is that there are many situations that can make it very difficult to ask the right questions.
When traditional due diligence won’t work
For many deals, a traditional due diligence relying on data rooms and on-site facility inspections simply cannot be carried out:
When we first wrote about Remote Sensing® in 2002, we had not yet formulated our Three BucketsSM approach to EHS. Today we see the Three BucketsSM playing a key role in Remote Sensing®, just as they do in the overall transaction, in transition management and in achieving operational excellence.
When traditional due diligence won’t work
For many deals, a traditional due diligence relying on data rooms and on-site facility inspections simply cannot be carried out:
- You may be embarking on a hostile takeover of a publicly traded company – and they’re not about to let you look around.
- You may be involved in a corporate merger or acquisition in which both buyer and seller are extremely sensitive as to who has knowledge of the proposed deal. For obvious reasons, leaks of any kind must be avoided. We have seen deals where an acquiring company has its VP of EHS interview a few of the seller’s EHS staff in a hotel room on a Saturday morning – and then the VP is expected to come back and pass judgment!
- You may be trying to acquire a business being spun off from a larger company that artificially constrains the type and amount of due diligence allowed. This is a game that’s often played between buyers and sellers – the party with the most information wins – and it’s nothing new.
When we first wrote about Remote Sensing® in 2002, we had not yet formulated our Three BucketsSM approach to EHS. Today we see the Three BucketsSM playing a key role in Remote Sensing®, just as they do in the overall transaction, in transition management and in achieving operational excellence.
Risks & Liabilities
This traditional bucket includes issues such as soil and groundwater contamination, air emissions, product stewardship, enforcement, litigation and things that go boom in the night. It also includes many less obvious but potentially more important issues, such as the potential liability from businesses that have been previously sold or shut down.
A perfect example: After divesting Solutia, Monsanto merged with other companies. Those merger partners might have looked at Monsanto’s then-current business and found nothing environmentally ugly. But a lot of liabilities had been spun off with Solutia, and when Solutia went bankrupt, those liabilities boomeranged back to Monsanto. The potential advantage that merger partners can gain by employing Remote Sensing® to uncover hidden liabilities like this should be obvious.
Governance
This bucket includes the company’s EHS vision, management systems, process safety management, maintenance procedures, assurance processes, and organization & staffing. Ultimately, Governance is about value creation, and Board oversight is critical: Outside directors have pivotal roles to play in using EHS as a competitive advantage.
Governance questions related to acquisitions include: How is the potential acquisition target being run? How much management repair work will be needed? How difficult will the transition be? And, finally, how much do you believe of what the company says about itself?
According to Robert Sutton, professor of management science and engineering at Stanford University, in his book “The No Asshole Rule,” a company’s true health is inversely proportional to its ‘asshole quotient.’ This sounds flip, but the negative impact of lousy management style is far greater than a number of perpetrators might suggest. Ultimately, how a target company stacks up on Governance questions will have a huge impact on the operational excellence of the merged enterprise, an issue that should be supremely important to outside directors.
According to Robert Sutton, professor of management science and engineering at Stanford University, in his book “The No Asshole Rule,” a company’s true health is inversely proportional to its ‘asshole quotient.’ This sounds flip, but the negative impact of lousy management style is far greater than a number of perpetrators might suggest. Ultimately, how a target company stacks up on Governance questions will have a huge impact on the operational excellence of the merged enterprise, an issue that should be supremely important to outside directors.
We use Remote Sensing® to uncover what’s really going on in a target company, not only among the nuts and bolts of daily operations, but also in the management style and the ways in which the company works together as a team (or not) to accomplish its goals. Pilko consultants average 27+ years of industry experience and they know where to look and how to obtain the insights needed.
Emerging Issues
Emerging Issues are those issues that can dramatically impact a corporation’s shareholder value and even its long-term viability. This bucket might contain issues such as climate change, litigation trends, regulatory changes, product stewardship issues, sustainability and social justice, among others.
There is an example in the public record of the planned acquisition of a chemical company. While the stats on this company looked good, its primary product was MTBE, used to raise octane in gasoline. For those who looked at the horizon back then, it was clear that MTBE would soon be banned – yet this manufacturer had no plans to migrate their business in another direction! Whoops.
Everyone can think of examples where wishful thinking becomes reality. It’s human nature. The job of the Remote Sensing® consultant is to cut through the clouds of Camelot to find the reality underneath.
How Remote Sensing® can help
Remote Sensing® “peels the onion” of corporate activity to reveal inner layers that are not apparent to a cursory due diligence effort. As any GoogleTM savvy person knows, it’s easy to find gobs of mostly useless information on the Internet. Our core competence as Deal Advisors is distilling the gobs into the few issues critical to a transaction. We are looking for factors that could (1) kill the deal; (2) impact valuation; or (3) dramatically affect transition planning and company integration.
Our related core competency is in communicating critical issues to Deal Leaders, senior executives and boards in terms they can use. The result is improved decision making and ultimately increased value creation.
The peels of the onion come off in two- to four-week increments. An initial broad look identifies potential issues that could impact the transaction. During the second iteration, we work with clients to decide on the issues that are worth investigating in more detail. Finally, we drill down on the key issues to find out all we can, which is sometimes even more than the target company knows about itself.
A key approach we use in Remote Sensing® is based upon our consultants' extensive network of industry contacts. We know experts around the globe in many fields, both working and retired. These contacts allow us to paint an accurate current, as well as historical picture of the business we are researching.
In U.S. jurisdictions, we use the Freedom of Information Act to obtain documents from various regulatory agencies. In other jurisdictions, life is more complicated. But because we have done an enormous amount of this work, we know where to look and what to ask for, making our effort very time- and cost-efficient.
In addition to checking agency files, we frequently visit with agency personnel to discuss works in progress, areas of concentration, and future areas of concern. The general knowledge gleaned from ongoing relationships with agency personnel is often useful to our clients, enabling them to deal with EHS issues ahead of the curve and for a lower cost.
For one $2 billion global transaction, Remote Sensing® involved taking street level photos of the facilities around the world, as well as compiling relevant satellite photos. Our client was able to get a sense of what the facilities and the neighborhoods looked like, which gave them the confidence needed to become the successful bidder.
Getting comfortable
For some transactions, there is no black-and-white answer to “Is this issue a deal-killer?” For instance, Directors would love us to look into a crystal ball and predict with certainty what regulations will be five to ten years out. But who really knows? Still, for some transactions "knowing the unknowable" can be critical for long-term success of a transaction.
On one $10 billion deal, I personally met with my client's board of directors on three separate "peels." The first two peels still left some questions with no clear answers, so we used the "Delphi Method," a great tool for evaluating risk in complex situations: We assembled a half-dozen experts and facilitated a session where they compared notes and tried to answer the difficult questions.
During these Delphi roundtables, we include experts from different disciplines – regulatory, technical, legal and even political – whichever are relevant to the issue at hand. Then we gather their opinions: What’s the future most likely to look like, socially, politically, and economically? What are the regulations most likely to look like for air, water, sustainability, carbon? When are regulations likely to be passed? From the combined wisdom of our experts, we put together a risk/probability analysis that we take back to the board as our view of the future.
For the board I mentioned earlier, this was the clincher analysis that freed them to move forward. We’ve gotten rave reviews from clients for this technique.
When to start
We have had clients come to us for Remote Sensing® as soon as they get the acquisition gleam in their eye – in several cases we’ve screened a half-dozen potential acquisition targets to help our client pick the most appropriate.
In most cases, however, we recommend that clients commission Remote Sensing® when the probability of doing a deal reaches 30%. I believe we are seeing a trend towards mergers rather than outright buying and selling, and I believe Remote Sensing® will become increasingly valuable and important.
With Pilko having worked on transactions totaling $425+ billion in 48 countries over the past 29 years, I believe we have experience that can prove invaluable to our clients. I welcome your feedback and look forward to exploring these issues further. For more information, please call me at 713-357-1000 or check out related articles on our website at www.pilko.com.
A key approach we use in Remote Sensing® is based upon our consultants' extensive network of industry contacts. We know experts around the globe in many fields, both working and retired. These contacts allow us to paint an accurate current, as well as historical picture of the business we are researching.
In U.S. jurisdictions, we use the Freedom of Information Act to obtain documents from various regulatory agencies. In other jurisdictions, life is more complicated. But because we have done an enormous amount of this work, we know where to look and what to ask for, making our effort very time- and cost-efficient.
In addition to checking agency files, we frequently visit with agency personnel to discuss works in progress, areas of concentration, and future areas of concern. The general knowledge gleaned from ongoing relationships with agency personnel is often useful to our clients, enabling them to deal with EHS issues ahead of the curve and for a lower cost.
For one $2 billion global transaction, Remote Sensing® involved taking street level photos of the facilities around the world, as well as compiling relevant satellite photos. Our client was able to get a sense of what the facilities and the neighborhoods looked like, which gave them the confidence needed to become the successful bidder.
Getting comfortable
For some transactions, there is no black-and-white answer to “Is this issue a deal-killer?” For instance, Directors would love us to look into a crystal ball and predict with certainty what regulations will be five to ten years out. But who really knows? Still, for some transactions "knowing the unknowable" can be critical for long-term success of a transaction.
On one $10 billion deal, I personally met with my client's board of directors on three separate "peels." The first two peels still left some questions with no clear answers, so we used the "Delphi Method," a great tool for evaluating risk in complex situations: We assembled a half-dozen experts and facilitated a session where they compared notes and tried to answer the difficult questions.
During these Delphi roundtables, we include experts from different disciplines – regulatory, technical, legal and even political – whichever are relevant to the issue at hand. Then we gather their opinions: What’s the future most likely to look like, socially, politically, and economically? What are the regulations most likely to look like for air, water, sustainability, carbon? When are regulations likely to be passed? From the combined wisdom of our experts, we put together a risk/probability analysis that we take back to the board as our view of the future.
For the board I mentioned earlier, this was the clincher analysis that freed them to move forward. We’ve gotten rave reviews from clients for this technique.
When to start
We have had clients come to us for Remote Sensing® as soon as they get the acquisition gleam in their eye – in several cases we’ve screened a half-dozen potential acquisition targets to help our client pick the most appropriate.
In most cases, however, we recommend that clients commission Remote Sensing® when the probability of doing a deal reaches 30%. I believe we are seeing a trend towards mergers rather than outright buying and selling, and I believe Remote Sensing® will become increasingly valuable and important.
With Pilko having worked on transactions totaling $425+ billion in 48 countries over the past 29 years, I believe we have experience that can prove invaluable to our clients. I welcome your feedback and look forward to exploring these issues further. For more information, please call me at 713-357-1000 or check out related articles on our website at www.pilko.com.
##
In This Section
Resources
Testimonials
Pilko's Grey Paper was honored with the Crystal Award in the E-mail Newsletter category by the American Marketing Association.
Resources
Testimonials
Pilko's Grey Paper was honored with the Crystal Award in the E-mail Newsletter category by the American Marketing Association.