Leaving nothing on the table: Unlocking off-radar transaction value

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The nature and breadth of transaction risks are changing fast, raising the question: are traditional approaches to M&A due diligence and risk mitigation still fit for purpose? Failure to evolve may leave Europe’s dealmakers ill equipped when it comes to company valuation and assessing future growth and profitability.

Yet while a number of innovative new approaches to identifying, quantifying and hedging transaction risks are emerging, they are only being employed by a minority of dealmakers across Europe. The result? Substantial value is being left on the table.

The changing nature of risk

Part of the challenge is that the risks to target companies are becoming more complex. Disruptive forces such as digital advances, environmental and political change, and the rise of new business models, are creating new operational threats and strategic risks.

At the operational level, for example, one recent study suggests that a group of NASDAQ-listed companies that had suffered data breaches went on to underperform the rest of the businesses on the exchange on share price growth for the following three years.1

Meanwhile, companies that are slow to react to the digital revolution at the strategic level can quickly become the latest corporate casualties. We don’t need to look too far for examples – whether it’s former telecoms powerhouse Nokia, video-rental company Blockbuster or children’s toy retailer Toys R Us.

Expanding the risk radar

As they grapple with the changing risk landscape, some dealmakers have already begun to take advantage of big data and advanced analytics tools, but they are only scratching the surface when applying data-driven insights to transaction models.

With more sophisticated tools and expertise at their disposal, acquirers have the opportunity to build a more accurate picture of the risks affecting target companies and the likelihood of their materialising. This will enable acquirers to better understand the true value of the businesses they are assessing.

To do so, however, they will need to venture off-radar when modelling risks. Whether it’s harnessing data on weather patterns to quantify risks in energy or retail industry transactions, or factoring data on road accidents into financial models for transport and logistics transactions, dealmakers have increasing power to predict the ‘known unknowns’ – and even gain insight into ‘unknown unknowns’!

Transferring risk

Cutting out risk blind spots will be a major step towards better deal outcomes, but, even where this is being achieved, buyers are letting further value slip away by failing to deal efficiently with associated financial risks.

Put simply, many acquirers are routinely overpaying for capital to hedge transaction risks. The speed with which M&A insurance has become a transaction mainstay is testament to the industry’s recognition of the problem.

Aon’s data on M&A insurance placement for deals across Europe, the Middle East and Africa (EMEA) shows increased uptake by both private equity (PE) and corporate buyers since 2014 (see Figure 1). Law firm Allen & Overy recently reported that warranty and indemnity (W&I) insurance was used in 78% of Western European PE exits they advised on in 2018, and 86% of those in the UK.2


Figure 1: M&A insurance goes mainstream across EMEA 

But the opportunities don’t end there; W&I insurance has raised awareness across the M&A industry about the untapped potential of insurance capital, and eagle-eyed dealmakers will be keen to explore other transaction risks that might be transferred more cost-effectively.

Together, these factors are redefining the value on offer in the M&A process. This report brings together insights from leading dealmakers at corporate buyers, private equity and real estate funds, investment banks and law firms, to understand how transaction practices are evolving. We find that, as dealmakers seek out new avenues to gain an edge, uncover fresh sources of value and improve return on investment, they will need to:

  1. Rethink the breadth and depth of pre-transaction due diligence: As the nature of risk changes, more specialist approaches to due diligence will be required across areas such as cyber risk, intellectual property (IP), human capital, risk and insurance, and environmental risk.
  1. Go deeper into risk insights: In the era of big data and increasingly sophisticated analytics tools, buyers can achieve a more holistic view of risk exposure. But to do so, they’ll need to harness hitherto untapped data sources and map new risks into financial models that usually don’t feature on their radar.
  1. Harness the arbitrage advantage: W&I insurance has switched dealmakers onto the value that can be gained by arbitraging the cost of insurance against the cost of an escrow. This is a start, but there are many other areas where dealmakers can benefit from this arbitrage to hedge transaction risks at a more attractive cost.

Analysis: How data breaches affect stock market share prices (2018 update), Comparitech, September 2018

Allen & Overy, M&A Insights Q1 2019

“W&I has been a real pathfinder in boosting people's awareness of how insurance solutions can be deployed in transactions.”

Shaun Mercer
Managing Director, The Carlyle Group