Due diligence

Due Diligence in M & AGroup 8Group MembersShriprakash Tiwari-169Sahil Save-140Aneeket Vare-176Bindu Singh-157Sanil Malwankar- 90Sanyam Khanorkar- 76Purva Sule-163Pravin Yeolekar-179Nilin Kaskar- 73Omar Jaleel- 64Vidit Trivedi-170

CONTENTSSr. No.CONTENTS1.INTRODUCTION2.TYPES OF DUE DILIGENCE3.PROCESS OF DUE DILIGENCE4.COMPLIANCES IN DUE DILIGENCE5.REASONS FOR M&A FAILURES6.CASE STUDY DAIICHI & RANBAXY7.CASE STUDY BRE-X MINERALS & FREEPORT-MCMORAN8.CONCLUSIONIntroductionReasonable steps taken by a person to avoid committing a tort or offence.

Generally, due diligence refers to the care a reasonable person should take before entering into an agreement or a transaction with another party.

Process of evaluating and investigating a prospective business decision by getting information about the financial, legal, intellectual and other material information from the other party.

It attempts to reveal all material facts and potential liabilities relating to the target company/unit/business.

Due diligence helps in understanding the following about the company:Capital structure including shareholding pattern

Composition of board of directors

Shareholders agreement or restrictions on the shares

Level of indebtedness

Whether any of its assets have been offered as security for raising any debt.5Need for Due DiligenceNeed for Due Diligence(contd.)Any significant contracts executed by it

The status of any statutory approvals, consents or filings

Employee details

Significant litigation, show cause notices and so on relating to the target and/or its areas of business

Intellectual Property of the Company

TYPES OF DUE DILIGENCEOperational Due Diligence

It is the process by which a potential purchaser reviews the operational aspects of a target company during mergers and acquisitionsThe ODD review looks at the main operations of the target company and attempts to confirm (or not) that the business plan that has been provided is achievable with the existing operational facilities plus the capital expenditure that is outlined in the business planIt will consider whether there is the potential for additional value to be wrought out of the target company by improving its operational function

Commercial due diligence

Commercial Due Diligence (CDD) is the process of appraising a target by reference to its markethow market or competitive uncertainty will impact the value of a company (e.g. due to new technologies, customers, trends, legislation, powerful buyers, or a new geographic market)the feasibility of realizing revenue/EBIT projections that appear very aggressive compared to in the pastthe validity of assumptions about revenue/EBIT projections that are based on the success of new products, customers or markets

Financial due diligence

Where the target company's financial status is reviewedTo be assured that a firm they wanted to buy showed correct figures in its financial reports, its accounting is correct and transparent, and tax risks are not significant.The main points of the investigation are: Fixed assets and inventories Accounts receivable Accounts payable Revenue and other income Cost of products and other expenses Tax risks

Legal due diligence

Legal due diligence is necessary to give the buyer the information that it needs to learn about the target company and to structure its purchase of the company and to structure its purchase of the companythe buyer and its counsel will search for more subtle indicators of value or potential liabilities in things suchOrganizational documents and important contracts (e.g., is the company restricted in how or where it operates its business or subject to unusual pricing terms or contingent liabilities?)Lawsuits to which the company is a party, Insurance policies benefiting the companyEmployee benefit and labor arrangementsIntellectual property owned or used by the companyRights or obligations under earn-outs or indemnification provisions The information learned in the legal due diligence process will be helpful for both the buyer's counsel and your company's counsel in drafting and negotiating the merger or acquisition agreement and related ancillary agreements.

Reputational Due Diligence Reputational Due Diligence concerns the careful evaluation of reputational risks attached to a business partner or target company including issues of integrity and reliability of the individuals involved, as well as the trustworthiness and predictability of the political environment.

PROCESS OF DUE DILIGENCEDUE DILIGENCE IN M&ALegalRisk ManagementHumanCapitalTechnicalOperationalTaxFinancial/Accounting Due DiligencePROCESS OF DUE DILIGENCE360 of Due DiligencePROCESS OF DUE DILEGENCE

PROCESS OF DUE DILIGENCESTEPS IN DUE DILIGENCECompiling of Due Diligence Check List

Procuring Detailed information/documents as per the checklist

Analyzing of Information/Documents

Critically evaluating the analyzed information

Preparing a report with suggestive actionsPROCESS OF DUE DILIGENCECompiling of Due Diligence Checklist

Compiling a due diligence checklist is a resourceful tool when undergoing a merger and acquisition. The checklist assists in covering all business components to ensure that a proper investigation is performed in order to prevent any delays or complications for the involved parties.

PROCESS OF DUE DILIGENCESome Important Points to cover in the ChecklistOverview of the AgreementAccounting Policies of TargetAudit & Review Processes of TargetCorporate & Legal aspects of TargetReview of Capital StructureReview of Income Structure, Tax Structure etc.Suppliers, Vendors, Personnel & Labor relationsCOMPLIANCES IN DUE DILIGENCEPROCESS OF DUE DILIGENCE- COMPLIANCESDue Diligence

Stock Exchange CompliancesProperty/ Leases Compliances

Labour / HR CompliancesIPRLitigation & Claims

Financial & TaxationEnvironment

Agreements/ ArrangementsCorporate CompliancesInsuranceCORPORATE COMPLIANCESComplete group structure & inter-group transactions

Nature of business

Financials

Statutory Registers & Minutes Books

List of all documents.LITIGATION, INVESTIGATION & CLAIMS COMPLIANCESReview of all disciplinary proceedings.

Review of any order or judgment

Review of any current litigation/arbitrationINTELLECTUAL PROPERTY RIGHTS COMPLIANCESReview of all intellectual property rights.

Review of all confidentiality agreements. LABOUR/HR COMPLIANCESBusiness activities, office locations & hours of work for each of the office.

Labour contract.

Employer supervision

ExemptionsENVIRONMENTAL COMPLIANCESLicenses, permissions, authorizations and consents from environmental authorities.

Details of any breach of any law, code.

Environmental management committee reports

Hazardous materials, spills, emissions etc. of the Company.CCI in M & AAll M & A with combined turnover of Rs 4,500 crore or more will require approval of CCI (Competition Commission of India) from June 1, with an objective to safeguard interests of consumers and promote industrial growth.

REASONS FOR M & A FAILURESReasons of M & A FailuresPoor Strategic Fit

Strategic fit includes business philosophies of the two entities time frame for achieving these goals way in which assets are utilized

Mergers with strategic fit can improve profitability through Reduction in overheadsEffective utilization of facilities, The ability to raise funds at a lower cost, and Deployment of surplus cash for expanding business with higher returns If merging companies have entirely different products, markets systems and culturesShifting away from the core competenciesFaulty evaluationIncomplete and Inadequate Due DiligenceFailure to Set the Pace for IntegrationOver LeverageLimited FocusReasons of M & A FailuresCASE - STUDYDue Diligence in M&ADaiichi Sankyo acquiring RanbaxyOn 11th June 2008, Daiichi Sankyo the third largest pharmaceutical company in Japan made an offer to buy control stake in Ranbaxy, the largest drug-maker by revenue in IndiaDaiichi Sankyo made an offer to purchase more than 50.1% voting right in Ranbaxy which included 34.83% stake of promoters, preferential shares and an open offerDaiichi offered a share price of INR 737 with a transaction value of around $4.6 billion, valuing Ranbaxy at $8.5 billionDaiichi ended up acquiring 63.92% shares of Ranbaxy by Nov, 2008Daiichis attraction from the dealLeading producer of generic drug - including a version of Pfizers Lipitor, a cholesterol-reducing treatment described as being the largest selling drug of all-timeGot access to Ranbaxys basket of 30 drugs for which the company had approvals in the US which included 10 drugs for which Ranbaxy had exclusive sales right to sell for six months after the expiry of their patentsGlobal footprintAccess to new markets

The merger failed because of:Poor due diligenceLack of understanding of generic businessActions taken by FDACultural differencesIssuesThe US Food and Drug Administration (FDA) announced an investigation into HIV drugs made by Ranbaxy

Daiichi Sankyo knew about the quality issues spotted by the FDA, but didn't expect imports of drugs to be barred

September 2008 - a ban was imposed on the imports to US of 30 of the companys generic drugs due manufacturing problems at some Ranbaxy plants

In spite of the issues raised by the FDA and a global financial crisis that was entering its critical phase, Daiichi Sankyo continued with the transactionIssuesOne more prominent thing that Daiichi probably missed on was the continuously increasing debt levels of Ranbaxy.Daiichi Sankyo did not try to lower the purchase price- even after news of disaster started to break around in the middle of 2008 and greatest financial crisis in history was forcing a brutal downwards adjustment in asset prices.2013 Ranbaxy pled guilty to US felony charges and paid $500 million in fines for manufacturing substandard drugs and lying about it.CASE STUDYDue Diligence in M&ASome major Failures Survey conducted by McKinsey and company shows that many parent companies often over estimate the value of target company due to lack of due diligence.

In 1998 the German auto car maker Daimler Benz merged with Chrysler Group for a value of $36 billion. It was perceived to be a merger between equal but after a few years, the value of Chrysler fell to a mere $7.4 billion and the merger had proved to be a failure.

The failure was attributed to inability to conduct due diligence It over estimated the value of the target company which led to the merger being unsuccessful.How due diligence saved a company from big fraudCanadian exploration firm, Bre-X Minerals Ltd., announced that it had made one of the world's largest gold discoveries containing some 3-4% of the world's reserves .

This news resulted in rise in the value of Bre-X shares giving the company a market capitalization higher than that of several major mining companies.

Eventually, Bre-X proposed to form a partnership with Freeport-McMoRan, a U.S. company. Before making a firm commitment, Freeport insisted on carrying out due diligence.After Due DiligenceThe results shook the mining industry

Bre-X reserves contained no significant gold

After the scam was uncovered, the Bre-X share price crashed, and disgruntled shareholders (who lost about $3 billion) began taking legal action against the company.

CONCLUSIONCONCLUSIONDue diligence conducted must be reasonable, but it need not be perfect.Due diligence is not just there to identify risks, it can also identify opportunities to improve effectiveness, cut costs and fully leverage resources.Even if an expert can later find fault, the experts ability to poke holes in the diligence of investigators does not automatically create liability. Companies are complex entities operating in a complex world; no investigation can uncover all the potential risks of an acquisition. The point is to make a good faith effort to do so, within the limits of time and funding, and in consideration of what matters most the long-term financial health of the surviving company and its stakeholders.