Engaging in deals can be captivating, sometimes overshadowing the crucial but less glamorous aspect of due diligence. The excitement, particularly when senior management is focused on a target, may result in inadequate examination of the strategic logic and possible challenges of a deal, with potential serious consequences.Let’s look at the example of Safeway’s costly oversight.
Safeway, a leading American grocery chain with a track record of successful mergers, rushed to acquire Dominick’s, an innovative regional grocer in Chicago, for $1.8 billion. The strategic rationale seemed impeccable, promising a significant boost in sales and a strong presence in a major metropolitan market. However, due to inadequate due diligence, Safeway overlooked critical misalignments between Dominick’s focus on prepared foods and Safeway’s emphasis on store brands and cost discipline. The clash with Dominick’s strong unions and customer resistance to Safeway’s private label goods resulted in market share losses to its competitor, Jewel. A thorough due diligence process could have uncovered these issues, potentially saving Safeway from a regrettable acquisition.
To enhance due diligence, successful acquirers go beyond merely verifying financial statements. They view due diligence as a comprehensive investigation into four key questions:
- What are we buying?
- What is the target’s stand-alone value?
- Where are the synergies—and the skeletons?
- What’s our walk-away price?
Effective due diligence begins by challenging the mental image created by senior executives about the target company. Instead of relying on secondary sources and biased forecasts, acquirers should build their own bottom-up view of the target and its industry.
Once the acquisition wheels are in motion, determining the target’s stand-alone value becomes crucial. This involves a rigorous analysis of the target’s books to verify reported numbers and assumptions. Common financial tricks, such as inflating sales projections or disguising recurring costs as extraordinary, must be exposed.
The final step in due diligence is determining the walk-away price—the maximum amount the acquirer is willing to pay. This requires a disciplined approach, and the decision-making body should be composed of individuals less emotionally attached to the deal.
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