The Role of the Credit Executive in Mergers and Acquisitions
Today's credit executives are exhibiting many ancillary roles, some of which may arguably be as significant as their primary tasks of managing the customer financial relationship. Astute credit professionals are open to advancing their role if for no other reason than self-preservation in the competitive employment arena. One of the opportunities for a credit person to gain recognition in the organization is to help the management team prudently evaluate mergers or acquisitions their company may be involved in.
M&A Background
The number of mergers reported to the antitrust agencies under the Hart-Scott-Rodino ("HSR") Act has increased dramatically from 1,529 filings in fiscal year 1991 to an estimated 4,500 in fiscal year 1998. It has been predicted that the market value of merger transactions this year could exceed $2 trillion, compared to $600 billion for the peak year (1989) during the merger wave of the 1980's.
It is fair to say that the current merger wave is significantly different from the "junk bond"-fueled mergers of the 1980's. Some of those mergers involved the acquisition of unrelated businesses that were targeted for their break-up value or designed to generate cash for corporate raiders. Today's mergers are more likely to be motivated by fundamental developments in the rapidly changing economy and reflect more traditional corporate goals of efficiency and competitiveness. Among the more prominent factors are the following:
- Globalization of competition
Many of the largest and most important product markets for American consumers have become much more global in scope -- automobiles, computers, pharmaceuticals, and commercial aircraft, to name just a few. A merger may enhance a firm's ability to compete in foreign markets by providing rapid access to an established distribution system, knowledge of local markets, economies of scale, and complementary products.
- Deregulation
Many mergers are taking place in industries undergoing or anticipating deregulation. In the 1980's, the Federal Trade Commission reviewed a substantial number of mergers in the natural gas industry, which was then undergoing deregulation. Now, deregulatory changes are taking place in electricity, telecommunications, and banking and financial services. Deregulation often engenders structural change and more competition. Mergers may enable firms to acquire quickly the assets and other capabilities needed to expand into new product or geographic markets. Deregulation also facilitates market entry across traditional industry lines. For example, banks seek to provide other financial services, and other firms seek to serve markets traditionally served by banks. Firms increasingly seek to provide a bundle of services that cross industry lines as regulatory constraints are lowered. We see that happening in several deregulating industries such as financial services, telecommunications, and public utilities. Consequently, we can expect to see a number of cross-industry mergers.
- Industry downsizing and consolidation
While this probably was a more important factor several years ago, a number of mergers continue to be associated with industry downsizing and consolidation. That is particularly true in some defense industries. With lower procurement levels and fewer new projects on the horizon, companies have sought to rationalize or reduce capacity through merger. Downsizing and consolidation also are significant forces in the health care industry. Changes in health care practices, such as shorter hospital stays, may result in excess capacity in some hospitals. A merger may enable two hospitals to eliminate unneeded capacity and operate more efficiently. Structural changes also are occurring in health care as firms seek not only to become more efficient but to meet broader public policy goals, such as increasing the cost effectiveness of health care, increasing the quality of care, and providing diversity of choice. This, too, can lead to mergers that cross traditional industry lines.
- Technological change
Economic progress is often driven by innovation and technological change, and mergers may be a response to that change or contribute to it. In a fast-moving, technology-driven economy, a merger may enable a firm to acquire quickly the technology or other capabilities to enter a new market or to be a stronger competitor. The communications industry is a good example. Other mergers may be driven by a desire to consolidate research and development resources to produce a greater research capability. Some pharmaceutical mergers fit that mold.
- Strategic mergers
Many mergers, perhaps more than in years past, involve direct competitors and appear to be motivated by "strategic" considerations. Firms are increasingly concerned about being number one or a strong number two in their markets, or perhaps even dominant. That drive can lead to mergers intended to boost market share, eliminate competitors, or acquire an important supplier of inputs needed by competitors. In these types of mergers the FTC may be concerned that a firm has acquired a dominant position. In addition, a concentrated market can make it easier to collude. These mergers also require close scrutiny.
- Financial market conditions
Low interest rates and low inflation have produced a favorable climate for investment, and that is reflected in the booming stock market. One result of the above described emphasis on strategic combinations is that relatively fewer mergers today are financed with cash or debt, as compared to the 1980's. Today, more companies are financing mergers through exchanges of stock. To the extent that a company's improved performance is reflected in higher stock values, its managers may be more willing to acquire another corporation or be acquired by another corporation through the exchange of stock.
Forward-Looking Analysis
The dynamics of the new economy make it especially important that merger analysis be rigorous and forward-looking. We in the field of business credit and receivables management operate under an identical charge. Particularly given the intense focus on reducing our firms' investment in accounts receivable while providing excellent service. In short, the accounts receivable component of the acquisition must be orchestrated carefully in order to prevent a slip in performance, and deliver a seamless transition to the total customer base.
The success of the acquisition, simply put, is a function of careful planning and integration across both firms. Below is a checklist of the important elements that should be examined by your credit organization while in the process of working with your management team on a merger or acquisition.
Acquisition Program for Accounts Receivable
- Points of Contact
- Your company's acquisitions attorney
- Your company's business unit contact
- Your company's information systems contact
- Seller's attorney
- Seller's credit contact
- Seller's information systems contact
- Letter of Intent
- Review draft language
- Identify concerns/opportunities
- Offer suggestions to mitigate concerns and capitalize on opportunities
- Due Diligence Phase
- Obtain survey information
- Aged Trial Balances (accounts/notes receivable)
- Written discussion regarding the collectibility of all receivables
- List, arranged by customer and month, of orders approved for future shipment
- Copies of all security documents, liens, mortgages, public filings, and guarantees pertaining to the accounts receivable base (real property appraisals where applicable)
- List and amount of any accounts receivable that are insured
- Confirmation of standard selling terms
- Selling terms for all customers sold to in last three years
- Anticipated selling terms for all orders not yet filled
- Bad debt write-off history for the last 5 calendar years
- Bad debt reserve levels for the last 5 calendar years
- Written discussion supporting present level of bad debt reserve
- Existence, status, expected impact (on Seller) of customer claims or lawsuits
- Description of any lawsuits brought by a customer in the last 5 years
- List of the customers accounting for more than 5% of Seller's annual business
- List of the customers who have threatened to materially decrease or terminate business with Seller
- Copies of all contracts, agreements, powers of attorney, etc. relating to the handling/management of the accounts receivable base
- Copies of all confidentiality agreements relating to the customer base
- Copies of all non-competition agreements relating to the customer base
- Copies of all service agreements (e.g. EDI, consignment, unique delivery/billing procedures, etc.) pertaining to specific customers
- Copies of all policies and procedures relating to the extension and management of credit and accounts receivable
- Information on any suspected or known environmental problems that are, or may, impact the creditworthiness of any active customer
- Copies, for the preceding 3 months, of all accounts receivable management reports produced in the normal course of business
- Copies of all audit reports prepared during the last 5 years regarding the management of, or accounting for, accounts receivable
- List of customers using electronic commerce (e.g. EDI, EFT)
- Analyze survey information
- Develop and support conclusions about the condition of accounts receivable, adequacy of reserves, general value, and ultimate collectibility
- Identify problem accounts/relationships which your company may wish to avoid
- Identify requirements for supplemental information
Asset Purchase Agreement
- Program Steps
- Review drafts of agreement
- Identify concerns and opportunities
- Obtain additional information as necessary
- Recommend language to mitigate concerns/capitalize on opportunities
- Attend information/negotiation sessions as requested
- Follow-up on each concern until mitigated or accepted
- Provide exhibits to agreement as they relate to accounts receivable
General Interface Review
- Program Steps
- Determine if your company's systems will interface with existing (Seller) systems:
- Order entry, approval, booking, acknowledgement, etc.
- Accounts receivable (includes credit checking)
- Plant scheduling & materials planning
- Electronic Data Interchange
- Pack/Ship
- Invoicing
- Data Collection (e.g. gross sales, profitability, etc.)
- Tax reporting
- Customer Master (set-up)
- Salesman Master
- Competitive Terms
- Deduction/claims tracking and resolution
- Lockbox processing and data transmission
- Cash application procedures and systems
- Derive and support conclusions regarding interface capabilities and requirements
Transition Services Agreement
- Program Steps (varies with services actually needed)
- Conduct joint coordination meeting with Seller's credit contact, information system contacts, etc. and your organization's counterparts
- Participate in internal coordination meetings with your Information System staff
- Clarify internal/external needs for services & hardware/software support
- Test systems using test data
- Review drafts of agreement
- Identify concerns/opportunities
- Ensure requirements are documented clearly within agreement
- Establish fee schedule to handle systems issues
- Define Post-Sale reporting expectations (where applicable)
Pre-Sale Phase
- Program Steps
- Continue coordination meetings with your company's Information System staff
- Develop welcome letter to customers including credit application, tax exempt forms, remit to address, etc.
- Establish transition date for administrative information (e.g. customer set-up, etc.)
- Hold internal transition meetings to implement system for digesting new accounts, file information, etc.
- Ensure Seller is completing the following:
- Making provision to release confidential customer financial information to your company
- Obtaining releases from all credit reporting services used by selling company to provide information to your company
- Providing up-to-date aged trial balance reports, open order reports, etc. to facilitate transition
- Preparing to assign security documents, guarantees, notes receivable, etc. to your company
- Producing copies of discrepant items (e.g. chargebacks, credits) for your use
- Establishing procedures to transfer post-sale cash collected to your company
- Establish contacts for various areas of transition services
- Agree upon and document timetable and responsibility for sale date activities
- Develop tentative credit representative account assignments
Sale Date Phase
- Program Steps
- Respond to last-minute needs of division, attorneys, Seller, etc.
- Ensure adherence (or acceptable alternative) to timetable and responsibility for sale date activities
- Ensure data/hardcopy information is downloaded/cataloged
- Send welcome letter and materials to new customers
Post-Sale Phase
- Program Steps
- Handle any issues that remain unfulfilled
- Reconcile data received to reports provided by Seller
- Resolve any discrepancies in data/records
- Run the following "opening" reports:
- Aged trial balance
- Open orders reports
- Customer account status
- Begin process of setting appropriate credit lines based on credit/financial information received
- Contact each customer via telephone, welcome them to your organization, establish/reaffirm contact points, communicate your company's commitment to service
- Request modifications to transition services as needed
- Pursue initiatives to reduce reliance on Seller's transition services
Process Review Phase
- Program Steps
- Review all facets of this process and refine/strengthen as necessary
Conclusion
The trend for increased acquisition activity should continue, driven by earnings pressures and the need to improve shareholder value along with the growth pressure and the need to change to stay competitive.
Rationale for continued growth in Mergers & Acquisitions:
- additional revenue growth from a larger customer base;
- efficiencies in operations;
- the ability to spread fixed costs to a larger customer base;
- diversification of income from both a product and geographic sense;
- stabilized asset quality;
- optimal deployment of excess capital; and
- a higher value for their common shares.
The winners in the consolidation game will be those organizations that can leverage their distribution networks and provide the greatest number of products and services across the widest customer base in an efficient manner.