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Due Diligence for High-Tech Targets

Putting an acquisition target under the microscope

As the high-tech industry continues to consolidate during the

global economic crisis, due diligence is becoming even more impor-
tant for private equity firms in search of acquisition targets. In this
volatile market, however, many firms are forgoing comprehensive
due diligence in an effort to close deals more quickly. This can lead
to sub-optimal outcomes. Rather than dispensing with due diligence,
we suggest accelerating it.

As more private equity (PE) firms necessary to make first bids. Then, as As more private
consider acquisition in the high-tech negotiations continue, market and
industry, due diligence is essential to operational due diligence determine equity firms con-
understanding a targets competitive the right price for the company.
environment, innovation capabilities, sider acquisition
complexity and true prospects for Time Is of the Essence
growth (see figure 1 on the following There are six due diligence success in the high-tech
page). Due diligence can also help firms factors that can help companies cap-
determine potential synergies and a ture the full value of a deal after
industry, due dili-
target companys value. Investment it closes:
managers use the process to probe for Identify actions that will have the
areas to increase revenue and reduce biggest impact on the top and
gence is essential to
costs and discover the potential bottom lines
benefits and hazards that lie beneath Ensure the product road map
understanding a
the surface. includes a strong research and devel-
When time is short, however, opment (R&D) pipeline
targets competitive
managers often forgo due diligence. Evaluate synergies and their value-
This is a potentially costly mistake add environment and
that can lead to overvaluation or Uncover red flags, including those
underappreciation of potential targets. associated with customers, suppliers true prospects for
Rather than omitting this essential and partners, early in the bidding
step in M&A, we suggest performing process, so that expectationsand growth.
an accelerated two-part approach. bidsare set correctly
A target attractiveness quick scan Identify and retain top talent
evaluates a target company within a Address competitive dynamics within
few weeks and provides information and across high-tech sectors
FIGURE 1: Due diligence is essential to understanding a targets competitiveness analyze many aspects of the deal by
answering the following questions.
Is the target commercially viable
Accelerate Innovation Invention Engineering Idea
innovation strategy on demand effectiveness to profit across geographies? The PE firm ascer-
Identify and address Create product and Ensure process Adopt tactics to
tained the targets financial strength
innovation potential process solutions to efficiencies accelerate time and segment growth rates by gathering
fulfill customer needs to profit
data from annual reports, management
presentations and interviews.
Manage Global Innovation Lean Complexity:
complexity innovation network design good vs. bad Is there adequate demand in the
Structure innovation Determine the Minimize the life- Find strategies to
markets it serves? Our analysis found
in a global context necessary capa- cycle costs of new manage complexity that the majority of the targets busi-
bilities and where and existing prod- effectively
Source: A.T. Kearney analysis to get them ucts or services ness was noncyclical, with significant
demand and an attractive business
As part of due diligence, forming ments shown in figure 2, assesses the recurrence of 85 percent, well above
cross-functional teams will help evalu- overall attractiveness of a target and gets industry averages.
ate the fair value of a target company to its core value. Additionally, the quick Does the target have a healthy
and potential long-term goals, such as scan accelerates the subsequent market balance sheet? Most areas projected a
whether to spin off the company, and operational due diligence, reduc- double-digit compound annual growth
merge it into the current portfolio, or ing the entire due diligence process rate (CAGR), even using conservative
pursue some other option. The depth from six weeks to three or four weeks. growth estimates. With a healthy bal-
and number of sectors within the high- ance sheet and strong growth rates
tech industry make this a crucial step. Case in Point across many products and segments,
When time is short, we advise Early in 2009, we helped a PE firm the overall outlook seemed positive.
our PE clients to conduct the target target a specialized global IT solutions What offerings stand out? We
attractiveness quick scan first, which provider operating in the energy, trans- identified patents and R&D capabili-
can determine in one or two weeks if portation and environment industries. ties, and learned that the target firm
a target is worth deeper examination. Using our target attractiveness quick had a stronghold in operational appli-
The scan, focusing on the eight ele- scan, the PE firm was better able to cations, a best-in-business on-time rate,
and a leadership position in technol-
ogy compared to its chief competitors.
FIGURE 2: Elements and advantages of a target attractiveness quick scan Even better, it would be extremely dif-
ficult for a new entrant to acquire or
Elements Advantages for PE firms replicate its areas of expertise.
What is the three- to five-year
Evaluate demand and growth potential Develops a fact base for the next
steps in the formal auction process road map? The high-tech industry is
Define areas of differentiation
Offers a competitive advantage by
evolving rapidly, so a comprehensive
Determine product value and long-term
road map developing a deeper understanding long-term strategy is required to create
of the target and working closely
Compare target with its current and with its managers to identifyGlobal
areas and sustain competitive advantage.
potential competitors for improvement
innovation Our analysis of the target firm revealed
Assess the best opportunities for
Identifies due diligence focus areas
increasing value
and develops a list of priority market
a clear overall vision, but the current
Identify firm and industry red flags and operational issues product, partner and go-to-market
Form the criteria for moving forward Reduces investment in performing strategies presented major challenges.
with a purchase due diligence as the quick scan
Identify focus areas for market and requires a short period of time and In addition, we found out that one of
operational due diligence helps determine the need for and
scope of further investigation
its businesses had a low growth rate
and was not critical for the future,
Source: A.T. Kearney analysis
which made it a good candidate for pated fully in the project life cycle What red flags could curtail
divestiture. from start to finish. growth? While one of the target firms
How does the target play in the What are the growth opportunities? businesses held a leadership position in
broader high-tech industry? The firms We looked at the opportunities for North America, the company was
strong midstream offerings and its growth, including integration, which is underperforming in five out of the
size could be perceived as advantages; crucial in high tech. We found several seven largest markets over the most
however, they also make the firm opportunities and analyzed the poten- recent three-year period. There were
inflexible and slow to respond to rapid tial financial ramifications. Our analy- opportunities to move into emerging
changes in demand. This analysis sis found nearly $2 billion in untapped markets such as Latin America, the
provided PE investment managers potential in certain markets, which Middle East and Africa. However,
with a richer view of the targets com- could be targeted relatively easily follow- the company was not likely to be up
petitive value. ing some modifications to the existing to the growth challenge because it
How does the firm stack up to organizational structure and strategy. was not equipped to manage large
competitors? The targets chief com- Implementing these recommendations projects and the risks associated with
petitor had a stronger market presence would yield an attractive increase in them. Considering these findings,
in Asia and an army of engineers in revenue within four years. Similarly, we we revised downward the CAGR
other divisions to support its IT solu- found unrealized, double-digit growth originally suggested by the manage-
tions business. The rival also partici- prospects in developing countries. ment team.

FIGURE 3: Typical category analysis for a high-tech firm

Leak detection

Irrigation network control Companys industries


Automated Hydraulic resource control

Water suite weather
Control and observation Meteorological
simulation system Water-quality monitoring system
system Air
for desalination plants

Low-level wind shear alert system

Market position*

Aeronautical terminal information system Revolver

High growth

Weather radar networks

Road weather information system

Seismic phenomena
monitoring Continuous emissions

Dispersion models

Mobile air-quality monitoring unit

Decision support systems for forest fire suppression

Mobile units for
forest fire suppression

Early-market initiatives High-growth markets Mature markets

Portfolio category
*Mature represents the market heavyweight in terms of share and influence; high growth reflects the leading alternative, Source: A.T. Kearney analysis
usually second place in terms of share; early reflects a player that is competing on price or some other measure.
We generally look for company- hensive analysis of the target company Our analysis of high-tech targets
and industry-specific red flags. and its industry. often reveals that product categories do
Common company-specific red flags Market-focused due diligence not correlate with how shareholders
include a lack of strategic focus, inef- assesses growth prospects by taking view the business. In addition, resources
ficient organizational structures caused a deeper look at customer segments, are often allocated to fulfill obligations
by unwieldy growth, and blockbuster customer purchasing criteria and dis- of the internal organization rather than
products that have reached the end tribution channels. Since the high- to increase shareholder returns. To
of their life cycles. Industry-specific tech landscape changes so quickly, better evaluate a target companys
red flags might include the ease with the focus is typically on probable dis- potential, and meet shareholders
which other players can enter the ruptions, the unique selling positions expectations, the targets portfolio is
industry. Apples entry into mobile of the targets products and competi- categorized into three main areas
phones is a good example. tors innovation capabilities. We also early-market initiatives, high-growth
What are the focus areas for due focus on achievable product prices, markets and mature markets. We then
diligence? Overall, the firm was a competitiveness and success factors differentiate resource allocation models
compelling acquisition target but the for a company in the specific high- accordingly. Figure 3 on the previ-
red flags needed further investigation. tech segment. ous page illustrates a typical category
During due diligence, the focus turned Operational due diligence focuses analysis for a high-tech firm.
to organizational capabilities such as on the targets organizational capabili-
large-scale project delivery, customer ties, production and operational cost- Realizing Value in High Tech
satisfaction in select geographic regions, competitiveness, and overall business Capturing value in high-tech acquisi-
and the ability to replicate early suc- performance. PE managers examine tions requires broad industry expertise
cesses in other geographic regions. what it will take to realize the desired and a meticulous focus on detailsin
amount of growth, and evaluate reten- terms of both the target company and
Market and Operational Due tion and compensation issues, includ- its industry. A target attractiveness
Diligence ing determining which staffers to quick scan, followed by thorough
After the target attractiveness quick retain or replace. Managers also iden- market and operational due diligence,
scan, we challenge our PE clients to tify potential risks from merging cul- allows PE firms to unlock the hidden
exploit the time between rounds of tures and the role of investors, so they treasures in this rapidly and constantly
bidding to engage in a more compre- can be mitigated early. changing industry.

Alex Liu is a partner in the San Francisco office. He can be reached at
Sieghart Scheiter is a partner in the Dsseldorf office. He can be reached at
Jan Stenger is a principal in the Frankfurt office. He can be reached at
Venkat Tummalapalli is a consultant in the San Francisco office. He can be reached at
Nishant Kumar is a consultant in the San Francisco office. He can be reached at

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