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Chapter 1: Introduction to due diligence:

Due diligence is intended to be an objective, independent examination of a target company which focuses upon financials, tax matters, asset valuation, operations, the valuation of a business, and provides assurances to the lenders and advisors in the transaction as well as the acquirers management team. The process is intended to provide the acquirer with adequate information about the value and risks associated with the target (Angwin, 200 1). Due diligence is a generally accepted process to undertake in evaluating potential Merger and Acquisition (M&A) targets. Sinickas (2004) defines due diligence as a process where each party tries to learn all it can about the other party to eliminate misunderstanding a nd ensure the price is appropriate.

According to Angwin (200 1), the purpose of such investigation is to give confidence to the acquirer and their advisors and lenders that they fully understand the value and risks associated with the target company. This also gives confidence in setting negotiation parameters. Effective due diligence should uncover issues which might de -rail negotiations or may lead to the failure of the acquisition during the post acquisition integration phase.

The sorts of issues whic h may be uncovered include pending litigation, inaccurate inventory assessment, puffed up financial accounts, weak cash flows, poor financial controls, tax contingencies, unrealisable investments, need for significant future investment, related party transactions and unethical practices. The target company management may also lack vital capabilities and be dependent upon critical factors outside of their control. These sorts of issues may compromise the apparent competitive strength of such a business and t he viability of its long -term strategic position (Angwin, 200 1).

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Due diligence includes the formal financial review but it also includes numerous non -financial elements, including the investigation and evaluation of organizational fit, ability to merge cultures, and the technological and human resources capabilities and fit. Merger failures often result from a lack of careful evaluation of both the hard financial and soft personnel and organizational issues that are critical to organizational success (Epste in, 2005). Due diligence facilitates firms to formulate remedies and solutions to enable a deal to proceed, by confirming the expectations of the buyer and the understanding of the seller. In many ways, due diligence lends comfort to an acquirers senior m anagement, the board, and ultimately the stockholders, who should all insist on a rigorous due diligence process, which provides them with relative (though not absolute) assurance that the deal is sensible, and that they have uncovered any problems pertain ing to it that may disrupt matters in the future (Moeller, 2009). While due diligence does enable prospective acquirers to find potential black holes, the aim of due diligence should be this and more, including looking for opportunities to realize future prospects for the enlarged corporation through leveraging of the acquiring and the acquired firms resources and capabilities, identification of synergistic benefits, and post merger integration planning (Howson, 2003). Though due diligence may not be chea p, as a result of fees charged for often highly complex work by professional services firms, the alternative of litigation or the destruction of stockholder value -as a consequence of having been penny wise and pound foolish in the execution of the due d iligence process- may prove far more costly in the long run (Moeller, 2009). Moeller (2009) recognises that due diligence may be only one part of an acquisition, in many ways it is by far the most significant aspect of the M&A process. Done properly, acqui rers should be better able to control the risks inherent in any deal, while simultaneously

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contributing to the ultimate effective management of the target and the realization of the goals of the acquisition. The underlying reasons for merger and acquisitio n failure all share one thing in common they could have been avoided by conducting appropriate due diligence. There is a profound need for entities to conduct intensive and effective due diligence in M&A deals. Background to topic: Customarily, the due di ligence assessment was always restricted to a review of the technical and financial aspects and that is why many executives rely on merely financial reports to make their decisions without taking into account other factors. For most companies in the past, the term due diligence was mistakenly taken to mean a study of the profit and loss and the balance sheet of the acquired company, some aspects of its market presence, as well as legal issues (Papadakis, 2007). The consequences of incomplete due diligence are demonstrated by the ongoing problems of Halliburton, which became embroiled in asbestos claims against Dresser, the company with which it merged in 1997. Although the extent of the due diligence process remains disputed, court documents alleg e that information on Dressers situation, including a letter from a complainant, was available during the due diligence period and not uncovered by Halliburton. The cordial nature of the merger talks and friendship between the two company leaders is cited as a possible reason for this laxity. The cost to Halliburton for this liability is generally estimated at more than a half billion dollars (Epstein, 2005). Traditional due diligence merely corroborates the history of a target entity whilst appropriately applied due diligence offers insight of the future value of the target across many aspects. Less than a decade ago, the due diligence focus was almost always limited to financial factors, pending law suits, and information technology (IT) systems. Today, t hose areas remain important, but they must be supplemented during the due diligence process by

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attention to the assessment of other factors: management and employees, commercial operations, and corporate culture. Newer areas of due diligence are developing rapidly: risk management, innovation, and ethical (including corporate social responsibil ity) due diligence (Moeller, 2009). The due diligence assessment is a highly specialised skill, for which there is no formal training. Most companies who target growt h by acquisition have dedicated M&A teams who specialise in the identification of potential acquisition targets, and have therefore developed good in-house capability with respect to evaluation and financial risk assessment. However, M&A teams seldom include expertise in assessing aspects of non-financial risk (Reichardt, 2006).

Although the number of mergers and acquisiti ons has declined over the past number of years, the deals that are being struck are far riskier than those of the 1990s. The increasing risk can be traced to at least three converging trends , according to Perry (2004) :

Companies in maturing industries are rebalancing their portfolios, or selling off pieces of the business. Companies that acquire these pieces must untangle the targets business processes from its parent company; in many cases, the pieces being sold have entrenched processes and cultures that are difficult to integrate into the b uyers organization.

Cross-border transactions increasingly common because of the global reach of todays industries are intrinsically riskier than those within a single country.

Expectations have changed. In the 1990s, a merger or acquisition was ex pected to deliver cost reductions. Now, M&A is often a core growth strategy as well. Achieving projected growth targets is far less certain than achieving projected cost savings and more difficult to measure.

While some studies have even indicated that seven out of ten mergers do not live up to their promises, the analysis of the causes of failure has often been shallow and the measures of

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success weak. For decades, success and failure in M&A has been studied in terms of narrow and uninformative measure s, such as short-term stock price, leading to the aforementioned claims that most mergers fail. Many have taken this finding at face value, moving on to the search for causes of failure, which include culture clash, lack of synergies, and flawed strategy (Epstein, 2005, p. 37, vol. 38).

As mergers and acquisitions become increasingly complex, the activities of due diligence become ever more important. The danger is not that companies fail to do due diligence, but that they fail to do it well. To M&A avail , there exists a handful of effectual due diligence best practices can reduce the risk and give deals a fighting chance.

Chapter Outline: Chapter 1 Introduction and background to research: Page 1

This chapter serves as an introduction to due diligence in mergers and acquisitions and explains to the reader what due diligence is, what due diligence is not, why it is performed and what are its objectives in practice. It is crucial that this chapter be formed at this instant, as many readers do not thoroug hly grasp the objectives and significance of due diligence. This chapter also makes note of the rationale of the problems and concerns that has arisen over the years with the implementation of due diligence.

Chapter 2 The Research Problem:

Page 6

This chapter establishes the reasons why reviewing some of the flaws of due diligence in practice were chosen as a topic of study. Furthermore, this chapter will emphasize the importance of the study, and overall will discuss: 1. Overview of methodology 2. Research question

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3. Scope and limitations of study 4. Significance of study

Chapter 3 Literature Review:

Page 11

This chapter establishes the principles that have arisen in various case studies deliberated and attempt to explain the possible reasons as to why the due diligence process is flawed and endeavour to establish the principles that have become evident by scrutinizing these case studies.

Chapter 4- Case Studies:

Page 23

A variety of case studies detailing unsuccessful mergers and acquisitions due to ineffective or inadequate due diligence is summarized, analyzed and discussed. Some of these national and international case studies that are scrutinized are:

Harmony for control of Gold Fields Limited Federal-Mogul bought T&N plc Geita Gold Mine acquires Ashanti Goldfields VeriSigns purchase of Jamba Hewlett-Packardss acquisition of Compaq Halliburton acquired Dresser

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Please Note- These case studies chosen have not all been adapted from journal articles. However as they remain factual in nature and objective in their description, I have taken them into consideration and will use them as part of my literature review although they are not peer reviewed.

Chapter 5 Conclusion and Further Research:

Page 32

This chapter concludes on the research problem identified, and also presents a need for further research on the deficiency of due diligence in practice.

References

Page 35

Appendices

Page 39

Three graphs from a range of past surveys conveyed by KPMG and EIU/ Accenture are presented which reveals note -worthy reflections of the significance of the due diligence process and its complexity in execution.

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Chapter 2: The Research Problem :

Overview of methodology: An extensive literature review will be undertaken in ascertaining the reasons why due diligence procedures have drastically altered over the years, and the manner in which they have caused radical failure in mergers and acquisitions. Chapter 3 will establish the principles that have arisen in thevarious case studies identified and attempt to explain he possible reasons as to why the due diligence process was flawed. Various national and international case studies of actual mergers and acquisitions that hav e failed due to some flaw in the due diligence process will be summarized, analyzed and discussed, the principles that have emerged from observing these case studies will be highlighted for emphasis . (Please see Chapter 4). In Chapter 5, a conclusion will be drawn from the observations above and will bring the research problem to a close . The research will also present a need for further research on the deficiency of due diligence in practice. Lastly, three graphs from a range of past surveys conveyed by KPMG and EIU/ Accenture will be presented which reveals note -worthy reflections of the significance of the due diligence process and its complexity in execution . This is to reflect the statistical data highlighting the importa nce and deficiency of due diligence in acquisitions.

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Research Problem: What are the flaws and shortcomings of due diligence procedures in mergers and acquisitions in practice? The research reported here focuses on the reasons why mergers and acquisitions fail specifically because of imperfect due diligence. Furthermore, my research identifies some of the deficiencies of due diligence procedures, and as a result establishes how the process lacks in mergers and acquisitions.

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Significance of study: Mergers and Acquisitions (M&A) are often seen by market analysts as glamorous, as a sign of a dynamic management and mark up share prices accordingly. For management, M&A can be a means of bolstering short -term performance and/or masking underlying problems (Howson, 2009).

The results in the KPMG (1999) survey showed that due diligence was the most important of the non optional pre -deal activities. Companies which prioritised this were 6% more likely than average to have a successful deal. This con trasts with the acquirers who focused their attention instead on arranging finance or on legal issues and were therefore 15% less likely than average to have a successful deal. This evidence highlights the power of due diligence if used to full effect. (Refer to Graph 3 in the Appendix .)

In a recent project, a U.S. insurer determined the target company value a European multi business financial institution to be around $5 billion. Taking into account related synergies both expected to derive from the d eal, the U.S. Company was initially prepared to pay $5.5 billion. However, a closer look at the people issues revealed: The once-off golden parachutes to senior management in the event of a change in control amounted to $100 million.
y

Unbudgeted pension co sts, governed in part by local laws, amounted to a total of $300 million.

Rationalizing the compensation plans the two companies amounted to a one -time cost of $10 million

And the complex regulations governing workforce streamlining would have created additional costs of $10 million.

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Taken together, these people related costs amounted to $340 million the amount by which the acquirer would have overpaid in the deal had it not performed adequate due diligence (Boschetti, 2006).

It is thus extremely important that due diligence procedures are performed with extreme accuracy, care and awareness. Seeing that m any companies turn to mergers and acquisitions for faster growth and aggressive expansion as an alternative or as a complement to internal organic growth, what is surprsising is that r espondents in the Economist Intellige nce Unit 2006 Global M&A Survey, revealed that onl y 17% of firms were highly satisfied with the rigour and accuracy of their due diligence - one might reasonably hope for a more sweeping confidence in such a key element of M&A. The survey also found that although due diligence is considered as a gruelling challenge by 23% of CEOs in making acquisitions. In many cases, derisory due diligence has proved catastrophic. In the study about half of the participants admitted that their due diligence processes failed to uncover major problems in the target companies. The literature suggests that the due diligence process is essential for M&A success. However, the scope and complexity of due diligence has increased as businesses continue their expansion. Therefore it is important that past M&A experience be explored to identify whether an organisation can learn from past mistakes and improve its M&A performance (McDonald, 2005). Whilst the survey showed that due diligence is one of the two most critical elements in the success of mergers and acquisition transactions (the other being the proper execution of the integration process) it is interesting to note that d ue diligence was considered to be of greater importance than target selection, negotiation, pricing the deal, and the development of the companys overall M&A strategy.

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Scope and Limitations: Due diligence, by definition, allows the seller and buyer to renego tiate the price if the buyer determines that there are problems with information (value of assets, likelihood of lawsuits, robustness of technology, etc.) or certain projections are unrealistic. This research report will not see to such issues. Due diligence fundamentally means assessing price and identifying financial risks - the definition of due diligence for the purposes of this research report will not deal with any other outcomes of due diligence other than identifying risks.
y

It is understood that ev en a company made up of well -educated high achievers can falter due to unpredictable market conditions, unforeseen competition, or technical setbacks. In some merger cases, economic and industry conditions should have been foreseen. In others, various even ts occur that dramatically impact the success of the merger and the company that could not have been anticipated such as 9/11 etc. These unforeseen, uncontrollable events which could not have been forecast have not been considered as flaws or deficiencies of due diligence in this research report as valid reasons for due diligence deficiency.

The aim of this research report will not discuss the various types of due diligence that an investigating entity can/should perform, but rather discuss why and how the procedures they did perform failed the acquiring entity. The purpose of the report is not to determine how to conduct due diligence but rather why these conductions fail in practice.

Therefore the intention of this research report is not to provide further checklists of further procedures to perform - these checklists covering the legal, financial and commercial aspects of due diligence, as well as other areas such as IT, intellectual property, and environmental risks have been studied in great detail and are not what the research endeavours to achieve. A basic understanding of these has b een provided in the chapter

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Chapter 3: Literature Review: In 1998, Harvey Price argued that in the present environment, the scope of the due -diligence process needs to be expanded. Although 13 years later, the information stand true. The rationale for enlarging the scope is based on the following: Acquisitions have become predominately "stock" transactions due to provisions of the Tax Reform Act of 1986 allowing corporate liabilities to be passed on to an acquiring company.
y

The environmental liability of purchasing a past polluter passes to the acquiring company and potentially to its lenders.

The increased number of international acquisitions necessitates a due -diligence analysis of the requirements of foreign ownership.

A mismatch of company cultures, market position, strategic direction and a myriad of other factors have caused a number of M&A's to fail.

Price (1998) stated that the role of the due -diligence process needs to be expanded to include an investigation prior to ident ification of specific M&A candidates as well as after the deal is done. The due -diligence process must continue to facilitate the amalgamation of the two operating entities into one.

According to the EIU/Accenture (2006) survey, only 18% of executives w ere highly confident that their company had carried out satisfactory due diligence. This is probably due to the lack of attention given to this critical aspect of a deal, or to the view that it is merely a box -ticking exercise conducted by outside advisers . In short, the probing of a wide variety of due diligence areas should provide a counterbalance to the short -termism of traditionally limited financial and legal due diligence, helping acquirers to understand how markets and

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competitive environments will affect their purchase, and confirming that the opportunity is a sensible one to undertake from a commercial and strategic perspective, especially in cross border deals (Moeller, 2009).

It is inevitable that most due diligence assessments will be conducte d against the backdrop of a pressing time frame, particularly under the scenario of a fire sale. (See case study 7 of

Geita Gold Mine and Ashanti Goldfields ). Similarly, access to pertinent information may be restricted, either by the aggressive time l ine for assessment completion (which may, for example, not allow for a site visit) . All of these factors contribute to the compilation of an incomplete data set on which to base the risk -assessment and ultimate investment decision (Reichardt, 2006).

Reichardt (2006) also maintains that the type of information available for due diligence assessment is dependent on whether the bid is hostile versus friendly , the amount of time available for data gathering and assessment given that the majority of due diligence

exercises are conducted against an aggressive time frame (particularly in the case of a competitive bid), the accessibility of the site. Hostile bids, aggressive time frames and/or remote site location may prevent the due diligence team gaining access to site, in which case due diligence may be restricted to a desk top review of available data. Reliance on exclusively desk top due diligence is particularly perilous where the project is located in an unfamiliar jurisdiction or involv es technologies, socio-cultural settings with which the potential purchaser has no prior experience. Similarly, some of the options listed above (such as auditing against the findings of previous audits or complaints registers) assume that access has been granted to in-house sources of information by the vendor, which is unlikely to be released in the instance of a hostile bid or which cannot be accessed due to the tight time frame. (Please see case study 5 and 7 in this regard.)

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The question for senior managers cont emplating an acquisition is whether the current round of M&A activity will leave them feeling more satisfied than their previous experiences. In several surveys of the last decade, senior executives consistently rated their transactions as unequivocally successful less than half the time, making the odds of success worse than a coin toss. It is hardly startling that the failure rate is so high when the magic of M&A pushes acquirers to rush into acquisitions ( Boschetti, 2006).

There is pervasive agreement among serial acquirers that moving as quickly as possible is best because if the due diligence process is lengthened, momentum can be lost, benefits delayed, and the acquired management team even led to believe that the acquirers are less than serious abou t achieving the projected financial benefit (Sadtler, 2009). Therefore the due diligence process is essentially almost always performed on a pressing time frame.

Due diligence teams are seldom structured to have the ability to identify, let alone quantif y, key areas of risk. As a result, these risks may be excluded from assessment of the overall project/company risk profile, which means that investment decisions may be made on the basis of incomplete data. Holistic risk management - which considers financial as well as non-financial risk- is consistent with the principles of enterprise -wide risk management. If a company considers non-financial risks significant enough to be focused on at a due diligence stage, then there is a better chance that such areas o f risk will be proactively managed throughout project life (Reichardt, 2006) . (Please see case study 6, Federal-Mogul and T&N, in this respect.)

Due diligence should commence from the initiation of a deal. Matters to search include finance, management, employees, IT, legal, risk management systems, culture, innovation, and even ethics . In general, the due diligence process largely conforms to organizational

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learning theory and exploratory learning, specifically . While an original structure to the approach is needed to ensure that all major areas are evaluated, effective due diligence also has an exploratory nature. If some information is identified that poses further questions, answers to them must be pursued even if they require movement outside of the o riginal structure. Thus, good due diligence can be described as semi -structured, containing both primary and exploratory inquiries (Harvey, 1995).

Along the lines of Price (1998), when broadening the scope of the due -diligence process, information should be sought prior to the identification of a target company. Currently, mergers occur too often based on chance occurrences where a CEO or board member learns that a potentially attractive merger partner is available. In principle, there is nothing wrong with this approach; however, it is myopic. The preferred approach , as seen in case study 8 (Inside Cadbury's sweet deal), should be based on a systematic assessment of potential industries and candidate organizations. In short, the due -diligence process must start long before a CEO or board decides to pursue a potential M&A candidate. The formal evaluation of candidates shoul d start with the information collected by a due -diligence team. The due-diligence process should provide objective input on how to compare industries and systematic means to assess the attractiveness of an industry. Without this detached third party assessment of industries, individual managers may lobby for their "favourite" industry.

In some cases, as revealed in Hewlett-Packard's acquisition of Compaq (case study 4), it has shown that the low probabilities of success were not necessarily due to a failur e of the traditional due -diligence process; rather, the process did not start early enough to gather facts about the types of acquisition candidates to screen or even consider (McDonald, 2005).

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Industry attractiveness or lack thereof may provide valuable insights into the acquisition of one company over another. Price (1998) also contends that there are five critical areas where the operations of the two firms must be combined to make the operation compatible. As displayed in the Cadbury case study, the due-diligence team can provide: (1) Historical data on various functional components of the acquired company, (2) An assessment of the quality of each functional area, (3) An evaluation of the key personnel in each area, (4) Insights as to how to modif y systems and functions to accelerate integration and (5) Identification of special opportunities for enhanced system performance by either correcting weaknesses or identifying opportunities that can improve performance.

In addition, Price (1998) noted that some of the failure may be due to inadequate integration after the acquisition or merger; the due -diligence process stopped too soon. Also, there are critical integration issues that must be addressed when combining two organizations. Often, failure to address these issues results in a failed merger. Again, the due -diligence team has obtained the insights that are invaluable in accelerating the amalgamation of the two operating entities. Furthermore, many managers will be constrained to examining compa nies in their particular industry because of a lack of knowledge about other industries. To complete the pre-acquisition due-diligence process, the team must examine the potential candidates' compatibility with the acquiring company. A company may be an id eal M&A candidate from a strategic standpoint but may create significant integration or "fit" problems after acquisition (Price, 1998).

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Some skills that are central to detailed due diligence assessment may not be permanently represented in the M&A depar tment, but are drafted in once an attractive acquisition target has been identified. At this stage, specialists in production -focused disciplines are called on supplement the expertise of the M&A department as a matter of course, but disappointingly few companies routinely include environmental or socio -economic experts on their due diligence teams. Moreover, key personnel who have an understanding of these areas of risk may depart from the operation on acquisition, either because they choose to leave, or because they are replaced by internal staff from the purchaser. In either situation, recognition of the issues that need to be managed will be permanently lost, leaving the vendor poorly equipped to manage these risks as they arise (Reichardt, 2006).

The role of due diligence historically has been to document the financial background of a potential candidate and compile legal informa tion on the firm being acquired as observed in the situation of Barrick Gold Corporation, case study 3. Another reason which is becoming more apparent according to Reichardt (2006), is commonly referred to as soft issues is often more of a token gesture than a genuine attempt to understand the full risk profile of the project or company under consideration, which is the predicament reflected in the circumstances of Halliburton and Dresser, case study 1.

The focus of a traditional due diligence process has been the t angible, internal environment as dicusssed earlier, as financial and legal experts audit the "hard assets" and at tempt to determine potential liabilities or future projected growth scenarios after the company is acquired, the attention of the auditors is primarily focused on verifying historical data and affixing value to the tangible assets of the company. Their att ention on liabilities or contingent liabilities sometimes biases the due diligence process toward a negative orientation. Those involved in more traditional due diligence would argue that the fields identified in Exhibit 1 have been encompassed within thei r due diligence in the past. The

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management f t e mpany t e acqui ed i examined it egard t executi e

remunerati n, empl yment contract , arrangement for future consideration

uyouts), and

ot er tangi le aspects relati e to t e management of t e company as displayed in case study Verisigns purchase of amba.

hat is being recommended is that each of the seven fields identified in Exhibit

be

audited, examining both tangible and intangible dimensions of the function. In today's market, the timing of transactions is largely driven by buyers rather than sellers, and, given the more cautious nature of buyers and their financing groups; the process is slowing down. hole due diligence

he growing concern about what is being purchased and

defending the price of the acquisition will help those in charge of due diligence to broaden the scope of the information collection process. hat is included in each audit and how

these audits are conducted becomes a focal point of expanding the due diligenc process. e he due diligence process should be as comprehensive as time and money will allow arvey, ).

Exhibit 1: Due Diligence Audit Requirements

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Although due diligence practitioners seek to produce a perfect sketch of the target company, the truth is one of time and cost constraints. As mentioned above, t ime restrictions have been of paramount importance in many deals. When this constraint is present it is often the case that the effective examina tion of the target acquisition, beyond the major financial, legal, tax, and future sa les projections, does not occur (Crisafio and Schliebs , 1989). However this would mean that choices and judgments need to be made about which issues are critical and need to be pursued. As due diligence pr actitioners attempt to give value for money by tailoring their enquires to their clients concerns as far as possible, the due diligence report can begin to lose objective balance which an advisor may bring, in preference for the particular interests of t he acquirer (Angwin, 2001).

Quite often it has been viewed as "too expensive" to bring in experts in every functional area to render an opinion (Hearne and Dean , 1989). Cost constraints are usually a function of the size of the deal. If the deal is relat ively small then it will be viewed as un -economic to invest a lot in due diligence because the personnel involved will have other things they can be doing that are more important. Both time and cost constraints also need to be viewed in terms of using warranties and representations to remedy problems that are not uncovered during the due diligence process (Harmon , 1992).

What is critical to the success of the due diligence process is the identification of the necessary information required, where it can best be sourced, and who is best qualified to review and interpret the data. It is said that in practice, requesting too much information is just as dangerous as requesting too little; having the wrong people looking at the data is also hazardous (Williams , 2008).

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As indicated by Reichardt (2006), failure to follow through on the due diligence findings even where due diligence has been conducted by an appropriately skilled team and identifies areas of significant risk, the company may fail to carry through on these findings once the investment has been acquired as shown in the position of Halliburton and Dresser (case study 1.) Under certain circumstances, this may result because company management does not share the due diligence teams perspective on the potential risk areas, particularly with respect to the biophysical and socio -economic environment.

More often, failure to follow through on due diligence recommendations may result from a disjunct between the due diligence team and the management team who assume

responsibility for the project on acquisition. Thus, even if environmental and social challenges have been identified at a due diligence stage, site management may remain unaware of these risks until they manifest themselves at a later date. At thi s point, it is likely that such issues will have to be managed reactively rather than proactively, which decrease the likelihood of these risks being managed in an appropriate and cost -effective manner (Reichardt, 2006).

Angwin (2001) notes that a perfec t synopsis (of a target company) suggests that there is only one way of appraising a business. Although the aim of due diligence is to provide an objective assessment of the target firm, this idea of objectivity is rooted in the philosophy of the professionals towards the scope, nature and timing of the work. Whereas for domestic acquisitions, there is a level playing field in so far as businesses conform to the same regulations and cultural norms, differing perspectives are likely to become important in cross-border acquisitions where transactions may take place between quite different business systems and national cultures. Under such circumstances, it is likely that businesses and their advisors from one national culture will place emphasis on different aspects and their handling of the pre -acquisition phase to companies in the target country. Values that may appear objective to one business system may not have the same

P a g e | 22
importance in another national system. These differences may well affect the choices t hat businesses from different national cultures might make in terms of:

1. The types of advisors they would use in the pre -acquisition period 2. The value they perceive in due diligence 3. The type of due diligence work they would have undertaken

Considering the complexity and variety of the issues regarding the analysis of a foreign target, firms often seek help from financial and legal advisors in the country where the target firm is headquartered. Conscientious work by Angwin (2001) examines how managers in Europe use advisors to value the due diligence process. He conducted a survey of European firms top executives regarding national perspectives on due diligence. His results show that interpretations of the due diligence process vary across managers of different countries. Specifically, managers from separate European countries stated diverse primary objectives for the due diligence process (i.e., help in the negotiation, insight into the existing management, evaluation of the assets, assess cultural fit, help to plan integration, commercial insight into the market). Moreover, he found that all aspects of the due diligence process were conducted by the acquiring firm, although acquirers of different nationalities tended to rely on external advisors fo r specific issues (i.e., financial), and the extent to which advisors were used varied considerably. The use of advisors injects external knowledge into the process. Using this approach should help avoid path dependence in learning during the due diligence process.

In line with the findings of Angwin (2001), a key feature of due diligence is that it plays a critical role in M&A and yet is assumed to be objective a nd neutral in approach. T his assumption may not be well founded , especially where M&A is acros s borders as different national cultures may give rise to variations in the expectations that acquirers and merger partners have of the value and role of due diligence. However, if both sides assume that

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their due diligence is objective and neutral there may be room for many mistaken

assumptions. The sorts of areas that would be examined are the target companys industry and how it is affected by:
y y

Macroeconomic factors, Competitive environment in terms of how it competes against current and potential competitors,

y y y y y y

History and development, Business in terms of products and services and their position in the market, Management and personnel quality and capabilities, Financial performance over time, Asset values Accounts and accounting policies, Information system

Studies, as confirmed by Cadburrys success (case study 8), have shown that the companies that are most successful are those who are willing to take on risk but employ rigorous risk-assessment and mitigation processes to ensure that their business decisions are consistent with their appetite in order for risk to be managed effectively, the nature and extent of the risk needs to be determined and understood - if this process is initiated at a due diligence phase and carried through on acquis ition, it allows the management of such risks to be planned for and appropriately resourced (Reichardt, 2006).

Moeller (2009) identifies the following key factors when conducting informative and timely due diligence as:
y

Identifying the critical areas to

probe: financial, legal, business, cultural,

management, ethical, risk management, etc.

y

Identifying the most important information to collect in those areas, as there is never enough time to

P a g e | 24
look at everything in as much detail as one might want. Identifying the right sources for the desired information. Identifying the right people to review the data: this should include those who know most about that area and also those who will be managing the business post acquisition.

y y y

Due diligence should not be a mere confirmation of the facts, but rather bridging the strategic review and completion phases of any merger or acquisition exercise. The due diligence process allows prospective acquirers to understand as much as possible about the target company, and to make sure that what it believes is being purchased is actually what is being purchased (Moeller, 2009).

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Chapter 4: Case Studies: Many prominent deals of the past were done with superficial due diligence, which resulted in acquisitions and/or mergers that produced sobering results. These various national and international case studies were all chosen have been summarized and discussed but have not all been adapted from journal articles. However as they remain factual in nature and objective in their description, I have taken them into consideration and will use them as part of my literature review although they are not peer reviewed.

Case Study 1: The consequences of incomplete due diligence are demonstrated by the ongoing problems of Halliburton, which became embroiled in asbestos claims against Dresser, the company with which it merged in 1997. Although the extent of the due diligence process rem ains disputed, court documents allege that information on Dressers situation, including a letter from a complainant, was available during the due diligence period and not uncovered by Halliburton. The cordial nature of the merger talks and friendship betw een the two company leaders is cited as a possible reason for this laxity. The cost to Halliburton for this liability is generally estimated at more than a half billion dollars.

Adapt d from, Epst i , M. J. (2005). The determi ants and evaluation of merg er. Business Horizons , 3746

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Case Study 2: Failure in Due Diligence: VeriSigns Purchase of Jamba

In June 2004, VeriSign acquired privately held Berlin -based Jamba for US$273 million. VeriSign was an internet infrastructure services company which provided the services that enabled over 3,000 enterprises and 500,000 websites to operate. VeriSign had extensive experience with acquisitions, having made 17 acquisitions prior to Jamba, including four that were valued at more than this particular purchase. Jamba had millions of subscribers and was the leading provider of mobile content delivery services in Europe. It was best known for the Crazy Frog character used in the most successful ring tone of all time. But, beneath the surface, trouble was brewing that could easily have been uncovered by even the most rudimentary due diligence: complaints to regulators had noted that Jamster, the UK and US rebranding of Jamba, was targeting children, despite the fact that Jamsters mobile content services were intended for adult customers only. Perhaps more disturbingly, only days before the acquisition VeriSign discovered that a significant portion of Jambas profits came from the distribution of adult content in Germany despite a VeriSign policy of not supporting adult or pornographic companies. There were backlashes in Germany over other issues and Jamba was forced to make a declaration of discontinuance regarding many of its contracts. Other legal actions were pending in Germany and the United States.

Adapted from, Due Diligence Requirements in Financial Transactions by Scott Moeller Available online at: http://www.qfinance.com/mergers -and-acquisitions-best-practice/due-diligencerequirements-

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Case Study 3: ...the consequences of some of these pitfalls are well illustrated by Barrick Gold Corporations troubled Bulyanhulu gold mine in Tanzania, which has been plagued by sustained NGO pressure and persistent allegations of human rights abuses since construction. A formal complaint was lodged by the Lawyers Environmental Action Team with the Compliance Advisor/Ombudsman (CAO) in January 2002 in respect of MIGA insurance guarantees issued to the project whilst it was under development by Sutton Resources Limited. Although the complaint was ultimately dismissed in January 2005 due to lack of evidence to substantiate the allegations, the CAO candidly concluded that, MIGAs due diligence had been constrained by the lack of a site visit and any independent verification of the facts leading to the controversy...

Adapted from, Reichardt, C. (2006). Due diligence assessment of non -financial risk: Prophylaxis for the purchaser . Resources Policy 31 , 193203.

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Case Study 4: ... In the classic case of Hewlett -Packard's acquisition of Compaq in 2001, the acquiring company had not conducted any research prior to the deal on how consumers rated Compaq products. When they did it, several months after the merger, they were astonished to reveal that consumers considered Compaq products to be inferior. However, it was too late to do anything about the merger itself...

Adapted from, Papadakis, V. (2007). Growth thr ough mergers and acquisitions: how it won't be a loser's game. Business Strategy Series , 43-50.

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Case Study 5: In the case of hostile bids , such as the abortive bid by Harmony for control of Gold Fields Limited in late 2004, the company being targeted for acquisition has no incentive to release data to the prospective purchaser. Under these circumstances, the prospective purchaser has to make do with information from publicly available sources and may choose to explore legal mechanisms to access other relevant data, for example, using the South African Promotion of Access to Information Amendment Act (No. 54 of 2002) , although there is no guarantee that privileged information will be released as a result of such legal action. Even under these restrictive circumstances, a reasonable amount of information on non-financial risk can be pieced together from publically accessible sources...

Adapted from, Reichardt, C. (2006). Due diligence assessment of non -financial risk: Prophylaxis for the purchaser . Resources Policy 31 , 193203.

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Case Study 6: In 1996, Federal -Mogul (a US auto parts company) bought T&N plc, Europes leading supplier of gaskets. With sales of $3 billion, T&N was bigger than Federal -Mogul itself. July 1998, Federal -Moguls share price was $72. By September 2001 it was $1. On October 1, 2001, the company filed under Chapter 11 of the US Bankrupt cy Code. What went wrong?

Problems Picked Up in Due Diligence Not Acted On

T&N had at one time manufactured building products containing asbestos, and for years it paid out an increasing number of compensation claims for asbestos -related diseases. Following the takeover, the number of asbestos claims against T&N and its former subsidiaries exploded. In October 2001 there were 365,000 asbestos claims pending. By the end of 2001, Federal Mogul had paid out $1 billion in claims. While Federal -Mogul was aware of the asbestos issue, Federal-Mogul leaders did minimal due diligence, failed to appreciate just how serious it was , and believed that, because it operated in the United States, it would be able to manage the litigation better.

Adapted from, Identifying and Minimizing the Strategic Risks from M&A by Peter Howson

Available online at: http://www.qfinance.com/mergers -and-acquisitions-best-practice/identifying -and-minimizingthe-strategic-risks-from-m-and-a?full

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Case Study 7: a fire sale scenario occurs when a company has to offload assets due to financial constraints. An example of this is the sale of Geita Gold Mine in Tanzania during 2000, which Ashanti Goldfields was forced to sell this asset at short notice due to seve re cash flow problems arising from its poorly advised hedging strategy. Under this scenario, the vendor has an interest in ensuring that the sale is concluded as quickly as possible so that the company can unlock the value of the asset, which leaves little time for due diligence assessment. In addition, such cash -strapped vendors are also likely to take steps to ensure that the purchase price is maximised, and may thus have an incentive to limit access to potentially negative information such as existing li abilities or situations of conflict. Fire sales usually attract several prospective bidders (since the vendor is forced to offload attractive assets to ensure a quick sale), which further contributes to a pressured due diligence time frame.

Adapted from, Reichardt, C. (2006). Due diligence assessment of non -financial risk: Prophylaxis for the purchaser . Resources Policy 31 , 193203.

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Case Study 8:

Due Diligence Success: Inside Cadbury's sweet deal

For years, growth for Britain's Cadbury Schweppes, a multi-billion dollar confectionery and beverage company, had always been accomplished the same way. The company made small bolt on acquisitions of regional brands. These acquisitions were not complicated; they did not require a sophisticated M&A process, nor did they trigger significant integration challenges.

But to compete globally, Cadbury needed to make a big move that would thrust it into the ranks of its major competitors. It targeted Adams, a confectionery company first owned by Warner-Lambert and then Pfizer . The Adams pursuit in 2002 was different from anything Cadbury had ever attempted. It was valued at more than US$4 billion, it was cross -border (Adams was based in New Jersey), it was a carve out that would require untangling of support services and business processes from Pfizer. Unlike a bolt -on, this acquisition would have to be integrated into Cadbury's existing regional confectionery businesses. At the same time, the company would have to clean up the problems from previous b olt-on acquisitions -a major risk factor of the deal.

With so much at stake, the company could not rely solely on financial due diligence . The executive team wanted to look at the key operational and management drivers that would affect the success of th e acquisition. And Cadbury needed to have a high degree of confidence in its valuation of the target, since competitors, all with deeper pockets, would also be bidding on the Adam's business.

With little experience in acquisitions of this scale, Cadbury so ught out subject matter experts, including A.T. Kearney, to determine the deals potential value. The experts ran workshops to determine synergies, developed action plans and identified other sources of value .

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All were documented and incorporated into the company's acquisition case, greatly

improving management's confidence in the acquisition model's rigor and accuracy.

Cadbury also needed to address the risk of business disruption that could result from decoupling the Adams business from Pfizer's infrastructure. One step was to help Cadbury challenge assumptions around how much transitional back -office support would be required from Pfizer post-closing. Another was to identify ways to simplify and speed up the untangling process while reducing Adam s' reliance on Pfizer for basic services.

Armed with a rich perspective, including an eyes -open understanding of integration risks, Cadbury was confident in its valuation of the target and was successful in the auction with a US$4.2 billion bid -- a more aggressive bid than both the market and competitors had expected.

The story did not end here. After Cadbury won the deal, the de -risking process continued well into the merger integration. Key members of the valuation or deal teams stayed involved to ensu re that knowledge gained during the enhanced due diligence process was used to develop and execute the pre -integration plan. This allowed Cadbury to flip the switch upon signing the deal, and have a perfect day one with no business disruption.

Adapted from, Herd, J. S. (Vol 32 No. 2 2004). Mergers and Acquisitions: Reducing M&A risk through improved due diligence. STRATEGY & LEADERSHIP , 12-19.

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Chapter 5: Conclusion It can be seen that in todays day and age of augmented analysis and apprehension over the faithful representation and trustworthiness behind executives behind them, given the climate of financial statements and the

what some higher officials have d one to

mislead shareholders, it is sensible to perform an effective and thorough due dil igence assessment before proceeding with an acquisition . A due diligence assessment to know the target entities industry, clients, customers, habits and practices, policies to procedures its past, present and its expected future . This report has shown that the due diligence process is indispensable, its scope and importance has never been more underestimated, now more than ever before.

In the current form, due diligence is essential to M&A success and its importance cannot be over emphasized. However, as this report has determined, due diligence is an ever evolving process. The deficiency in due diligence is not in the concept in itself, rather in its execution. The due diligence of the last decade is significantly different from the due diligenc e required in acquisitions today. Traditionally, due diligence audits were too heavily focused on the accounting and legal aspects of a M&A. Undoubtedly, these are important areas, but one must understand and appreciate the target firms' macro -environment, marketing, production, management and information systems etc. to avoid acquiring a firm with further dilemmas.

In line with the research presented , due diligence should not be viewed as a cost but as an investment in reducing the probability of failure of a M&A and a way to enhance the value of the combined entity. A myopic and outdated orientation to due diligence is still being used despite years of research of unswerving scholars. It has been held that companies should see the due diligence team as valuable and insightful discernments as they gather essential

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information and insights about the motivations of the acquiring firm and the attractiveness of industries in which to seek potential M&A candidates.

Many establishments have been exposed in the case studies presented in this report, which have proven the consequences of incomplete and inadequate due diligence, and the disastrous effects it has had on acquirers, as well as target companies. Whilst in practice, many companies may often fin d themselves making decisions based on imperfect or incomplete information, they can and should increase their comfort and confidence and should insist on more thorough, rigorous due diligence. This report has made clear that although due diligence may only be one element of a potential acquisition, in many ways it is by far the most significant aspect of the M&A process, and this report revealed statistical data emphasizing this statement.

The scope of the due diligence process has drastically been redefined over time as it will continue to change going forward. The research presented her e had brought together many respected authors views and in put to the deficiency of due diligence. Although all the autho rs conducted independent studies of the process, they all shared one viewpoint: The due diligence process as it stands, lacks in execution extensively. Each author argues in a different way as to how the process lacks, but nevertheless unanimously agrees that there are exists significant deficiencies of due diligence in practice.

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Further research

According to Shimizua (2004), t arget selection is a crucial concern in the due diligence process. In fact, depending on the acquisition motives, the focal firm searches for target firms with different characteristics such as size, complementary resources, local network ties etc. Despite the importance of this process, we lack studies specifically focused on the due diligence deviancies and shortcomings in practice in a South African context.

Firms that make multiple acquisitions should learn from their prior experiences (Very and Schweiger, 2001). As the importance of and opportunities from cross -border M&A's are likely to increase further in the global economy, learning from acquisition experience could be a critical source of competitive advantage. However, the extant research on learning from acquisition experiences is rather limited and contradictory (Finkelstein and Haleblian, 2002; Hayward, 2002). Moreover, given the high failure risk of M&A's, firms must be prepared for unforeseen events and respond to them effectively. Virtually no research has been done in the area of learning from relatively large failures, such as divestitures or liquidation M&A's (Shimizu and Hitt, 2004). Although mistakes and failures are not a pleasant topic for practitioners, opening this black box and providing managerial insights would significantly inform scholarly research and practitioners.

This study showed that the presented due diligence pr ocess is applicable and useful in practical transactions. The study has revealed a number of strengths and weaknesses encountered in the process of making them subject to management. A closer analysis of further case studies is required to gain a better understanding of the performance of the different steps of the process. Such an in depth study is a prerequisite for comparing the performance of other due diligence methods.

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APPENDICES: GRAPH 1:

When asked to draw on their recent experience to identify the critical elements of a successful cross-border M&A transaction, respondents most often cited orchestrating and executing the integration process (a factor cited by 47%), conducting due diligence (43%), and energising the organisation and understanding cultural issues (40%). These same factors are generally seen as key to successful domestic transactions, too, though cross-border deals obviously place greater emphasis on culture and integration.

Extracted from Accenture / Economist Intelligence Unit 2006 Global M&A Survey. (2006). Global M&A Survey. Accenture. Available online at: http://www.accenture.com/NR/rdonlyres/7FF8E735 -5756-43AC-8929F61CF10407E1/0/ExecutiveSummary.pdf

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GRAPH 2:

Respondents were a little more satisfied with their due diligence capabilities 57% said they
were satisfied with the rigour and accuracy of their due diligence on companies and markets. However, only 17% were highly satisfied with those capabilities, and one might reasonably hope for more widespread confidence in such a key element of M&A

Extracted from Accenture / Economist Intelligence Unit 2006 Global M&A Survey. (2006). Global M&A Survey. Accenture. Available online at: http://www.accenture.com/NR/rdonlyres/7FF8E735 -5756-43AC-8929F61CF10407E1/0/ExecutiveSummary.pdf

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GRAPH 3:

The survey results suggest that successful companies were managing to achieve long -term deal success by prioritising three hard key components in the pre -deal phase. These were synergy evaluation, integration project planning, and due diligence. This planning helped them to achieve swift and substantial value extraction on completion of the deal. It also offered evidence of where less successful companies are going wrong, by concentrating on mandatory activities such as legal and financing

Extracted from KPMG. Unlocking shareholder value: Keys to success. London: KPMG, 1999. Available Online at: www.imaainstitute.org/docs/m&a/kpmg_01_Unlocking%20Shareholder%20Value%20%20Th e%20Keys%20to%20Success.pdf