LBO Due Diligence Critical Activities

1
LBO Due Diligence Critical Activities
2
Objectives

• Provide a broad overview of a Consultants
  typical due diligence analysis
• Provide specific tools and methodology used to
  facilitate an informed opinion
• Illustrate high impact analysis via samples of
  key due diligence slides

3
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

4
Summary
Due Diligence Overview
A Consultant utilizes several standard analytical
tools to determine whether a deal is attractive
during the due diligence process.
Is this a good business to be in?
Key Question
Identify landmines
Identify opportunities
Method

• Market Analysis
• Competitive Position
• Customer Evaluation
• Company Analysis

Tools

5
Identifying Landmines
Due Diligence Overview
Potential Landmines

• Negative market growth expectations
• Rapid erosion of barriers to entry
• Market evaporation through technological
  obsolescence

Market

• Highly aggressive behemoth competitor in key
  segments
• Competitors outperform company on key customer
  needs

Competitive Position

• High levels of customer dissatisfaction on key
  product/ service attributes
• Low customer retention (high churn)

Customers

• Exceptions of accelerating input costs
• Structurally high cost producer

Costs

6
Identifying Opportunities
Due Diligence Overview
Potential Opportunities

• Attractive vertical/horizontal integration
  opportunities
• Potential for growth through geographic expansion

Market

• Attractive acquisition/consolidation plays
• Joint venture/merger opportunities to provide
  complementary products/services

Competitive Position

• Capabilities to address unmet customer needs (or
  entire customer segments)
• Opportunity to increase customer retention

Customers

• Plant consolidation opportunities driven by
  excess capacity
• Potential for SGA reduction
• Dissemination of internal/external BDP
  opportunities

Costs

7
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

8
Due Diligence Analysis
Analytic Tools
Market Analysis
Competitive Position
Customer Evaluation
Company Analysis
Output
Market Definition/ Sizing
Industry Dynamics
Industry Trends
Competitor Market Map
Competitor Dynamics/Profile
Competitor Benchmarking
Customer Analysis
Impact of Input Costs
Cost Reduction Opportunities
Internal BDP Opportunities
Growth Opportunities

9
Critical Activities Data Sources
Analytic Tools
Market Definition/ Sizing
Competitor Dynamics/ Profile
Cost Reduction Opportunities
Industry Dynamics
Industry Trends
Competitor Market Map
Competitor Benchmarking
Customer Analysis
Impact of Input Costs
Internal BDP Opportunities
Growth Opportunities
Activities
Primary Data Gathering

• Management interviews

• Customer interviews

• Competitor interviews

• Industry expert interviews

• Supplier interviews

• Plant/facility visits

Secondary Data Gathering

• Confidential memorandum

• Annual report/10-K

• Analyst reports (industry and company)

• Brava

• Literature searches

• Market research reports

• Trade publications/ associations

• Lotus one source

• D B Filings

• World Wide Web

• Internal company data

10
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

11
Overview
Market Definition and Sizing
Objectives
Analysis
Data sources
Tips

• Market definition establish relevant market
  segments
• not too broad to be meaningless
• not too narrow as to leave out relevant segments
• Market size identify growth and size of defined
  market
• establish total market potential
• establish target company growth potential
• establish target company market share

• Definition of relevant market segments
• Estimation of market size
• top down says market is XB total
• bottoms up sums revenues for each individual
  competitor in the market to generate estimate of
  total market

• Confidential memorandum
• Management interviews
• Competitor interviews
• Industry expert interviews
• Annual reports/10-K
• Analyst reports
• Literature searches
• Market research reports
• Trade publications/ associations
• Lotus OneSource
• Internal company data

• Market definition is first and most important
  step
• identify all segments which have customer or
  distribution overlap
• begin by thinking big, i.e., capturing all
  potential relevant segments, then narrow down
• management definition may be too narrow
• Market size should include both overall size of
  relevant market segments and historical and
  projected growth rates
• top-down market sizing takes the overall market
  size for all players/segments
• found in market research reports, literature
  searches
• bottoms-up market sizing arrives at the total
  market by adding up all the individual players
  and/or segments

12
Business Definitions Products
Market Definition and Sizing
Product based frameworks can help define business.
Product Segments
High
Leisure
Toys
Office
Commercial
Housewares
Competition
Housewares
Leisure
Leifert AG
Jardin
Toys
Mattel
Office
PHS Group
Extent of Cost Sharing (Estimated)
Commercial
Tupperware
Zag
Curver
Plysu
Rubbermaid
Low
High
Other business
Low
Extent of Customer End-User Sharing
Plastic Co. core business
Source Amadeus Brokers Reports
13
Business Definition Cost and Geography
Market Definition and Sizing
Cost sharing and geographic assessment can also
be used to determine the appropriate business
definition.
Costs
Customers
Competitors
"We strive for Pan-European product designs with
local appeal" - PlastiCo
Competitors
North America
Developed Europe
Eastern Europe
RoW
National
Plysu
Diapazon
Pollmerbyt
Regional
Curver
Addis
Global
Mattel
Rubbermaid
Tupperware
Core business
Other business
Favors Global Presence

• Customer tastes are regionalizing

• Strong economic benefit to global presence and
  scale

• U.S. innovators are leading industry
  globalization charge

Source Amadeus Brokers Reports
14
Market Map
Market Definition and Sizing
Ultimately, you will need to drive to a market
map.
Multiplexers
CSU/DSU
Modems
166MM
1,033MM
1,067MM
272MM
381MM
316MM
95MM
100
Other
Netrix
Other
Other
Other
ACT
Other
Other
Other
80
Cray
Paradyne
Newbridge
Stratcom
Adtran
Paradyne
Motorola
Racal
60
Adtran
Datacom
Zoom
GDC
PCSI
Racal
NET
Paradyne
Motorola
Digital
GVC
Link
GDC
Tellabs
ADC
40
Hayes
GDC
Kentrox
Ascom Timeplex
Motorola
Telco
Systems
Motorola
Micom
Larscom
20
Newbridge
Newbridge
Paradyne
US Robotics
Paradyne
Paradyne
Total
3,330MM
0
Sub-T1
Low-
Analog
T1 networking mux
T1
T1
High-speed dial modem
mux
speed
private
access
CSU/
mux
DSU
DSU
modem
Sources Company Data Consultant's Analysis
15
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

16
Overview
Industry Dynamics
Objectives
Analysis
Data sources
Tips

• Illustrate competitive dynamics within industry
• aggressive
• well behaved
• Identify shifts in distribution channels
• new or alternative channel development
• profit impact
• Identify fundamental industry shifts
• new products
• replacement / substitute products

• Determine nature of competition within industry
• Profile competitive behavior of each of the major
  players
• Analyze distribution channel trends
• Identify major product developments

• Confidential memorandum
• Management interviews
• Competitor interviews
• Industry expert interviews
• Annual reports/10-K
• Analyst reports
• Market research reports
• Trade publications / associations
• Internet

• Association, industry expert and managerial
  interviews are key
• they are closest to the dynamics of the industry
• Historical pricing or profit trends (e.g., per
  unit) can illustrate examples of price competition

17
Industry Profit Trend
Industry Dynamics
The purpose of industry dynamics is explaining
the profit trend.
Sources Amadeus Company Financials
18
Industry Value Chain
Industry Dynamics
A value chain can be used to describe the nature
of competition.
Ad Capture - Classified
Free Paper Distribution
Production - Pre-Press - Printing
Paper
Composition
Paid Paper Distribution
Ad Capture - Display

• Total paper costs reduced through participation
  in paper buys (8 discount to market)
• Volatility in newsprint costs reduced through
  fixed price forward contracts (e.g. Holmen in
  Sweden)

• High brand awareness and strong local presence
  (target is typically 1 or 2 in key markets)
• Incentivised direct sales force and titles with
  the ability to accurately target desired audience
  (e.g., Heavy Truck Buyer)

• Efficient, automated systems to enable
• tight copy deadlines
• reduced labor costs
• less pre-press
• lower material costs
• electronic transmission to printers
• uploading to Internet

• Reliable and high quality output (either in house
  or third party)
• Color printing capabilities
• Fast throughout allowing comprehensive production
  lead times

• Access to key drop sites (estate agents for
  property, garages for used cars)
• A network of regularly serviced street dispensers
• A strong network of relationships with
  retailereither consolidated (France) or
  fragmented (Russia)

Sources Confidential Memorandum Industry
Interviews
19
Summary of Dynamics
Industry Dynamics
Look for ways to summarize the key dynamics.

• Within the pharmaceutical industry, increasing
  competition, mergers, and down-sizing are forcing
  companies to focus on their core business(RD
  and marketing)
• investments in packaging capabilities are
  increasingly difficult to justify

• The increasing pace of change within the
  pharmaceutical industry puts a premium on
  flexible packaging capabilities
• increased competition within each drug category
  leads to greater fluctuation in demand
• ethical to OTC conversions require rapid ramp-up
  into mass production and significantly impact
  sales of competing drugs
• packaging, as a marketing tool, must increasingly
  respond to competitor moves and demand
  fluctuations

• The number of drugs and the variety of packages
  used in the marketplace is increasing
• greater number of approved drugs per category
  encourages use of samples
• ethical to OTC conversions move existing drugs
  into broader distribution
• increasing consumer/marketing orientation of OTC
  packaging encourages sophisticated, targeted
  packaging

Increasing use of contract packagers (as a cost
effective alternative to developing new, more
flexible internal capabilities)

• Shift toward use of novel packaging approaches
  (particularly blister packing) favors contract
  packagers who can more easily incorporate new
  equipment and techniques into their operations
• most Ethical to OTC converted drugs packaged in
  blisters to encourage consumer compliance with
  instructions
• samples usually blister packed

Sources Interviews Consultant's Analysis
20
Porters Five Forces
Industry Dynamics
Porters framework represents a straightforward
way to summarize industry dynamics.
Potential entrants
Threat of new entrants
Rivalry among existing firms
Bargaining power of suppliers
Bargaining power of buyers
Industry competitors
Suppliers
Buyers
Threat of substitute products or services
Substitutes

21
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

22
Overview
Competitor Market Map
Objectives
Analysis
Data sources
Tips

• Determine size of market and market segments
• by appropriate segmentation
• geography
• customer
• channel
• Illustrate company position relative to
  competitors within and across segments
• determine competitive position overall and by
  segment
• evaluate competitor threats
• identify consolidation opportunities

• Definition of market and appropriate segmentation
• Market size
• Segment sizes
• Major competitor sales by segment

• Confidential memorandum
• Management interviews
• Customer interviews
• Competitor interviews
• Industry expert interviews
• Supplier interviews
• Annual reports/10-K
• Analyst reports
• Literature searches
• Market research reports
• Trade publications/ associations
• Lotus OneSource
• DB filings
• World Wide Web
• Internal company data

• Use business definition framework to define
  appropriate markets
• cost / customer sharing
• Specify what elements market includes and
  excludes
• regional vs. national vs. international
• non-captive only vs. captive and non-captive
  market
• Check, check, and double check numbers
• reality check market and competitor sales levels
• use multiple sources for verification
• some companies may be divisions of other
  companies
• obtain management perspectives

23
North American Metal Roofing/Siding Sales (1995)
Competitor Market Map
Competitor market maps are usually build up
across several segments.
Sources 1995 Freedonia Report 1991 Ducker
Report Salesforce Interviews Competitor
Interviews Management Interviews DB Filings
Consultant's Analysis
24
North American Melamine Market (1995)
Competitor Market Map
or regions.
Note Includes both captive and non-captive
producers Source Consultant's Analysis
25
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

26
Overview
Competitor Dynamics/Profile
Objectives
Analysis
Data sources
Tips

• Evaluate nature of industry rivalry
• passive
• aggressive
• Determine basis of competition (by competitor)
• Understand competitor strategy
• Determine strengths / weaknesses of competition

• Perspective on intensity of rivalry
• Value proposition (by competitor)
• price
• service (lead times, delivery times / accuracy,
  after sales
• breadth of product offering
• quality
• Competitor strategic initiatives
• high vs. low end pricing
• channel / product focus
• growth objectives (organic vs. acquisition)

• Confidential memorandum
• Management interviews
• Customer interviews
• Competitor interviews
• Industry expert interviews
• Supplier interviews
• Annual reports/10-K
• Analyst reports
• Literature searches
• Market research reports
• Trade publications/ associations
• Lotus OneSource
• DB filings
• Internet
• Internal company data

• Interviews are key to understanding competitive
  dynamics
• Check for consistency across multiple sources
• Exhaust all internally available data before
  proceeding with interviews

27
Competitor Overview
Competitor Dynamics/Profile
Part of the profiles purpose is to provide
needed background information on competitors.
Ownership and Nationality
Competitor
Products
Geography
Aroma Chemicals
Essential Oils
Europe
U.S.
Asia
ROW
Flavors
Other
Fragrances
Roche Holdings (Swiss)

• Givaudan Roure Tastemaker

N/A
N/A
N/A
31
44
16
9
Public (U.S.)

• International Flavors Fragrances

N/A
N/A
N/A
30
36
34
Bayer (Germany)

• Haarman Reimer

Private (Germany)

• Firmenich

N/A
N/A
35
45
20

• Bush Boake Allen

Public (68 held by Union Camp) (U.S.)
N/A
36
36
16
12
Private (Germany)

• Dragoco

Significant fragrance presence
Public (Japan)

• Takasago

N/A
22
78
N/A

• Quest International

Unilever (U.K.)
N/A
N/A
N/A
27
43
18
12

28
Competitor Recent Events
Competitor Dynamics/Profile
Cataloging recent events adds a dynamic element
to the profile.
Givaudan Roure

• Feb 1997 acquired the flavor manufacturer,
  Tastemaster from Hercules Inc. and Mallinckrodt
  Inc. for 1.1B putting an end to rumors that
  Roche might sell Givaudan Roure
• Focusing growth on Asia, Africa and Latin America
• Declining sales for last 3 years

International Flavors and Fragrances

• Major re-organization underway including plant
  closures in U.S., Mexico and Brazil and expansion
  in Spain, Asia and Latin America
• 100M RD spend in 1997 in 28 laboratories in 22
  countries

Haarmann Reimer

• June 1995 acquired Florasynth which improved
  coverage of Asia Pacific and China
• Major producer of citric acid
• Fined 50M in January 1997 for participating in a
  citric acid price fixing cartel

Flrmenich

• World's largest private company, founded in 1895,
  high quality position
• New development center in Singapore, good Asian
  coverage
• "We wish to get to 10 by 2000 (7 1996)through
  organic growth and possibly acquisition"

Bush Boake Allen

• Investing in plant capacity in U.S., U.K., South
  America, China, Philippines, Italy, etc.
• Major producer of terpene aroma chemicals grows
  vanilla beans in India

Dragoco

• Speculation that Dragoco may enter the German
  Stock Exchange in 1997

Takasago

• Investing heavily in flavor and fragrance
  capacity in U.S., Germany, Spain and France
• Dominant Japanese player with 35 domestic market
  share in flavors and fragrances

29
Competitor Conduct
Competitor Dynamics/Profile
You will need to drive the competitor profile to
a conclusion regarding the targets position.
Sources Management Interviews DB Reports
Salesforce Interviews Consultant's Analysis
30
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

31
Overview
Competitor Benchmarking
Objectives
Analysis
Data sources
Tips

• Competitor interviews
• Analyst reports
• Market research reports
• Lotus OneSource
• DB filings
• Internal company data

• Comprehensive list of competitors
• Competitor financials (DB, public data)
• Target company financials

• Determine performance relative to competitors
• cost of goods (e.g, materials purchasing)
• operating costs
• return on assets
• return on capital
• Identify areas of potential improvement
• establish competitor Best Demonstrated Practices
  (BDPs) as a target
• identify potential benefit from achieving BDP
  performance

• Think broadly about areas in which to compare
  target company to competitors
• profitability
• SGA
• COGS
• other line item comparison
• Adjust conclusions based on competitor product
  mix
• product mix differences often explain differences
  in costs or profitability
• confirm apples to apples comparison

32
Relative Profitability (1995)
Competitor Benchmarking
A normative band is often the first benchmarking
analysis done.

33
Competitor Comparison
Competitor Benchmarking
Profitability is the most common metric used to
compare competitors.
1996 management forecast
12
10.3
10
8.0
8
Average non-DDP plants
Industry average estimate
5.5
6
5.3
4.8
4.0
3.9
Return on Sales
4
2.2
2
0
(2)
(2.6)
(4)
GVK America
American
MDL
Funder
Pickering
Albany
Norcross
Laminates
Revenues
15.6M
8.4M
19.8M
31.0M
20.8M
24.8M
23.2M
Utilization
74
60
61
58
69
65
65
Treater
Yes
No
1 yes, 1 no
Yes
No
Yes
Yes
By laminating equipment manufacturers Sources
Interviews DBs DDP Consultant's Estimates
34
Direct Sales Force Comparison
Competitor Benchmarking
Other metrics can be valuable as well in
highlighting opportunities.
Note For Adtran and ADC Kentrox, estimates on
percentage of direct sales force are based on
annual reports Sources Analyst Reports
35
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

36
Overview
Customer Analysis
Objectives
Analysis
Data sources
Tips

• Confidential memorandum
• Customer interviews
• Competitor interviews
• Internal company data

• Define relevant customer segments
• Determine differences among customer segments
• Determine significant trends in customer
  concentration, loyalty of large customers

• Assess companys customer relationships
• problem areas
• areas of competitive weakness
• improvement opportunities
• Identify appropriate customer segmentation for
  analyzing customer results

• Customer analysis will likely involve external
  customer interviews
• start as early in the case as possible
• complete adequate number of interviews
• get customer list from company (avoid cold-call
  interviews if possible)
• Clarify objectives and output of customer
  interviews before you start
• develop specific blank slides to avoid forgetting
  critical questions
• Request existing customer analysis from company
• marketing may have already segmented market
• corroborate findings with companys findings
  before final meeting

37
Types of Research Methodology
Customer Analysis
The private equity practice relies mostly on
telephone surveys to understand competitors.
Quantitative
Qualitative
Combination
research
research



Telephone surveys
Focus groups
In-depth interviews



Mail surveys
Informational
Electronic focus

interviews
groups
Intercepts


Store observations
Consumer panels

Omnibus studies

Scanner data

Test marketing
38
Telephone Surveys (In-house vs. Out-house)
Customer Analysis
Telephone interviews can be conducted by three
groups1) an outside market research vendor, 2)
case team members or 3) temps.
39
Using a Market Research Vendor
Customer Analysis
There are still several steps to do after
selecting a market research vendor
40
Temp Interviews
Customer Analysis
Get the right number of temps
Be prepared
Brief and Train
Maintain tight quality control
Get the data entered

• Decide on required N
• Estimate completes/hour per temp
• use lower productivity then case team tests
• consumer surveys will vary from .5-3/hour
  depending on incidence as length
• business to business surveys are usually done at
  .5-1.0/hour
• Subtract lunch, debriefing time
• Add 1-2 more temps for attrition/poor performance

• Have them sign confidentiality agreement (if
  necessary)
• Make sufficient copies of survey
• Get temp passwords for PCs
• Prepare sample, but keep original copy
• Type instructions and your contact information
• Have answers for tough questions ready
• who are you working for?
• what is this for?

• Explain objective
• never say target or client name
• never let them know its for an acquisition
• Read through entire survey
• Provide definition sheet
• Set timing expectations

• Monitor calls using conference room next to temp
  room
• tell them you will do this
• give feedback as necessary
• Read through first 3-5 completes for each temp
• Encourage sharing of knowledge between temps
• Check-in regularly
• Debrief at the end of each day
• Tabulate results daily

• Choose software
• Create template
• Test form
• Spot-check vs. paper surveys

41
Types of Samples
Customer Analysis
A Consultant uses 4 sources for survey samples
Random DigitDialing
Client Lists
Purchased Lists
Consumer Panels

• Randomly selected phone numbers from desired
  locations selected by city, state or zip code

• Companies such as Survey Sampling sell lists of
  names and phone numbers selected by specific
  behaviors (e.g. own a computer)

• Mail or phone surveys with a large number of US
  households who are recruited to be a panel member

• Client provides lists of customer names,
  addresses and phone numbers. Often accompanied
  by behavioral data (e.g. spending)

• projectable to full population
• increase incidence
• no bias

• projectable to full population
• sample inexpensive
• no bias

• increases incidence

• high response rates
• can customize
• have background as part of sample

Pros

• not always accurate
• hard to project to full population

• low incidence studies will be expensive per
  complete

• risk of bias if users self-identified
• hard to project to full population

• hard to project to full population

Cons
42
Questionnaire Design Common Problems
Customer Analysis

• Designing the questionnaire before developing
  blank slides
• Not reviewing with Consultant's Research and Data
  Analysis Group
• Poor sequencing skipping between issues or
  asking sensitive questions first
• Using improper questioning procedure
• too many open-ended questions (consider focus
  groups or reword to be closed-ended)
• confusion between rating and ranking
• writing questions without regard to data analysis
  options yes/no vs. a scale
• inconsistent scales excellent to poor or
  satisfied to not satisfied
• Biasing the respondent
• dont ask leading questions
• Poorly worded questions
• very long
• two or more questions combined into one
• inexact time reference e.g., in the past year
  -instead, always ask in the past 12 months
• mutually nonexclusive or non-exhaustive
  alternatives categorize response options clearly
  
• inadequate instructions for respondent dont
  assume they know the scale
• unrealistic questions about future behavior

43
Common Questionnaire Sections
Customer Analysis

• Adhere to Consultant's ethical standards
• Assure responses are confidential (if true)
• Be ready to answer questions about who will use
  and why

Introduction

• Always verify you have the right decision-maker
• distinguishing between past and future behavior
  can be critical

Screening

• Three general ways
• ratio on a 1 to 5 scale (most effective if more
  than 5 criteria)
• rank in order of importance (misses distance
  between ranks)
• distribute 100 points (great if lt5 criteria)
• Asking open ended question first can help
  differentiate if they rate everything the same

Purchase Criteria

• Consumer surveys
• employment, age, household size, marital status,
  income
• gender is usually recorded but not asked
• Corporate surveys
• employees, revenue

Demographics
44
Analysis
Customer Analysis
Comb charts summarize the results of customer
surveys very effectively.
Blanket
Competitor Average
Sources Customer Interviews (n 12)
Consultant's Analysis
45
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

46
Overview
Input Costs
Objectives
Analysis
Data sources
Tips

• Determine impact of price changes in key inputs
  on margins
• levels of passthrough
• Understand projected price movements of key
  inputs
• likely effects on future margins

• Industry perspectives on level of passthrough as
  input price fluctuates
• understand drivers of passthrough in terms of
  buyer and supplier power
• Relationship between historical changes in key
  input prices and product gross margins
• Projected future prices of key inputs
• understand drivers of future price changes

• Competitor interviews
• Industry expert interviews
• Supplier interviews
• Analyst reports
• Market research reports
• Internal company data

• Determine existence of price stickiness
• draw scatterplot of historical prices of key
  inputs vs. gross margin
• lag gross margin to account for pre-sold
  contracts (if necessary)
• choose specific product if possible (representing
  significant percent of sales)
• Run regression to quantify lack of passthrough
• if enough data points exist
• Obtain several projections on input prices to
  ensure robustness
• must understand drivers of expected price
  movements

47
Steel Pricing Over Time
Input Costs
Historical and projected prices are often
available.
Cold-Rolled Sheet Prices

• We expect to see more capacity coming on in the
  second quarter of the year.... We believe that
  supply will begin to become noticeable in
  mid-1997 and affect the market more heavily
  through the latter part of the year and into
  1998, probably coinciding with a trough."
• Smith Barney, Ferrous and Related Products
  Industry Report, February 1996
• The next wave of new steel competition will occur
  in 1997 first quarter, as four new steel plants
  start up Nucor in South Carolina, IPSCO in
  Iowa, the LTV-Sumitomo Metal Ind-British Steel
  joint venture in Alabama, and the BHP-Coreill
  joint venture in northwestern Ohio.... We are
  not raising our industry-wide forecast of a 4
  1996 and a 3 1997 pricing decline...."
• Donaldson, Lufkin Jenrette, Steel Industry
  Report, May 1996

DLJ projection
Smith Barney projection
Sources Purchasing Magazine "Cahners Publishing
Company," American Metal Market Smith Barney DLJ
48
Gross Margin vs. Cost per Pound (1995)
Input Costs
You need to link those back to profitability.
Unpainted Light Gauge Steel






Steel Cost per Pound
Source Roof Co. Financials
49
Pass Through Capabilities
Input Costs
In businesses where costs can be passed-through,
surveys can help across stickiness.
For every 10 increase in your cost of steel,
can you raise prices by
For every 10 decline in your cost of steel, do
you lower prices by
75 pass through on cost increases
85 pass through on cost decreases
Assumes less than 10 equals 7 and greater
than 10 equals 13 Source Consultant's
Customer Surveys
50
Company Cost Structure (1997)
Input Costs
One first step in assessing potential for cost
reductions is looking at the current cost
structure and drivers.
172M
172M

• Global scale

• National scale
• Operational efficiency

• National scale
• Operational efficiency

• National scale

• National scale (printing)
• Global scale (newsprint)
• Capacity utilization (owned production)
• National scale (third party production)

Cost driver
Sources Confidential Memorandum Management
Interviews
51
Cost Reduction Summary
Input Costs
SGA integration
Purchasing savings
Manufacturing synergies

• Consolidate Rhodes and MTs overhead
• finance, HR, MIS, customer service functions
• 1.7M annually
• Delist stock exchange
• 650K annually
• Consolidate insurance costs
• 500K annually

• Reduce Rhodes cold-rolled steel purchase price
• 20 per ton reduction
• 600K in savings
• Consolidate steel purchases
• 800K in savings
• Combining refrigerant valve purchases generates
  minimal savings
• Few input overlaps exist other than steel

• Move MTs refrigerant production from Elkhart to
  Rhodes Nashville plant
• 400K annually
• Shut down Peru facility
• 450K annually
• Further manufacturing synergies not yet identified

Identified Opportunities
Identified Savings
2.8M
0.6-1.4M
0.9M
Sources Confidential Memorandum Industry
Interviews
52
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

53
Overview
Costs Reduction Opportunities
Here is an example of some opportunities.
SGA Integration
Purchasing Savings
Manufacturing Synergies
Identified Opportunities

• Consolidating Rhodes and MT's finance, HR, MIS
  and customer service functions would provide,
  1.7MM in savings
• Stock exchange delisting would save 650K
• Consolidation insurance costs would provide an
  additional 500K in cost reduction

• Rhodes could reduce purchased cold-rolled steel
  price by 20 per ton yielding 600K in savings
• Volume discount by consolidating steel purchases
  could yield a further 800K in cost reduction
• Only minimal savings likely by combining
  refrigerant valve purchases
• Few input overlaps exist other than steel

• Moving MT's refrigerant production from Elkhart
  to Rhodes' Nashville plant would save 400K per
  year
• Shut down of Peru facility would provide on-going
  savings of 450K
• Further manufacturing synergies undoubtedly
  exist, but have yet to be identified and
  quantified

2.8MM
0.6-1.4MM
0.9MM
Identified Savings
54
SGA Integration
Costs Reduction Opportunities
SGA savings in a merger are often broken out by
department.
Savings as Percentof Rhodes
Savings as Percent of Combined Entity
Category
Estimated Savings
570K

• Financial/Accounting

49
34
370K

• Executive

20
10
330K

• MIS

74
26
230K

• Customer Service

47
16
150K

• Human Resources

24
19
0K

• Purchasing

0
0
0K

• Engineering/RD

0
0
0K

• Miscellaneous Administration

0
0
GA Combination
1,650K
8
11
650K

• Legal/Professional

500K

• Insurance

2,800K
Total
Sources Company Financials Company Headcount
and Salary Data Management Interviews
Consultant's Analysis
55
Steel Purchase Savings
Costs Reduction Opportunities
2-4 purchasing cost reductions are common.
Hot-Rolled Steel
Cold-Rolled Steel
346
336
497
467
336
477
467
Average1995 Midwest Steel Price/Ton
Volume Discount 3
Potential Purchase Price/Ton
Average1995 Midwest Steel Price/Ton
Volume Discount 2
Aggressive Purchasing 4
Potential Purchase Price/Ton

• Theres about 15-25 per ton in savings given
  Rhodes current cold-rolled purchasing practices
  there is also a bargaining chip through joint
  purchasing of cold-rolled and hot-rolled steel to
  the tune of about 10 per ton. Total savings
  would range from 0.6M to 1.4M.
• Tim K.

56
Manufacturing Synergies
Costs Reduction Opportunities
Manufacturing reloads and closures are also good
sources of savings.
Variable Cost Savings
Fixed Cost Savings
Average 2.4M
Peru
Elkhart
Lubbock
Ashland
Crossville
Paducah
Nashville
Hannibal
Tillsonburg
Petersburg
Rhode Island
Note Assumes 20 variable cost savings can be
achieved from plant consolidationSource
Consultant's Analysis
57
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

58
Overview
BDP Opportunities
Objectives
Analysis
Data sources
Tips

• Identify opportunities for improvement by
  replicating Best Demonstrated Practice (BDP)
  within the company to all other parts across
  company
• by store
• by plant
• by region
• by salesperson
• by department
• etc.
• Identify BDP opportunities in almost any area
• COGS
• operating expenses
• overhead
• sales growth

• Determine significant differences between
  locations, plants, regions, etc.
• Management view on explanation for differences

• Confidential memorandum
• Management interviews
• Plant/facility tours
• Internal company data

• Management interviews are key to finding internal
  BDPs
• top management will have a feel for
  opportunities
• managers in the field will usually have
  numerous ideas for improvement
• Double-check findings of internal BDPs with
  company management
• there are often subtleties which can explain part
  or all of the difference between BDP and WDP
  (Worst Demonstrated Practice)
• even if managements explanation is not valid, it
  is important to understand their perspective

59
BDP Steps
BDP Opportunities
Doing a BDP analysis involves several steps.
Process Step
Key Success Factors

• Organizations should produce similar
  products/services under similar operating
  conditions

Select comparableorganizations for BDP
Disaggregate organizationsinto major processes

• Lay out major (3-5) processes

• Gather data
• Identify best practice organization for each
  process

Construct first-cut BDP

• Adjust data for uncontrollable elements (e.g.,
  labor rates, product mix) to ensure an
  apples-to-apples comparison

Construct adjusted BDP

• Calculate potential impact (revenue increase or
  cost savings) by unit and by process

Quantify impact

• Focus on organizations and processes with the
  most potential
• Determine drivers of differences at a more
  disaggregated level

Peel the Onion inleveraged areas

• Set a BDP target
• Establish a detailed schedule
• Assign responsibilities

Develop an action plan

• Obtain commitment at all levels of the
  organization
• Communicate goals, deadlines and responsibilities
• Celebrate successes along the way

Implement

60
Possible Reasons for Better Performance
BDP Opportunities
Following is a list of possible reasons some
companies perform better than others
Purchasing
Manufacturing
Distribution
Selling

• More consolidated supply (VMRs)
• Lower cost raw materials
• Higher quality raw materials
• More parts outsourced
• More parts made in lower-cost countries

• Products
• Simpler products
• Fewer product variations
• Plants
• Fewer, more highly-focused plants
• More efficient production process (longer runs,
  less waste)
• Better equipment
• Better quality control
• Labor
• Longer-term contracts
• Better structured incentives
• Better supervisor-to-labor ratio

• Better delivery method (truck vs. train vs.
  airplane)
• More (or less) frequent deliveries
• Larger (or smaller) delivery sizes

• Better trained salesforce
• Larger salesforce
• Better organized salesforce (by region, by
  product, by industry)
• Better structured incentives

61
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

62
Overview
Growth Opportunities
Objectives
Analysis
Data sources
Tips

• Identify and prioritize revenue growth
  opportunities
• Develop perspective on appropriate growth vehicles

• Identify and prioritize viable growth channels
• share gain (existing products / market)
• new products
• new segments
• new geographical markets
• Advantages / disadvantages of specific operating
  vehicles
• internal organic growth
• joint venture / licensing
• acquisition

• Confidential memorandum
• Management interviews
• Customer interviews
• Industry expert interviews
• Analyst reports
• Market research reports
• Trade publications/ associations
• Internal company data

• Management and customers are great sources of
  growth opportunities
• Look at how competitors have been growing
  successfully
• new channels
• new customer segments
• penetration of existing customer segments
• product line extensions
• new geographies

63
Framework
Growth Opportunities
This is a common framework to help think about
opportunities.

• New businesses
• New segments
• Geographic expansion

• Share gain with new products permutations

New products

• Share gain with existing products

• New segments
• Geographic expansion

Existing products
Existing markets
New markets

64
Adjacency Mapping
Growth Opportunities
Here is a generic way to develop a good list.
Existing products
At what costs?
What we sell?
New capabilities
New products
Cheaper substitution
Value added services
New sourcing
Backward integration
Forward integration
New channels
Geographic expansion
New capabilities
New customer segments
Existing customers
To whom?
How we sell?
65
Business Definition
Growth Opportunities
management software
Product
data base management
communications
Technology
Beverages
media
luxury goods
publications
soft drinks
branded merchandise
high speed packaging
wine
clothing
cider
high gravity brewing
hybrids
food
beverages
packaging materials manufacturing
spirits
distilling/brewing
bottling/canning
barley growing
beer
blending
Forward Integration
Backward Integration
Britain
Ireland
marketing
home delivery
Continental Europe
physical distribution
wholesalers
retail advertising
North America
off- trade
manu- facturing
Asia
35-45yr old adult male drinkers
pubs
Africa
night clubs
sales
Rest of World
sports bars
HORECA
marketing
Duty Free
vending
Channels
all male drinkers
financial
petrol stations
Geography
HR
Direct-to-home
home vending
female drinkers
joint ventures
non-alcohol adult drinkers
Consumer Segment
turnaround management
Capabilities
66
Six Models of Growth
Growth Opportunities
Products/Capabilities
Customer
Channels

• Focus on particular customer segment
• Focus on consolidating customer base in core
  regions (acquisitions)

• Product differentiation
• Focus on niche products/ markets
• Increased share of wallet/ product innovation

• Focus on/dominate channels delivering lower costs
  or higher service routes to market

Focus on existing

• Geographic expansion
• Define new customer segment

• New to world products
• Expansion to new related product lines

• Develop new channels which deliver lower cost or
  higher service routes to market
• Expand to new (already existing) channels

Expand
67
Profit Pool
Growth Opportunities

Profit pool analysis can help you prioritize
opportunities.
25
23
20
15
Operating Margin
Leasing
10
9
6
6
6
5
New Products
5
4
Auto Insurance
Warranty
3
Service Repair
1
After Market Parts
2
2
Auto Loans
Auto Rental
OEM
Used car dealers
Gasoline
0
0
50
75
100
25
of Industry Revenue
68
Anti-Trust Issues
Growth Opportunities
Acquisitions can be a key part of growth
strategy. However, anti-trust issues are common.

• All acquisitions must be filled with the FTC
  under the Hart-Scott-Radino Act.
• If the FTC does not act within 45 days, the
  transaction is clear to go forward
• often if there is a problem, the FTC is just
  looking for further data or documentation
• only in rare cases does it file suit to stop the
  deal (e.g. Staples-Office Depot)
• The HHI is a tool you can use to evaluate the
  potential for FTC involvement
• HHI or Herfindahl-Heirschman Index is an index
  calculated by taking the market share of each
  company in an industry, making it a whole number,
  and summing these squares
• in a totally consolidated industry, the HHI will
  equal 10,000 (100x100) vs. only 2500 when four
  companies split the market equally
• the FTC uses the following guidelines
• under 1000 unconcentrated
• 1000-1800 moderately concentrated
• over 1800 highly concentrated

69
Defense Profile I
Growth Opportunities
Another deterrent to MA activity can be defense
mechanisms, put in place to protect management.
Mechanisms
Explanation
Shareholder rights plan (poison pill)

• Poison pills provide for issuance of stock at
  below market prices and dilute potential
  acquirers
• often made deadhand by preventing new directors
  from repealing the pill

Staggered board

• Directors are not elected at once, making it
  impossible to win a proxy fight immediately

Supermajority vote for mergers

• Need more than 50 of shareholders to approve a
  merger

Limited ability to call special meeting

• Shareholders may not be able call a special
  meeting or a majority may be required
• needed to replace the board/vote on proposal

Hard to replace directors

• Can not be removed without cause
• Can not be removed by shareholdinrs majority vote
• Vacancies filled by board vote

Advance notice provisions

• Time requirements for proxy resolutions and
  director nominations can slow down the process
  and deter acquirer

Director indemnification

• Eliminates threat of personal litigation as long
  as directors believe they are acting reasonably
  in the companys best interest

70
Defense Profile II
Growth Opportunities
Mechanisms
Explanation
Insider ownership

• Substantial ownership by insiders or friendly
  parties forces negotiation at a minimum

Blank Check Preferred

• Allows the board to set out the rights for future
  classes of preferred stock

Limited ability to act by written consent

• If shareholders can not act by written consent or
  unanimous written consent is required, that will
  limit ability to force a takeover

No cumulative voting

• With cumulative voting, a shareholder gets votes
  equal to the number of shares times the number of
  directors up for election. By allowing
  sharehlders to use all those votes for one
  candidate, it increases their ability to elect a
  minority director

Super majority charter/by-law amendments

• Need more than 50 of shareholders to amend
  charter or by-laws, which might contain
  anti-takeover measures

Freeze-out statute

• State law which can prescribe a lengthy waiting
  period before a hostile acquirer can complete a
  merger, even when holding a majority of the shares

• State law which required approval of
  non-management. Non-acquirer shares to give
  voting rights to acquire shares

Control share statute
71
Defense Profile III
Growth Opportunities
Mechanisms
Explanation
Greenmail restrictions

• Some states force a failed acquirer to pay the
  target any proceeds from an appreciation in the
  stock price

No directors duties

• Some states do not allow boards to consider
  non-stockholder or non-monetary considerations in
  making decisions

72
Agenda

• Due Diligence Overview
• Analytic tools
• Market Definition and Sizing
• Industry Dynamics
• Competitor Market Map
• Competitor Dynamics/Profile
• Competitor Benchmarking
• Customer Analysis
• Input Costs
• Costs Reduction Opportunities
• BDP Opportunities
• Growth Opportunities
• Key Success Factors
• Startup Checklist

73
General
Key Success Factors

• Constantly think of due diligence as defense,
  remember the 80/20 rule Due diligence is
  primarily an exercise in assuring that there are
  no significant deal-breaker issues. Think
  about the most leveraged way to quantitatively
  get comfortable with an issue (e.g., customer
  base appears stable).
• Be prepared to work quickly LBO due diligence
  projects are typically in the 2-6 week range vs.
  3-6 months.
• Invest time in up-front thinking Taking the time
  at the beginning of the case to clearly lay out
  the important issues, and critical questions.
  Preparing blank slides will focus your work on
  these critical questions and minimize yield loss.
• Have a bias to output The compressed time frames
  dictate that output begin almost immediately.
  Try to get your ideas and analysis sketched out
  into slides every day. Ask yourself, What have
  I learned today, and how does it change the
  answer? You will have difficulty if you save
  your slides to the end.
• Think Value Creation Take time out during the
  case to consider value creation insights--where
  can the LBO client create potential upside?

74
Operational
Key Success Factors

• Be prepared to take a stance on limited data
  Many times you will not be able to get all the
  data you want to address an issue. You must have
  an opinion anyway, because you know more than
  anybody else.
• The phone is your friend A large part of
  Consultants value added is getting feedback from
  customers, competitors, and market. Being
  diligent and aggressive on the phone will only
  make your job easier.
• Be prepared for, and quickly recognize, data
  limitations In the case of limited data (due to
  lack of sources, lack of time, etc.) always have
  a backup in mind for the next best data
  alternative.
• Check, recheck, and check one last time for data
  inconsistencies LBO clients get a perverse
  thrill out of finding and hammering on these
  inconsistencies. If they find them, you lose
  credibility.
• Dont be afraid of saying I dont know LBO
  clients will push and push until