The Hindu Business Line : The experience factor in due diligence

IF THE NDA Government had followed the ground rules of due diligence, it is doubtful whether it would have considered selling Hotel Manali Ashok to Auto Impex Ltd, Hotel Airport Ashok of Kolkata to Bright Enterprises (P) Ltd (an associate company of Modern Publishers of the Malhotras) and Centaur Hotel to the Batra Hospitality group.

In these cases, though the acquirers were cash-rich with huge real estates, they had no hotel/travel business experience. Hence, there was complete lack of synergy between the sellers (hotels) and the acquirers.

The adverse comments of the Comptroller and Auditor General of India on the Centaur Hotel deal — which resulted in a loss of about Rs 145 crore to the exchequer because of a reduction in lease rent from 6 per cent to 2 two per cent prior to selling the hotel property — are well known.

But a more fundamental lapse was ignoring the fact that the acquirer had no experience or expertise in hotel business. It was a costly gamble by the NDA Government, assuming that the new management would embark on a "sound post-deal implementation plan."

The transfer of Centaur Hotel to the Sahara group with a comfortable margin of profit proved that the acquirer never wanted to run the hotel. It would be strange to assume that the Government and the bureaucrats were unaware of contemporary practices in due diligence, as the EU, in December 2000, had laid down takeover principles which, inter alia, discouraged large deals that lacked synergy of operations between the buyer and the seller.

In an article in Chartered Secretary (December 2004 issue), `Due diligence, the bridge between the acquirer and the target company', Ranjan Mukherjee suggests that the principal function of due diligence, pertaining to mergers and acquisitions (M&A), is to bridge the acquirer and the seller symbiotically and "a valuable tool for making a decision for M&A".

Referring to cases of bias favouring the acquirer in due diligence reports, he says that some M&As unfortunately do not combine the interests of both the sides in a balanced way; he cites Watson Wyatt's M&A Survey of 2000 on 300 global companies (123 in EU).

Any transaction that aims at bigger business volumes, competitive edge and cost reductions, synergy of operations is a must. Which is why elaborate documentation about the target company is indispensable for the acquirer.

While the Watson Wyatt survey noted instances of apathy by target companies in volunteering information to the intending buyers, the disinvestment exercise during the NDA regime faced no such problems. Rather, the acquirers got details (including huge real estate) within a very short period.

The European experience was very different as the principles of due diligence were neither violated nor obfuscated by non-professional motives.

The European due diligence "take anywhere between one and two years to complete the whole merger process with the due diligence time ranging from a few days to three months."

One of the neglected areas in due diligence in Europe is workforce potential and organisational culture. The stress is on tangible assets, market share, techno-commercial competence, financial strength and HR practices and management styles.

On the contrary, the `K factor', a model developed by PwC, stresses on "the cultural assessment in the pre-M&A period and alignment of cultures between the target company and the acquirer is an important element in the post-M&A stage," Mukherjee writes.

Essentially, a kind of knowledge audit of intellectual capital of the target company, it quantifies knowledge of personnel during the tenure in target companies.

There are instances of poor post-deal integration in acquisitions (such as Daimler's acquisition of Chrysler and overpayment for acquisitions). But it was exactly the opposite in Indian PSUs. Absence of synergy was linked to under-payment to the target companies.

(The author is a Kolkata-based freelance writer.)

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