“Going downhill everybody picks up speed.” – Business Proverb

The current credit market condition and economic slowdown are shaping up to be of a scale unmatched in history and is forcing many industries to consider how to move forward. Banks are having a hard time withstanding further credit losses amidst a slowing economy and deterioration in earnings capacity. The economic slowdown has also impacted private equity and hedge funds and their ability to generate returns of the old days.

It is important to note that the current crisis has not solely impacted financial institutions. All industries have experienced a blow. While companies across all industries will emerge from this cycle stronger than before, others will be considerably weakened. The disparity between the strong and weak players is growing, and unfortunately it is larger than ever before.

Given this, many industries could experience substantial consolidation in the very near future, even though there are few companies sufficiently capitalized to pursue a merger and acquisition (M&A) strategy. Although, you might be surprised to find out that some market participants, such as private equity firms, still have deep pockets and the rules of the M&A game are changing daily. Rules that previously limited private equity investments in banking companies were recently loosened, and now it is expected that these types of investments will pick up.

Because of this and for other reasons, some companies will continue to pursue M&A activity as part of their strategy and as a reaction to changing market conditions. Mergers and acquisitions, joint ventures and alliances are often the instruments companies rely on to build critical mass and acquire new skills and technologies. This is why we felt it important to share some helpful M&A information for companies who are interested in pursuing such a strategy in this economic downturn.

Why pursue an M&A strategy in the current turmoil?
As revenues slow and margins are under pressure, the natural reaction for management is to cut costs, protect the balance sheet and lower the priority on M&A. If past is prologue, companies should look to a different course and regard an economic downturn as a time to pursue M&A activity, if possible. Counter-cyclical M&A activity can separate the leaders from the laggards. Leading companies might be able to secure the best deals now as many current owners need to sell their investments due to financing issues.

It is important to remember that as economic growth slows, top-line growth alone will be insufficient to deliver the returns expected by investors. Companies pursuing M&A activity may need to restructure and repackage their assets to control costs, achieve higher returns on capital, and ensure all entities within the organization are equally aligned with the overall growth objectives.

In tight credit market conditions, proceeds from corporate restructurings are a form of capital and can be an attractive financing option for a debt reduction strategy, enhancing financial flexibility, obtaining funding for growth, and preserving/improving credit rating. Restructuring also impacts a wide range of treasury functions that need to be actively managed: cash and liquidity, bank account management, working capital management, foreign exchange and hedging, supply chain management, regulatory reporting and compliance, performance monitoring, and benchmarking.

How do you manage M&A in a downturn?
In today’s international business environment, there is an increasing importance for organizations to successfully execute an M&A strategy while also having adequate corporate governance and risk management processes in place. These processes help capture the value of the transaction and manage the expectations of all stakeholders. As a results, companies are currently proceeding with a great degree of caution and are placing a greater emphasis on these tactical aspects of M&A to quickly minimize business discontinuity and establish a “business as usual” environment.

In addition, companies include a substantial part of their value creation/synergy targets in the acquisition purchase price. Due to the expected future defaults and economic issues, management wants to quantify the risk of not being able to meet those value creation/synergy targets more than ever before.

1. A risk-based approach to M&A projects focuses on events or circumstances that could create obstacles in meeting the M&A objectives. Knowing this information, management can better set the objectives and evaluate the process used to set these strategic objectives: the monitoring process and the desired level of risk mitigation. We believe that a successful approach toward M&A in a downturn should consider a number of the following aspects: Make sure potential issues (e.g. default of major suppliers or customers) are addressed early on in the process. M&A deals are completed within a limited time frame, and management should ensure that control issues are addressed during the planning process, not after. 
2. Develop, evaluate and validate quantitative financial models that support critical decisions. Risk management techniques such as simulated Value-at-Risk (VaR) could involve generating cash flow and product repricing scenarios. One of the key implications is that in the current “perfect storm” scenario, the negative impact on the acquisition as a foundation for value/growth would be much worse than what companies forecasted using traditional base case levels. Supplemental, more holistic stress tests can provide more information as to whether or not there are good chances of making the M&A profitable in a range of scenarios.
3. Ensure awareness of regulatory and other compliance issues. Transactions are often bound by tough regulatory frameworks where competitive advantage and avoidance of monopolies are concerned. Non-compliance with these frameworks has been the reason for many M&A failures.
4. Document the target company's business processes and control points. Review the main processes and mapping of the main risk areas and control activities for future use by the internal audit function. This review can also save time during a post-acquisition audit.
5. Audit the integration process to identify control weaknesses and report risk and control findings to business units, the audit committee and the board of directors. This report should include control weaknesses identified, documentation of the target company's internal control system, and remediation plans for compliance with the bidder company's control system.
6. Assess whether specific M&A goals have been achieved and prepare a lessons-learned document about the current process to set a smoother course for a future M&A event.

What is the role of the CFO?
CFOs are in one of the best positions from the executive management team to navigate the business through the current economic turmoil and make sure M&A initiatives are linked to the strategy of the business. This is because the CFO usually is involved in all M&A phases, from strategic planning through opportunity identification, initial evaluation, execution, and even integration. However, many times the CFO’s focus shifts away from the transaction once a deal is signed and integration begins. The integration process then often becomes the responsibility of middle management who may not necessarily be empowered to commission the proper resources or make critical decisions.

This course of action could potentially have a negative impact on the governance activities of both the acquiring and target companies. Lack of proper leadership can lead to a significant weakness in internal controls due to pressure to enhance financial performance in post-deal situations. Unfortunately, the current economic environment has also increased the risk of fraud and the associated expensive litigation and class action lawsuits. Because of this, the CFO should understand the company’s vulnerability to fraud and misconduct and prepare the company for the messy aftermath of the credit crunch. The good news is that now that monitoring governance, risk and control activities are increasingly embedded in day-to-day business processes, the focus of the CFO is starting to shift back to these issues that were put on the back burner in recent years.

To make the best of M&A activity in a downturn, companies must exert discipline throughout the deal cycle, from planning through execution, and finally, integration. For the CFO, pursuing an M&A strategy in today’s business environment represents another opportunity to take a step along the evolutionary path from yesterday’s scorekeeper to today’s business partner, and eventually, tomorrow’s corporate change agent.