Plus de la moitié des acquisitions envisagées sur les marchés émergents échouent à l’issue des étapes dites de due diligence. Price Waterhouse Coopers nous dit pourquoi.

1. www.pwc.com
Getting on the right
side of the delta:
A deal-maker’s guide
to growth economies
January 2012

2. Editorial team:
John Dwyer, Alastair Rimmer, Nick Page, Richard Skinner, Ward Duvall,
and Claire Davies
Key contributors:
China: Matthew Phillips and Curt Moldenhauer
India: N.V. (“Shiv”) Sivakumar and Amit Nawka
Russia: Lev Vilyaev and Andrew Cann
Brazil: Luis Madasi, Alexandre Pierantoni and Mikail Ojevan
Middle East & North Africa: Hani Ashkar and Ziad Sarkis (Saudi Arabia),
Nitin Khanna (UAE), Maye Ayoub (Egypt) and Antoine Abou Mansour (Lebanon)
Sub-Sahara Africa: Simon Venables and Peter McCrystal (South Africa)
Eastern Europe: Jonathan Thornton and Charles Bates (Czech Republic)
US: Manuel Iraola
Japan: Philip Blythe and Matthew Wyborn
UK: Sir John Stuttard, Leonard Sinclair, Yael Selfin , Simon Harris, Maciej Grygiel,
Craig McVicar, John Glynn, and Jacqui Rivett
France: John Hadley and Ghislain de La Tour d’Artaise
Canada: Vanessa Iarocci
Australia: Richard Shackcloth and Sean Gregory
Netherlands: Johannes Postma

3. Contents
Introduction 3
Executive summary 4
The importance of deals in growth markets 10
Avoiding the pitfalls of past deals 14
1) Lack of transparent financial information – minding the gaps 14
2) Justifying developing market valuations – getting real 17
3) Non-compliant business practices – discerning the manageable from the deal breakers 20
4) Post completion operations issues – integrating and taking control 22
5) Difficulties with negotiating and contracting – making it to the dotted line 24
6) Partnering conflicts – reconciling differences and managing great expectations 27
7) Government interference – managing an additional stakeholder 30
Nuances of individual markets 33
Getting on the right side of the delta January 2012 1

4. 2 PwC

5. Introduction
Doing deals in growth markets is a topic that features regularly While there are plenty of examples of successful deals
in our client conversations. For many companies doing a deal is in growth markets, the deal makers we interviewed
the best – or only – way of tapping into growth markets, largely acknowledged that deals in growth markets are inherently
because it is faster than going-it-alone. And deals in growth riskier. There is a much bigger deviation, or range, of potential
markets are not just about low cost manufacturing, access to outcomes. We refer to this range as the delta, and in growth
natural resources, or market access for basic global products. economies, the delta between a good deal and a bad one is
Doing a deal in a growth market can also provide buyers with much bigger than in developed markets. If things go well,
access to best practice in core operations, innovation investors stand to make a lot of money. But if things go
capabilities and capital. badly, investors can lose big – an average of 50% of their
investment in the deals analysed where transparent
For this study, we carried out an assessment of over 200 deals, information was available. And the impact on reputations
including publicly announced deals and a broader set of can be considerable, as evidenced by the many high profile
private deals that PwC has advised on. We interviewed 20 examples of problems that emerge after the ink has dried on
senior deal makers who have bought businesses in growth the sale and purchase agreement.
markets to understand the root causes of problems, and how
they overcame the challenges encountered. Collectively, the Growth markets are different, which is why our strongest
companies they represent have completed over 140 acquisitions recommendation is to build the local machinery needed to
in growth markets, with considerable success. In addition, the get a deal done well in advance of executing the first deal.
contributors to this study have been involved in hundreds of This and other recommendations resulting from this study will
deals in growth markets. help companies to avoid doing bad deals, to successfully
complete on good deals, and to make sure a good deal doesn’t
Deals in growth markets remain incredibly challenging. Our turn bad after the deal trophy is on the shelf. In short, the
research suggests that over 50% of deals that enter detailed study aims to help deal-makers get on the right side of the
external due diligence in growth markets fail to complete. delta between a bad deal and a good one. Anyone can get
We believe this is materially higher than in developed markets. lucky on one deal, but it takes investment and a rigorous
One key reason for this is that many companies’ boards struggle approach to consistently get it right.
with perceived ‘sky high’ valuations in growth markets.
John Dwyer Alastair Rimmer
PwC Global Head of Deals PwC Global Head of Strategy
Getting on the right side of the delta January 2012 3

6. Executive summary
It’s tough, but you’ve got to do it The majority fail to complete,
Doing deals in growth markets is a tough and failure can hurt
business but not doing those deals, or Our study shows that 50-60% of deals
failing to make them work could make that go into external due diligence in
the broader business outlook even growth markets fail to complete.
tougher. Access to high growth economies, All of these failed deals represent a
with large populations, rising affluence considerable opportunity cost – whether
and the potential for innovation make a it is letting a good deal get away, or
presence in growth markets a necessity for spending management attention, time
many companies. Doing deals in growth and money that could have been better
markets is a challenge worth taking on. used elsewhere on a good deal. Exploring
And challenges abound: negotiations can deals that don’t complete can also damage
drag on, and considerable time and credibility with investors. Though deal
effort can be spent on a deal that does completion rates are also low elsewhere
not complete. Even if a deal does in the world, the cost of failing in a
complete, a lot can still go wrong: it can growth market can be much higher due
emerge that risks were missed during to the scale of the opportunity lost.
due diligence, post-merger operations
can be mismanaged, and conflicts with The delta factor for completed
partners can arise, ultimately resulting in deals is high
costly failure. In addition, once business Even after a deal is sealed, a large
managers have had their fingers burnt percentage of deals subsequently result
in a particular market, they are often in significant difficulties – and at a very
reluctant to return, hence closing off high cost. Where sufficient data was
key markets. available in the public domain, we found
that post-deal problems cost the buyer
on average c. 50% of the original
What we mean by growth markets investment. And in half of these cases,
In this report, we have taken a broad definition of growth the buyer either lost control or divested
markets that consists of the world excluding Western the business at a loss. Post-deal problems
Europe, the US, Japan, Canada, Australia and New also bring a number of other intangible
Zealand. Obviously, this represents a wide range of costs, foremost among them being
economies. The BRICs are in a league of their own, negative investor sentiment and
and within the BRICs, each market varies considerably. unrealised deal value. Conversely, if you
However, the rest of the E7 (Mexico, Indonesia, and get it right, the upside is great.
Turkey), and the next tier of large and growing economies
(South Africa, Nigeria, Egypt, South Korea, Vietnam, and Although only a small percentage of
the Philippines) also present attractive opportunities. deals that have problems make it into the
public domain, there are a much larger
number of deals with problems that
don’t make it into the press. This includes
a group of under-performers that is
potentially the most dangerous of all.
4 PwC

7. Figure 1
Assessment of deal issues in growth economies
Deals that failed to complete Deals that resulted in issues post-completion
Transparency of Transparency of
financial information financial information
Justifying valuations Justifying valuations
The asset
Non-compliant Non-compliant
business practice business practice
Post completion Post completion
people issues people issues
Negotiation & Negotiation &
contracting difficulties contracting difficulties
The seller
Partnering conflicts Partnering conflicts
The government Government interference Government interference
0 10 20 30 40 0 10 20 30 40
% of deals % of deals
Source: PwC Analysis database of growth market deals with problems.
Investments that under-perform, but not and competition for assets in growth markets, government involvement is
so much to justify closure or divestment, markets is stiff. Three other issues often part of partnering. Problems with
can be both difficult to fix and difficult explain another 50% of problems. financial information, such as a US
to exit. These investments take up Teams fail to obtain approval from the private equity firm’s recent concerns
considerable management attention, and government. Financial information is over accounting at an investment in a
may prevent the company from pursuing less transparent – there is less of it, children’s apparel company in India, can
a more successful strategy in the market. managers are less willing to share it, emerge after a deal completes. Financial
They’re not dissimilar to the ‘walking and accounting practices are different – information may have been signed off
dead’ of the venture capital industry. which make it difficult for buyers to get by an inexperienced auditor, financial
comfortable with a deal. Often there are information may not have been signed
Nearly 40% of deals failed non-compliant business practices (e.g. off at all, or there may be issues that are
to complete because of a corruption, labour & tax compliance) not identified by local standard auditing
valuation mismatch which can become deal breakers. procedures. Non-compliant business
Deal risks typically relate to one or more practices are also common problems.
of three key elements: the asset itself, 30% of post-deal problems For this reason, FCPA (Foreign Corrupt
the seller, or the government. Through concern partnering Practices Act) and Anti-Bribery reviews
our past deal analysis and through The most common problems that are critical. We have identified a number
interviews, we have identified the most emerge after a deal completes concern of situations where these were not
common pitfalls both before and after a partnering, causing c. 30% of deal carried out properly and problems were
deal completes. These problems are not problems post deal identified in our later encountered with outside authorities.
unique to growth markets. What is survey. Even sophisticated investors can There is also a range of potential
specific to growth markets are the have problems in this area. High profile operational issues that make it difficult
degree, frequency, and root causes of examples of partnering problems include to integrate and take control of an asset.
these problems. Danone disputes with its partner in China,
and the TNK-BP joint venture in Russia. By examining a number of deals we
As shown in Figure 1, the most common Beyond partnering, the same issues that traced the root causes of these problems
barrier to deal completion is an inability prevent deals from completing also to a set of critical differences in practices
to get comfortable with valuations, frequently emerge after a deal completes. and governance between growth markets
explaining 40% of failed deals in our Direct government interference is a and developed markets. This has led to
data set. The magnitude of future growth common problem, and with a prevalence the following set of recommendations.
is uncertain, there are few comparables, of state-owned enterprises in many
Getting on the right side of the delta January 2012 5

8. Recommendations 1) Understand the strategic Finally, developing a rationale is hard.
There is no silver bullet to increase the rationale early Developing a strategic rationale also
chances of success in doing deals in We see a common theme across less takes time: 1-2 years in our experience.
growth economies, but drawing on the successful or less experienced companies Often, it requires building up data from
experience of successful deal-makers of not developing a strategic rationale for primary sources. Also, interviewees
and our own expertise, we have five growth market deals early enough. consistently highlighted the need to
recommendations to ensure you are on Companies often only have limited educate the boards and shareholders of
the right side of the delta factor. resource charged with developing Western companies. Board members
business across a number of markets. and shareholders often hold pre-
Their boards wait until a target conceived concerns about growth
acquisition has been identified before economies, which may be easily
seriously looking at a market. dispelled myths, or easily addressed
risks. Our view is that this element of
The reason for this is understandable for developing the rationale is not given
many companies. It’s difficult to build enough attention.
the international deal infrastructure of a
multinational company. Due diligence “Doing deals in developing countries
will be imperfect and valuations are is a cultural challenge. There is a
high, so a strong strategic rationale is need to educate the management in
critical to completing a deal. However, mature markets on the necessity to
there is also a tendency to under-invest
take higher risks in growth markets.”
in resources in doing deals in growth
economies. Some companies focus on M&A Director,
the short-term potential of growth Global Electrical Distributor
economies. We see companies that treat
growth markets as high risk ventures
that could generate a small percentage of 2) Prioritise markets
current sales, as opposed to markets that Although there are common themes
could generate 30%, 40% or more of across growth economies, each market is
global sales. We also see companies that different. This is one reason why local
fail to consider strategic considerations capabilities are critical for success. With
for a deal like checking the rise of a a requirement for increased investment
potential global competitor. in individual markets, there is a case for
prioritising markets. This allows the
There is also a risk of underestimating company to focus scarce resources on
the need for developing a strong fewer markets to increase the chances
strategic rationale for a deal. The need to of building scale positions that can
develop a strategy for a new market may support future growth. This is particularly
sound obvious, but we are surprised that the case for smaller companies, who may
our survey suggests that some companies lack the international deal infrastructure
go ahead with a deal without addressing of a multinational company. Also, some
key questions about the market and of the most effective M&A strategies are
competitors. ‘platform strategies’, or making a large
initial acquisition to enter a new market
and then bolting on smaller acquisitions.
This strategy requires greater focus on
fewer markets.
6 PwC

9. 3) Go there • Understanding market potential to “I can’t emphasise enough the
Growth markets are different. Reflecting help with valuations; importance of doing on the ground
this, being on the ground was consistently due diligence... If you don’t ask the
• Identifying a target short-list to
identified by interviewees as the best question, you don’t get the answer.
improve the chances of choosing the
way to reduce risks in a number of
right partner; and A lot of people discover key risks on
areas, including:
day one, because they didn’t ask the
• Engaging with multiple levels of
• Giving stakeholders context to
government to increase the chances of
right questions.”
address their concerns;
obtaining approval and to understand Partner, Global Asset Manager
• Improving the quality of diligence to potential future changes in the
increase the transparency of financial government’s position.
information and reduce risks from
non-compliant business practices;
Figure 2
Views of local PwC contributors
Eastern Europe Russia & CIS
“Eastern Europe is in some ways becoming closer to a “Very often, small-and medium-sized Russian companies
developed rather than a growth market, but corruption in have issues with tax compliance. This can lead to potential
businesses related to government contracts is still an issue tax liabilities, especially as an acquisition often triggers a
in many Eastern European countries.” review by tax authorities.”
“We strongly recommend that an FCPA or similar review “Thorough due diligence can often identify these practices
is undertaken to identify any practices ongoing in the and therefore the risks can be quantified. But this takes
company that a western buyer cannot continue post deal.” time and patience.”
Jonathan Thornton, Partner, Deals Andrew Cann, Partner, Deals
China
Middle East & “Strong competition from rival
North Africa bidders and alternative sources
“There are issues specific of funds makes valuations the
to individual markets such key issue for China. Based on
as living hardships and our data, differences in
security risks. expectations around valuations
explain nearly 50% of deals
“Companies need to start withdrawn after beginning
recruiting for key managers external due diligence.”
even earlier, and factor in
higher costs for key staff.” “Bring your stakeholders on
board early on. Spend more
Hani Ashkar, Partner, time on the strategic rationale
Middle East Deals Leader
for the investment. Discuss
what approach you’ll take
to valuations.”
Brazil Sub-Sahara Africa Matthew Phillips, Partner,
China Transactions Leader
“The regulatory environment, “Government policy is more central
particularly for tax and to deals in Africa. There is often a
labour, is a complex one. There higher level of political interest and India
are high taxes and social perceived interference in deals. Some “Indian companies often have a large
charges on payroll, sales and countries can change the rules on tax number of transactions with companies
income. Taxes are diverse and or legal parameters quickly.” owned by other family members. Other
legislation changes fast.” family members who are not in the forefront
“Local knowledge is paramount.
“Conduct a phased approach Investors need to visit government often play a significant role in making or
to due diligence so you can departments and ambassadors to breaking a deal.”
identify the key issues, understand anything which could “Find the real decision makers and start
including corruption, and then cause the government to intervene.” talking to them early on.”
focus on them.” Simon Venables, Partner, N.V. Sivakumar, Partner,
Luis Madasi, Partner, Deals Southern Africa Deals Leader India Deals Leader
Getting on the right side of the delta January 2012 7

10. 4) Put key people in place Identifying people in the organisation or
Ultimately, the people involved will recruiting people to fill key positions will
most influence whether your deal is take time, but is worth the investment in
a success or not. Companies should: any case.
• Build a short-list of local advisors
including finance, strategy, corporate
“By day one, decide on your project
finance, law, forensics, and integration or integration manager – a local or
specialists. In selecting advisors, local someone who knows the market is
knowledge and experience are as best. Get your senior management in
important as previous relationships. place and make sure all lines of
communication are completely clear.”
• Build a deal team of both dedicated
Head of M&A, Global Insurer
deal leaders and deal ‘moonlighters’,
people who can work part-time on a
deal to provide specialist input across
finance and operations. The deal team
should include nationals who are on
the ground, and should also include
the people that will manage and go
into the business post-completion.
8 PwC

11. “When we do deals in emerging 5) Adopt best practice for deal. These choices largely reflect
markets, we do the normal due approaching deals in growth markets trade-offs between risk and reward
diligence: financial, tax and legal. Many boards need to accept that a (either speed or upside). These choices
But that’s not enough for some of ‘normal’ deal approach is not do not have obvious answers, rather they
appropriate for a growth market. reflect preferences specific to companies’
these assets and some of these places.
There is too much ground to cover; cultures and strategies.
You have to do more than the normal
competition from rival bidders can be
due diligence. Sometimes you have to strong and appear irrational; sellers’ The delta between a good deal and a bad
be creative.” expectations are different; and there is one is that much greater in growth
Africa M&A Executive, too much uncertainty over future markets, but we believe it’s possible to
Strategic Industry performance. Past deals show that there get on the right side of this delta.
are a number of best practice measures Companies can de-risk deals in growth
and tips to manage individual risks in economies by recognising these markets
“Due diligence needs to be wider in growth markets. as large opportunities that require some
growth markets to cover things you initial strategic thought, by prioritising
How a company applies these measures markets and establishing a presence on
would not normally consider in the
will be influenced from the outset by its the ground in those markets, putting key
West like employee relations,
size, culture and risk-appetite. There are local resource in place, and adopting
political risk, and market practices” a number of difficult choices about how best practice for a deal. We believe
Head of Corporate Development, to approach deals in growth economies companies that take these steps increase
Global Bank – such as how much weight to give to the their chances of doing a good deal and
long-term strategic option value of a avoiding bad ones.
“It is difficult to use traditional
valuation methods to come to a
single figure. Having an option value Figure 3
is a key way to mitigate this. We use Best practice measures and tips
earn-outs. We like it when people are
left with minority stakes to help Area Measures and tips
crystallize value.”
Financial information • Phase diligence: first thorough high-level initial screen, then in-depth
Partner, Global Asset Manager • Gather data in a bottom-up manner in priority areas (with exclusivity
if possible)
Valuation • Conduct additional research to improve comfort with forecasts
• Use earn-outs/deferred consideration to align interests of management
• Combine long-term strategic option value with conservative DCF
(e.g. scenarios, higher discounts)
Business practices • Conduct FCPA/Anti-Bribery review
• Conduct diligence on key individuals/partners and common issues
(tax, labour, related party transactions)
• Understand if non-compliant practices can be managed
Post-completion • Address critical areas such as governance from day 1
operations issues • Slower pace thereafter
Negotiation & contracting • Adapt to local negotiating approaches (e.g. relationship focused,
more direct negotiations with stakeholders, engaging a broader group
of stakeholders)
• Encourage seller to use an experienced advisor
• Have a back-up (e.g. negotiate with multiple parties, develop an
organic option)
Partnering • Avoid 50/50 JVs
• Research partner extensively
• Discuss exit plans with your partner early
Government interference • Run scenarios for changes in government positions
Getting on the right side of the delta January 2012 9

12. The importance of deals in
growth markets
92% of CEOs expected growth in You have to be there growth markets are the key drivers of this
their Asian operations, 86% Though the activity levels of multinational economic growth. In particular, growth is
expected growth in Latin America, companies doing deals in growth markets based on increasing wealth for the circa
and 75% and 72% expected growth in 2011 remained subdued in volume 4 billion people who fall into the world’s
terms, in value terms 2011 activity poorest socio-economic group, earning
in Eastern Europe and Africa
surpassed 2006 levels. between $1,000 and $4,000 per year, and
respectively. Conversely, only 55%
often referred to as ‘the Next 4 billion’.
and 48% of CEOs expected growth The key motivation behind both current
in North America and Western and future activity is access to large and Acquiring a business is one way –
Europe respectively. growing markets. Roughly six billion of and in some countries the only way –
PwC 2011 Global CEO Survey the world’s seven billion people live in for foreign companies to access these
growth economies.1 PwC forecasts that, at markets. Deals can also provide
current market exchange rates, the GDP of multinationals with local capabilities,
the E7 (The BRICs plus Mexico, Indonesia manufacturing bases, or access to
and Turkey) could surpass that of the G7 resources. They can also be a way of
(the US, Japan, Germany, France, the UK, acquiring growth markets rivals that
Italy and Canada) as early as 2031. may be tomorrow’s key threat in the
Increasing productivity and wealth in global market.
1 World Bank statistics.
10 PwC

13. Figure 4
Deals from North American & Western Europe to growth economies, £bn
£bn
200
176
180
161
160
138
140
127
120
106
100
80
66
60
40
20
0
2006
2007
2008
2009
2010
2011
Number of deals 1,900 2,033 2,148 1,406 1,712 1,720
Source: Dealogic, PwC Analysis.
Figure 5
PwC macro economic outlook – January 2012
Source: PwC Economics.
Getting on the right side of the delta January 2012 11

14. It is important to note that deals in Also, capturing growth is likely to require
growth markets are not necessarily only local innovation capabilities. Customers
about bringing best practice to growth and consumers have different tastes
markets. In many cases, companies in across growth markets. With increased
growth markets are not constrained by competition for their Yuan, Rupees,
legacy investments, so building a Real and Roubles, global products are
business from scratch provides an insufficient to gain share. This is even
opportunity to learn from the mistakes more so the case for serving the low
of the past to establish world class income consumers within the next four
operations. The banking industry is a billion. Many of the ground-breaking
good example of this, where banks in innovations to serve this market will
Brazil and Turkey have developed some come out of growth markets.
of the best technology in the world.
12 PwC

15. But deals in growth markets are
costly from many angles
Though the rationale for seeking deals
in growth markets is clear, finding and
vetting such deals can be costly and
time-consuming. This upfront
investment can make it hard to walk
away if a deal proves to be a bad one. Figure 6
But if the potential deal was truly bad, Cost of deal issues as % of total investment or book value for ten public cases
the effort to identify the risks that
make it a bad deal represent time and %
money well spent. Much more money 120
will invariably be spent if a bad deal
goes through.
Of the problem deals we looked at,
100
10 had sufficient public information
available to estimate in a robust way the
cost of the issues. For these, we found
that the cost of problems on these
“bad” deals averaged around 50% of
80
the total investment. While this does
not represent a statistically significant
sample size, it indicates the order of
magnitude of costs of post-deal problems.
Costs consist of divesting the business at 60
a loss relative to book value or initial
investment, fines, and write-downs Average: 49%
against book value.
In addition, there are also considerable 40
indirect, intangible, or personal costs,
in terms of share price impact, negative
investor reactions, or even individuals
serving prison sentences. In many cases
the total investment is written off or sold at 20
a loss, meaning diminution of capital and
strategic market position, as well as higher
psychological and reputational risk hurdles
when seeking to re-enter the market.
0
Beverages
Media
Forestry
Banking
Travel
Telecoms
Banking
Beverages
Manufacturing
Financial Services
As the experience captured in our survey
illustrates, 50-60% of deals that enter
due diligence in growth markets fail to
complete. Comparing publicly announced
deals, deals by developed economy
companies in growth markets fail more
often than the deals they do in developed Indicates the business was closed/exited
countries.2 We also believe deals in growth
markets are more likely to result in Source: Company reports and press articles.
problems after completing.
Over the next pages, we look at each of the
most common pitfalls in turn, considering
their root causes and the suggesting ways
that companies of all sizes can mitigate
those risks from pre-deal, through
negotiation to post-completion.
2 Source: Analysis of Dealogic data comprising deals by Western European and North American multinationals
investing in growth economies vs. deals by the same buyer set investing in Western Europe and North America.
Getting on the right side of the delta January 2012 13

16. Avoiding the pitfalls of past deals
1
Lack of transparent Common problems & root causes than in similar companies in the West.
financial information – Difficulties understanding financial In the case of a carve-out, building up
minding the gaps information in a business often prevent information can be even more difficult.
deals from going ahead. But there are
a much greater number of examples of Secondly, information can be
completed deals that had worse than presented in a different way, because
Common problems
expected performance or where local accounting policies and practices
• Difficulty understanding financial unexpected liabilities emerged because can differ from those in the West,
information prevents necessary the true financial position of a business making it difficult to verify financial
disclosure was not understood before completing information. Financial accounts are
the deal. It is rare for a shareholder to generally in the local language and may
• Risks are not given enough weight
publicly fall out over the validity of be in a different format. There may be
company accounts, but that is what has less discipline around recognising bad
been reported in relation to a US private debts, and a desire to avoid bad news can
Root causes equity investment in an Indian children’s result in costs building up in the balance
• Managers place less emphasis on apparel company.3 Elsewhere, a series of sheet and liabilities not being recognised.
financial information, so less is allegations made by analysts and
available – e.g. poorer accounting investors of false financial reporting by
systems Chinese companies listed on Western
exchanges remain unresolved and have
• Accounting policies and practices led to regulatory investigations and
differ from those in home markets “There are a lot of family-owned
market uncertainty.4
– e.g. two sets of books companies who are often
disorganized in how they keep
• Managers are less willing to A lack of transparency can come in three
forms. Firstly, there is less information.
information and are understaffed in
provide information because of
Many businesses are understaffed in key positions. This makes diligence
concerns with confidentiality
finance and IT and have less developed difficult and lengthy.”
• Deal teams obtain insufficient financial reporting systems, because
local advice companies in growth markets tend to “They don’t understand what selling
have less stringent requirements for practices should be in terms of
information than companies in providing information on the
Mitigating actions developed markets. Because owner business. They think a two page
• Conduct thorough initial review managers and family-owned businesses financial statement is sufficient and
are common, there is less need for don’t fully realise the time and effort
• Prioritise issues: decide what is
financial and management reporting,
important in conjunction with required to carry out a full due
and there is a greater focus on cash-
local advisors diligence process.”
rather than accrual- based accounting.
• Where possible, obtain exclusivity This will vary by type of business. For South America Investment Manager,
and spend time building up key example, public companies generally Global Private Equity Fund
data bottom-up have better information than private
companies, but even public companies in
• Put risks in context to take
growth markets have less information
calculated risks
3 “Asia fundraising goes on despite fraud allegations”, Financial Times, October 13, 2011
4 “Muddy Waters Claims on China Companies Have Yet to Be Proven,” Bloomberg, December 1, 2011
14 PwC

17. A prevalence of local GAAP can make it This would suggest flat or declining sales
difficult to present financial information rather than growing sales and that the
in a way that is meaningful to foreign seller’s portrayal of the growth of the
companies on IFRS or US GAAP. In business was better than reality, which
markets such as Brazil, local GAAP is can lead to valuation problems.
relatively easy to reconcile to IFRS, but
compliance with local GAAP by many Thirdly, even if the information is
small and medium-sized enterprises is available, the seller may be unwilling
poor. Finally, third party confirmations to share information, because of
“In terms of accounting, lots of can be unreliable. concerns with confidentiality.
things are not completely clean in
businesses in Eastern Europe. If it’s One executive that we spoke with about “They also don’t want to provide
totally misleading, we won’t do it. a deal in Sub-Saharan Africa provided an information as they see it as
But often, the entire industry in the example of the first problem area. He confidential. There are also
market does it a certain way. It indicated that even three years after frequently ‘creative accounting’
might technically be a liability, but completing the deal, “the financial
decisions and the quality of
in the local context the liability will systems are still appalling”. What the deal
accounting and financials is not
never materialize.” team found after completing the deal
was the target’s finance team lack of
good.”
Investment Manager, Global Private basic spreadsheet skills. South America Investment Manager,
Equity Fund Global Private Equity Fund
There are also extreme examples, as a
China-focused deal executive with a
“There was nothing malicious. It was global FMCG company we spoke with
a lack of experience and insufficient highlighted. “I have been to companies
systems. Their attitude to the that said they have 30% growth, but when
financial accounts was not cooking you get there, they have a warehouse full of
the books, but they were more finished products, and no raw materials.”
flexible in representing financial
information.”
“We quantified the impact and asked Case study – Latin America
ourselves, ‘are we willing to take On a deal PwC worked on in Latin America, the team encountered both
this risk?’” inadequate financial information and weak accounting policies. There were
Investment Manager, European several short comings in accounting procedures and no control testing in the
Private Equity Fund external audit. Most concerning, the auditors had not signed off on one set of
accounts because one month’s financial data had been lost when the company’s
server had been moved
To help address the inadequate financial information, a PwC team first spent
time understanding what was available in the company and to identify critical
gaps. A key objective at this stage of the due diligence was to explain what was
common to the market and which areas were unique to the company.
Subsequently, PwC continued to work with management to build information
up from trial balances. They built profit & loss statements by product and
region, identified key performance indicators and worked with the
management team to alter systems to track these indicators.
Getting on the right side of the delta January 2012 15

18. Mitigating actions from growth markets, there is likely to be
In terms of how to overcome these even greater pressure on deal teams.
issues, the key theme coming out of both Buyers from other growth markets are
our discussions and our experience is often more prepared to do a deal
around using local advisors in the without data in key areas, because they
diligence teams so the context of the frequently are more focused on the
risks involved can be put into focus. strategic rationale for a deal (e.g. access
Deal teams will be unlikely to get to markets or raw materials) rather than
comfortable with all risks, but the financial rationale. This can put
“When you do diligence in emerging understanding context allows deal teams those less exposed to developing
markets, you have to roll-up your to take calculated risks. markets at a disadvantage.
sleeves and get your hands dirty.”
Africa and Southeast Asia M&A By understanding what is normal for On average, there is less transparency
Executive, Global Branded an individual market, and what is not, in company accounts in growth markets
Drinks Company it is possible to focus on the issues that than in more developed economies and
are critical for the business in question. this presents a risk to foreign investors.
Given the breadth of issues at play, this However, we do not think it is feasible
“The problem is you can’t spend that initial scan may need to be wider than a or even necessary to eliminate all of this
diligence in developed markets. risk. What is important is to focus on
much time with people during a
critical areas and spend the time with
diligence because you will scare
Once critical areas are identified, it is local advisors to obtain data, bottom-up
management.” necessary to take an approach to due if necessary. Exclusivity greatly
diligence that is different from that taken facilitates this: there is unlikely to be
“You can send in your advisors to in developed economies. Local teams are time or appetite for working with trial
help. It came down to PwC doing important for this process. Shared balances in an auction. This makes it
hard work on paper ledgers.” language and culture help teams to critical to identify off-market deals,
explain the need for specific types of rather than solely relying on a limited
Africa M&A Executive,
analysis, find solutions to build the data, network of intermediaries and
Strategic Industry
and understand what the data is saying. corporate finance houses. Another
challenge to obtaining exclusivity is that
However, in order to do this, significant it exposes the vendor to the risk that the
access or exclusivity is needed. To buyer withdraws. To obtain exclusivity,
contrast the above case study, another foreign buyers may need to offer some
PwC team worked on a separate deal in concessions, for example in terms of time
Latin America where the client did not frame, and they must be able to convince
have exclusivity. It faced the similar a vendor that they are likely to go ahead
difficulties understanding financial with the deal. To do this, it is important
information. The PwC team was able to that Board members and senior
produce an initial red flag report executives are familiar with doing deals
identifying information gaps, but the in growth markets and are bought in
client was not able to persuade the target early into the strategic opportunity,
to work with PwC to address those gaps. and where possible into the specific deal
In the end, the buyer lost out to a rival in question.
bidder. With increasing competition for
assets from up-and-coming multinationals
16 PwC

19. 2
Justifying developing
market valuations –
getting real
Common problems
• Large gaps in expectation between
buyer and seller
• Worse than expected performance
Root causes Common problems Root causes
• Uncertainty over future growth: Nearly 40% of the deals we assessed Valuations using traditional techniques
market demand, distribution failed to complete because the bidder are difficult because of greater
channels, and future competitor was unable to get comfortable with the uncertainty about future revenue
actions valuation of the business. The beer growth. The key sources of this
industry, with frequent auctions, has uncertainty are future market demand,
• Few comparables numerous examples of international distribution channels, and competitor
• Competition for assets companies losing deals because of high actions. Valuations may also be higher
valuations in growth markets. The because many sellers have strong
bidding war over Harbin Brewery in alternatives to doing a deal with a
Mitigating actions China is one of the highest profile foreign investor. There are often rival
• More research to increase comfort examples over the past decade, but there bidders. Stock markets also offer
with projections have been a number of recent auctions as attractive valuations. Finally, many
well, for example the Sona Group in companies have access to low cost capital
• Structures such as earn-outs Nigeria. These competitive auctions were from local banks.
• Combine conservative short-term affected by a number of factors, but
Discounted Cash Flow valuations were potentially the key “The risk/return profile is often not
(e.g. scenarios, higher discount determinant of who won the bid. For the there. Sellers have inflated price
rate) with long-term strategic winners, there is the risk of having expectations. They’re too big to fail
option value over-paid, while those that lost the bid in their own territory. They know the
now lack a strategic asset.
local banks, can get favourable
terms, and can roll over loans. They
High prices are often predicated on high
“There is always someone willing never have to sell. I’ve not seen one
growth, but there are cases of lower
to pay the asking price and price distressed seller of a good, sizable
than expected growth post-completion.
in 12% growth, or more.” For example, several consumer banks Eastern European business.”
from Western Europe invested in Russia Investment Manager,
“The hard part was getting just ahead of the financial crisis only to Global Private Equity Fund
comfortable. There were no good find subsequent performance was worse
historical precedents or data. Real than expected. Not simply the result of
estate had only been a real business the financial crisis, the main reason cited
in India since 2005, when the doors is actually stronger than expected
were opened to foreign investment in competition. Barclays has divested its
India, and there was not a lot of Russian retail business, and Swedbank is
information available to help judge in discussions to divest its retail business
in Russia after selling its retail banking
how much cash flow would be
unit in the Ukraine in 2011.5
generated from these investments.”
Director, Global Asset Manager
5 “Swedbank In Russia Retail Talks With Raiffeisen”, Dow Jones News Wires, 4 August 2011.
“Barclays announces sale of Russian arm to Igor Kim”, Reuters, 25 October 2011.
Getting on the right side of the delta January 2012 17

20. “One of the pitfalls of doing deals in As with financial information, the main However, taking these actions is unlikely
growth markets is getting reliable challenge with valuations is a lack of to provide the board of a global company
market and economic data. information. It is difficult to obtain with the same level of comfort as it
Understanding historical and accurate historical data on market spend, would be able to obtain in home markets.
much less good forecasts for future Uncertainty around future growth, and
projected beer consumption is key
demand. While most companies are good difficulty in understanding the business’
for valuations. It is difficult to get
at short-term cash management, there is financial situation, mean that the
data that is reliable, precise and strategic rationale for a deal must
generally less long-term planning.
specific enough.” Companies may have a one-year budget, be that much stronger to justify
Head of M&A, Global Brewer but many are unlikely to have a three- or proceeding with a transaction that might
five-year plan. There are fewer otherwise look expensive. As such, some
comparable transactions to suggest what flexibility with traditional valuation
“It is difficult to make a valuation growth rates other buyers have assumed mechanisms is necessary. We believe
based on DCF. Growth hypotheses in recent transactions. what is important is a degree of
conservatism in short-term projections,
and wacc are more volatile in growth
Mitigating actions while separately considering the
markets than in developed countries.
There are ways to mitigate these risks. strategic rationale for an investment
Working capital is difficult to which might therefore justify a much
The global brewer we interviewed does
predict, as it is not necessarily its own consumer research to underpin higher multiple than in developed
followed in the financial reporting.” projections and uses larger than normal markets. Considering the option value
contingencies with revenue of an acquisition in conjunction with
“PER and other multiple ratios projections. Structuring solutions like a conservative Discounted Cash Flow
are difficult to obtain. Multiples/ earn-outs can also share risk and align model is one way to ensure that you are
valuations are less often disclosed in the interests of managers and partners. taking into account upside and strategic
the BRICs. Companies are not easy to rationale without throwing the
compare in terms of growth dynamics.” credibility of underlying assumptions
into question.
M&A Project Leader, Global Facilities
Management Provider
Case study – forecasting out of a conflict
In one private equity investment in a growth market, the minority private
equity investor had developed a conflict with another shareholder. The parties
reached an agreement for the private equity investor to buy out the other
shareholder’s stake. However, the private equity investor could not justify the
valuation, largely because of uncertainty over future growth.
PwC was hired to build a detailed model to support long-term forecasts. The
resulting growth projections helped to support the valuation, so the private
equity fund could buy out the other shareholder.
18 PwC

21. “You need to do as much as possible
to ground the business commercially,
but you have to apply more of a
strategic lens. You need to be more
flexible about how you think. No one
can tell you what the market will
look like in ten years time. You need
to treat it more like an option play
due to the high level of uncertainty.”
Africa and Southeast Asia M&A
Executive, Global Branded
Drinks Company
The high valuations and risks of The 3-7 year investment horizons of
growth markets mean that private most private equity funds can present
equity firms must have clear value potential challenges when funds seek
propositions to clear their hurdles to help their portfolio companies
rates for return on investment. For invest in growth markets. Entry into a
example, one value proposition in new market has a long-term strategic
China is helping mid-market option value for a company. However,
companies prepare for an initial private equity investors may not be
public offering. Many of the largest willing to fully value this option
private companies in China have because they are unlikely to be able to
access to lower cost capital from realise the value at exit. Entry into a
banks and public listings, while many new market may not be valuable to a
smaller companies are unable to future trade buyer who already has a
obtain debt financing and lack the presence in that market. Also, in a
financial reporting and governance secondary buyout, a private equity
capabilities required for a listing. For fund may not fully value the option
these smaller companies, private value if it only impacts profits in the
equity can provide much needed long-term.
capital while putting in place the
systems and controls to prepare the
company for a public listing in three to
five years.
Getting on the right side of the delta January 2012 19

22. 3
Non-compliant Business Common problems a subsidiary of a global corporation
practices – discerning In understanding financial information, or private equity fund. Many of these
the manageable from the there are a number of accounting and business practices can present
deal breakers information practices in growth markets considerable risks for a foreign buyer.
that differ from those in developed Common areas of problems include tax
economies. In most cases, these practices and labour compliance, corruption, and
are common and innocuous, but some fraud & misappropriation. These problems
Common problems
reflect a more serious risk. can expose a foreign buyer to potential
• Tax compliance – “black cash” reputational damage from bad public
transactions In the same vein, there are a number relations, or investigations and fines from
of business practices that may be more outside authorities. If rectified while local
• Corruption
common in a developing economy, competitors continue the practice, the
• Fraud & misappropriation and thus present a limited risk for the business may become uncompetitive.
business, but would not be acceptable for
• Labour practices & compliance
Root causes Figure 7
• Less developed/unenforced Business practices that present problems for multinationals
business and regulatory Area Description Example
environments Tax compliance • Companies often keep two sets • In the Latin American case mentioned
of books previously, PwC identified tax liabilities
• Less formal governance structures • Low levels of tax compliance that represented 35% of the target’s
(both corporate and personal). enterprise value
We have come across staff paid
in cash in paper envelopes, which
Mitigating actions did not go through the accounts to
avoid payroll taxes
• Spend time on the ground with • For company directors who are also
local teams/advisors paid in dividends or shares, this can
present a significant risk for the
company
• Targeted due diligence covering
key individuals and common Corruption • Some practices may be acceptable • Within a year of eLandia International
under local law or norms (or Inc.’s acquisition of Latin Node Inc., FCPA
issues (e.g. tax, labour, corruption) unacceptable but poorly enforced), issues in Honduras had caused it to
but fall afoul of international bribery discontinue the target’s operations, and
• Understand if the practice can laws incur additional costs relating to the FCPA
– Foreign Corrupt Practices Act in the investigation, its attempts at remediation,
be managed United States and Latin Node’s bankruptcy6
– Bribery Act in the UK
Fraud and • More related party transactions7 than • One high profile example of alleged
misappropriation in developed markets although more misappropriation of funds in growth
often than not, these are benign markets concerns recent accusations of
• However, some will have unrecorded embezzlement in the NASDAQ-listed
transactions, fraud (potentially China Medical Technologies8
including false audit evidence such as
fake invoices) or misappropriation of
funds
Labour • If a foreign buyer discovers child • Black empowerment regulations in
labour in a business, it poses an South Africa
ethical dilemma and a reputational • There are often stricter workers’ rights
risk. The child may be the sole bread regulations in former communist countries
winner for a household. The foreign • Other markets, such as Brazil, are difficult
owner may need to consult with because of extensive labour laws and
government and local and regulations
international NGOS to find the right
solution
• Foreign ownership may require the
company to comply with new labour
laws
Others • Range of other risks which may • Melanine milk contamination scandal in
present risks for foreign investors, but China in 20089
primarily concern health & safety, and
loss of intellectual property
6 “Latin Node Inc.: Undiscovered FCPA Violations Wipe Out an Investment”, Shearman & Sterling, April 15, 2009.
7 A related party transaction is an arrangement between two parties who are joined by a special relationship prior
to the deal, for example a shareholder’s company being hired as a supplier.
8 “China Medical shares plunge on fraud allegations”, Reuters, December 6, 2011.
9 “Fonterra puts up $8.4m to provide care in China”, New Zealand Herald, October 11, 2008.
20 PwC

23. “I can’t emphasise enough the Many of the issues we come across in this Once identified, it is possible to
importance of doing on the ground area concern related party transactions. understand if the risk can be managed,
due diligence. I was in the office on For example, sales and purchases can be or if it runs throughout the company.
Friday and some cash arrived in a made through related party special First and foremost, we recommend that
purpose vehicles at below and above companies conduct and FCPA or Anti-
brown envelope. We wouldn’t have
market rates respectively. This moved Bribery review. In general, we believe
discovered that in a normal
profits out of the target company (thus that tax compliance can be managed,
management Q&A process.” minimising taxes). Related party vehicles either through new policies or
Partner, Global Asset Manager can be nearly impossible to trace to the indemnities in the sales & purchases
ultimate shareholders, may be agreement. However, indemnities are
unregistered for tax purposes, and are often only effective with an element of
“There may be corruption, but unless often closed down after a short time deferred consideration. The key to
the business has a high component of frame (e.g. six months). managing fraud and misappropriation is
government interaction, then it’s less to understand if any identified
Root causes irregularities are benign related party
likely that there are high levels of
While multinationals are subject to transactions, or evidence of something
corruption in the business, and it
strict regulations and standards, many worse. We believe this can best be
should be manageable. If there are growth market companies use less understood by assessing individual
high levels of government formal governance structures. We transactions, as well as conducting due
interaction, then we spend a lot of believe buyers can rectify these practices diligence on key managers and
time making sure the business by putting in place specific policies and stakeholders.
doesn’t rely on extra payments and improved controls. The key risks are
bribes.” failing to complete a deal because of Industries with high levels of
business practices that could be government involvement (e.g. mining &
South America Investment Manager,
corrected, or failing to identify and plan metals, industries where the government
Global Private Equity Fund
to rectify inappropriate practices. is a key customer) generally present the
greatest risks for corruption. However, if
“Partners can have a different corruption is not endemic, then it may be
“There is rarely a sufficient level of possible to put in place controls which
approach to regulatory compliance.
control in place: no statutory audit limit corrupt practices and the risk of
In China, some may open stores
processes, no business continuity running foul of global regulations.
first and then ask for planning
planning, etc. It is necessary to
permission later.”
understand and recognise this and In some cases, it may also be possible to
put into place a programme to bring Corporate Development Manager, employ constructive solutions to raise
the business under control over a Asia Pacific Retailer standards. In one example of potential
12-15 month period.” child labour, the buyer created an
Mitigating actions apprenticeship program with reduced
Head of M&A, Global Insurer The key challenge to managing business hours, equal wages, and a training
practice-related risks is determining program. Whatever the solution,
what can be rectified and what cannot. rectifying these practices can add
“If we can cordon off the part of the Spending time on the ground and costs to the operations of a business
business where [there are non- asking targeted questions is often the which local competitors are unlikely
compliant practices] and put in place key to identifying business practice- to incur. But the impact of any
a plan to stop the practice – for related risks. rectifying measures on the
example in parts of procurement – competitiveness of the business
then we will do the deal. On the deal should be considered as part of the
we did, procurement had to be rebuilt valuation of the business, and could
from the ground up. However, if there therefore become a deal breaker.
are questions around corruption in
the core business, or its operating
license, then it’s a deal killer.”
Africa M&A Executive,
Strategic Industry
Getting on the right side of the delta January 2012 21

24. 4
Post completion Common problems A senior executive in the banking
operations issues – There were several instances of people industry acknowledged these same
integrating and taking issues post-completion creating language and cultural risks, but also
control operational difficulties in the deals we difficulties navigating informal
assessed. Given the nature of these governance structures.
issues, we believe a large number of
these people problems are likely to go “When you buy a company whose
Common problems unreported and the actual percentage of staff is local, they have often had no
• Wide range of factors causing deals that experience problems in the exposure to an international bank’s
worse than expected performance integration and taking control phase is policies and procedures and we have
post completion much higher than reported.
to impose these upon them. This is a
massive cultural shift and people do
In a joint venture we advised on in India,
the buyer put none of its own employees
not appreciate the extent of this.
Root causes
on the ground in India. Within a few Language barriers only serve to
• High requirements of foreign- years, the JV ran into trouble. The make this more difficult.”
owned businesses: local operating foreign buyer had complaints around
experience, deep business & a lack of transparency, and difficulty “There are also informal social
finance expertise, foreign achieving global standards for structures and deferential dealings.
language skills, cultural affinity governance, quality and technology. In Africa, we found the head of risk
• Different attitudes to management After protracted legal proceedings, was deferring decisions to someone
among local staff the international buyer was forced to in the team two notches below him.”
surrender its share in the investment.
• Living hardships in some markets Head of Corporate Development,
One public example of post-deal people Global Bank
issues is a major UK industrial group’s
Mitigating actions investment in metal fabricating mills in
• Getting the right people in place Russia. There were delays launching
• Setting the right pace operations and the investment under-
(address critical areas from day 1; performed against expectations.
slower thereafter)
“Bringing people into Russia with
good project management skills took
us longer than we expected. And so
we did not execute our projects... this
is our delay. I thought we could do it
much quicker. You are dealing with
import licenses, you are dealing with
approvals from the government and
they are helpful, but it takes time.
We thought it would be easy. But we
have a language barrier.”
Group President of Division
22 PwC