Overcoming M&A Challenges

0:00This episode is brought to you by Firm Room. Searching for a data room that offers simplicity without compromise? Elevate your data room experience with Firm Room, the world's most intuitive virtual data room. Try it free for 14 days, no strings attached. And when you're ready to power up, sign up for unlimited users and 10 gigs of storage at a flat rate of$495 a month. Boost your team with Firm Room, a tool built by dealmakers for dealmakers. Check it out, firmroom.com. Again, that's firmroom.com. I'm Kisan Patel and you're listening to M &A Science, where we talk with deal professionals and learn valuable lessons from their experience.

0:50This podcast focuses on stories, strategies, and what actually happened during M &A deals.

1:03Hello, M &A scientists. Welcome to the M &A Science Podcast, where we learn from the best in M &A to uncover proven techniques for enterprise value creation. If you're interested in learning more about the products and services we develop to support world-class M &A teams, or want to get involved with our community of forward-thinking M &A practitioners, visit mascience.com. You can start by subscribing to our free weekly newsletter for the latest insights and events. Again, that's mascience.com. I'm your host, Kisan Patel, CEO and founder of M &A Science. Joining me today is Doug Bernard, Executive Vice President, Corporate Development and Legal Advisor at CF Industries.

1:40CF Industries is an American manufacturer, an S &P 500 chemical company, based in Northbrook, Illinois, a suburb of Chicago, traded on NYSE under CF. Today we're going to talk about how to overcome challenges in M &A to increase deal success. Doug, how are you doing? I'm doing great. And thank you for having me here today, Kisan. admire what you're doing and looking forward to our interview. Likewise, we are here live in the M &A Science Studio in the heart of Chicago. So thank you for coming down and make this happen. We don't get to do too many in-person interviews in our studios. I'm glad that you made it down.

2:17Very exciting. I know usually I'm thinking people take a break from doing M &A deals, but I don't think you're taking a break from any deals. I think you're moving on to the next big thing. That's right. Why don't we kick off a little bit about your background? So I've been doing deals for a little over 40 years now. I was a partner in the private equity practice group at Kirkland & Ellis. And after that, I've had three general counsel roles. The first one was with a PE, private equity portfolio company, pretty large. It had 30 ,000 employees in multiple countries, mostly in Asia. After that, general counsel with an advertising group based here in Chicago, but with 500 offices in 90 countries.

3:00Wow. And for the past 20 years, general counsel at CF Industries. CF Industries, like you mentioned, S &P 500 chemical company,$11 billion in annual revenue,$6 billion in EBITDA, and$15 billion in market capitalization. I wanted to tell you an interesting story about how it all began 20 years ago at CF. When I joined the company, it was near bankruptcy. It had lost a lot of money for five years in a row. I helped take it public one year later, about the same time that Google went public. And astonishingly, over the next 10 years, as newly public companies, CF stock outperformed Google stock for that 10-year period.

3:44So it was an amazing turnaround from near bankruptcy when I joined to the company that it is today. Wow. Big win. That's a big, big change to be on the inflection point. I'll just mention one other thing. Since this is M &A science, I guess you could call me an M &A scientist. I have a bachelor's degree in physics from MIT and an MBA in finance and accounting from Chicago Booth. So I like your M &A science approach. Hey, I love it. That's what we're always looking for is growing this community with more scientists. And it's really interesting. I was looking at your background. You've worked on not only a lot of deals, but you've worked on a lot of big deals.

4:22I have a wide range from small to middle market to multi-billion dollar deals over the years, particularly at CF as the company grew so dramatically. And in the chemical industry, deals come in what you might call bet the farm sizes a billion on up. Most recently at CF Industries, a number of multi-billion dollar deals. When you look at back and you summarize your scorecard, is it number of deals or total transaction value? The way I measure my own performance is what I like to think of as batting average. Of all the deals where I get involved at the outset, how many get all the way to the finish line?

5:05And we're going to talk about some of the ways a deal practitioner can increase their batting average. Make sure that if the deals you work on should happen, they get done. Awesome. I'll get your score at the end then. So before you even start a deal, what kind of mindset should you have to be prepared for surprises that come up? In order to improve your batting average, there are two things I always try to do at the outset of a deal. One is to understand the lay of the land better than anyone else. And the other is to always act and come across as an honest broker. Because if people come to trust you and they realize you know the lay of the land, they're going to allow you to work your magic, find ways to find common ground and cross off issues one by one.

5:57What do I mean by lay of the land? There are three or four components that go to the lay of the land. The first is to try to understand the relative negotiating leverage of the buyer versus the seller. And that's equally important whether you're the buyer or the seller, representing the buyer or the seller. So what goes to relative negotiating advantage? One important aspect is whether the seller has alternatives. Are there competing bidders? If it's a pre-IPO target, is an IPO an alternative to a sale? And maybe if it's in a strong growth phase, maybe the seller might decide just to defer selling it if the time isn't right.

6:42Another component that goes to leverage is whether the buyer has synergies. And if it does, how that compares to competing bidders synergies. The third component of leverage is whether or not this acquisition is strategically important to the buyer. Because buyers behave very differently if it's strategically important to them to get the deal done. Otherwise, they're very price sensitive and they just want the lowest possible price for yet another deal that isn't strategic. I also try to identify impediments to closing. For example, the need for regulatory clearance, increasingly difficult today.

7:25The need for financing, as opposed to a buyer that can just write a check without financing. And then how long is it going to take to get regulatory clearance to raise financing and so on? And ultimately, what is the likelihood of success or failure if the deal hangs in the balance on regulatory clearance or financing? Yet another part of lay of the land is where is the buyer on the learning curve? Does the buyer already know going in just about everything worth knowing about the target? Or at the other extreme, will they need to do a lot of due diligence to get comfortable and understand what they might be buying?

8:05I suppose the last thing I mean by knowing the lay of the land is to do triage on the negotiating issues. Is it an issue on which the buyer and seller can likely agree? Can they at least find common ground if it's a little contentious? And the third triage category would be what I call zero-sum issues, where someone will win and someone will lose. Once you know the lay of the land and you've done triage on the issues, really where I think deal professionals can add a lot of value is turning those seemingly zero-sum issues into issues where there is common ground so that the parties can put that issue behind them and get to closing.

8:50You covered a lot there, Doug. That's the most scientific of my answers, but I thought it's important to get a framework. Yeah. So I want to break this down and make sure I got it. So we have leverage, understanding what other alternative options are, if that could be an IPO or how competitive this is going to be. And then I think the synergies, almost like looking at the comparison of what the synergy is going to look like with some of these competitive bidders as well. The other stuff would be the impediments of doing the deal. What's going to prevent it if there's regulatory things like that sitting in the way?

9:21So we had negotiating some of the specific things, items to get to close. On that last point, the triage, figuring out which issues are easy to resolve, which ones can be resolved with some effort if you find common ground. And the last category, obviously the most difficult, are the zero-sum issues where there will be a winner and a loser. If it's going to be a successful deal on those zero-sum issues, the party with the most leverage is likely going to win them if there's to be a deal at all. Okay, so we had these different areas. is we had, in terms of lay of the land, we had negotiating the leverage, knowing what the alternative options are, if it's to go IPO, if it's to look at who the competitors are.

10:06Then you had the specific synergies, the competitors, how they look at the deal and their synergies. And then you have the various impediments to get to close. Is there some regulatory requirements and things of that sort? As you get to close, it's negotiating the issues that come up and how you triage that. And that's where I was curious if you had specific examples around that. We may get to that. I just want to say in many deals, leverage depends on whether getting the deal done is strategically important to the buyer. Because if it's a must-do deal in some sense, it changes the negotiating dynamics.

10:40But leverage is always important. Most important when the buyer wants it so bad it hurts, when it's strategically important to them. What if it's the other way out, Doug, where you're looking at a company and they're in bad shape, revenues declining. And you're looking at this thing like, I don't know who else would buy this thing. And this is maybe that one. You still see some strategic alignment there, but it's going to be a lot of work to make this thing work out. I do have an example. It was a business line that year after year for 10 years had consumed cash rather than generated cash. And I was tasked with selling it.

11:18And so how do you find someone willing to pay a meaningful amount for a business that consumed rather than generated cash year in and year out, even in good times? And I was able to get that business sold and that deal closed because I recognized it was strategically important to the buyer to expand in its existing business line. In negotiating with my counterpart, I decided it would be a losing approach to focus on numbers, financial metrics. I negotiated with just one piece of paper, and it compared the relative size of the buyer to our cash-consuming subsidiary in the buyer's own industry. And then I said, well, Wall Street analysts think your company with your size is worth X.

12:13I'm guessing you think they have it wrong that your company's worth even more than the Wall Street analysts claim. So you just have to scale that down to our target, which is a smaller version of you. And that equates to X. That worked. The opposite, more traditional approach of saying here are the historical financials. we think you can maybe actually generate cash some year if you play your cards right, would never have worked. So it had to be reframed that way and couldn't have been if the buyer didn't view it as a strategically important deal instead of one driven by the numbers. One person is trash, another person is treasure.

12:55You figured that one out. In some sense, you've seen one deal, you've seen them all, but I think it's more accurate to recognize that every deal is different. They differ along these dimensions I describe. If you master the lay of the land and you come across as an honest broker, you can usually find a way to get any deal done as buyer or seller. Can we talk more about the honesty part? Because I think that part doesn't get talked about a lot, where there's a relationship you need to develop, which essentially gives you that foundation of trust. I feel like if you fundamentally don't have that, you're not in a great position to get the deal done.

13:30It's easiest to get people to accept you as an honest broker if you have a substantive, deep understanding of the lay of the land. If you're representing the seller, you know why the buyer wants to do this deal, vice versa. And if you've given some thought to the likely open issues that need to be negotiated and have come up with approaches issue by issue, how you can find common ground and explain why that's where the common ground lies in terms that counterparty understands. You understand where the counterparty is coming from. It turns into more of a workmanlike instead of contentious process.

14:11So in order to be an honest broker, you do need to know the lay of the land better than anyone else. And once you know the lay of the land that well, it's relatively easy to work constructively instead of intentiously. Are you being pretty objective then where you're essentially sharing the cards or your perspectives? Yeah, it's the rare issue where the common ground is razor thin. Usually there's a range from pro buyer to pro seller within which both parties could agree if it came to it. So depending on whether you're the buyer or the seller, you're representing the buyer or the seller. You want to scope out the most favorable part of the common range issue by issue and try to get most, ideally, all the issues to land in the common range so the deal gets done, but at your end of the common range, issue by issue.

15:04Can you have an example of that? I'd have to give it some thought, but it's an approach I've used deal after deal. I was thinking, heading into this interview, trying to estimate how many deals I closed. It's probably over a hundred. I found that approach works best in terms of batting average if applied consistently deal after deal, whether you're buyer or seller. But here's the issue point. We're basically looking at common grounds, but there's a definition of common grounds between both sides and really figuring out where there's a nice mutual overlap that doesn't stretch it too far. I've thought of an example and it goes to synergies.

15:45You might have a financial buyer, in which case they probably don't have any synergies unless they already have portfolio companies in the same industry and it's a roll-up. Then they would have synergies, but often financial buyers don't. But strategic buyers almost always have synergies. In other words, there's value created if they add the target to their existing business in the same industry. So the synergy in some sense is the fair market value. It's what's on top of the fair market value, the value created in the buyer's hands, adding it to the buyer's empire. That needn't and usually doesn't go all to the buyer.

16:28In a competitive situation, the seller can often end up with the most approaching all of the value created by adding this target to the buyer's empire. The common ground is the range between the fair value, what a financial buyer would pay if it had no synergies, and the bigger number where you add in the synergies, the value created by putting the buyer and the target together. Once you recognize that is the range where the parties could play your cards right, agree, if you're the buyer, you try to save for yourself most all of the synergies, the value created from the deal. And if you're the seller, you try to extract most all of it for yourself since the buyer is going to realize the synergies if they're real.

17:22Yeah. How transparent do you see the buyers in terms of, hey, here's our model. This is how we're modeling this deal out and where we've identified synergies. It usually comes out automatically in a competitive auction where the competition drives the deal price higher and higher until one by one people with inferior synergy drop out. It's become uneconomic for them, leaving in theory at least just the buyer with the greatest synergy of all the bidders. It's the rare counterparty that will put its cards on the table about something as central to the deal as the price, but you can often estimate synergies from outside looking in.

18:09And how do you negotiate that? Because if I'm a seller, I'm trying to take your lens into, I want to make this deal strategic. Like I get a sense from this buyer, there's a lot of value because they've got this massive distribution. They're going to be able to add this product and quadruple sales in a matter of a couple of years. And I guess, how do I acknowledge that, but then start negotiating off of that and saying, this is how much value it's going to create. This is going to be worth X dollars because of what I'm interpreting from the value you're going to realize. It may be more of an art than a science in the end game.

18:41I once worked on a divestiture of 40 % of the public company parent. It was a competitive auction. I was with the seller. We opened all the bids, and of the four or five bids, the highest one stood well higher than the other bids. So our investment banker, without batting an eye, called the bidder that had put in the meaningfully higher bid than other bidders, said, you're close. If you add another$100 million, it's yours. Even though that bidder had already put in a far higher bid than the other bidders, That bidder swallowed hard, added$100 million. And so that's the art of negotiating in an auction.

19:26Yeah, playing some poker games here. Yeah, it's part science just estimating what they could afford to pay and still come out ahead with the estimated value created by buying the target. Or you can play poker and just come up with some way to test your hunch that they have more in them. And of course, few buyers lead with their final and best offer. It almost goes without saying they have more in them. Question is how much? How do you get good at this? I feel a lot of people don't have this in terms of you got to be in the business for a while to start understanding that valuation is based on the buyer's perception of the value and the synergy part of it.

20:09How do you get good at that of just starting to identify and looking at companies and how they would find synergies and deals? I approach it maybe from the other direction. I spent roughly 10 years in private practice representing PE, private equity buyers, and they usually didn't have any synergy. They were loathe to participate in auctions, competitive bidding situations, where there would be other bidders, strategic buyers with synergies that they didn't have value created that they couldn't create. PE buyers will often take a pass on competitive bidding opportunities with strategics bidding against them and fish in different waters, try to get exclusive books at something for sale.

20:59How do you get good at it? I think it's just working on enough deals. You get the hang of it, thinking about what's going on and why, playing some of your hunches and seeing what happens. It's almost like you got to get in their shoes, get in their mindset, I think. You can do a lot worse than learn enough about the counterparty and see the deal through their eyes. That helps you negotiate against them. It also helps you identify the common ground to put difficult issues behind you and get the deal done. And if you are inherently fair, you come across as fair and knowledgeable. It's happened a number of times in my career where both parties just look to me to find ways to resolve issues and trust me to do something fair for all concerned.

21:49Have you found anything unique for information gathering in terms of listening to earning calls or certain things that really give you some good media information to help you with that? Yeah, it's on the subject of earning calls. AI is newest on the scene. And traders on Wall Street are literally turning AI loose on earnings call transcripts, looking for clues, what's said, what's not said, words chosen. But back to my example of trying to sell our cash-consuming business, I spent some time I'm confirming my hunch that the eventual buyer probably find this strategically important acquisition and might be willing to let a little thing like cash consumption rather than generation be secondary.

22:37Yeah, this is good. How about when you're moving along the deal? When does it start getting tricky and problems start surfacing? Typically not at the outset. It's the honeymoon phase. Both the buyer and the seller would like to see the deal happen. So they work together to build momentum, and often that means postponing dealing with some of the more difficult and contentious issues. Once the momentum has been established, the lawyers, the tax professionals arrive on the scene. In most deals, that's when the elephants on the table become evident. The contentious issues, the difficult issues, the zero-sum issues are revealed.

23:22And so that's when the going gets tough and when it's really important to see if there's some way to turn the so-called zero-sum issues into common ground issues. And if you're creative, you can turn more than a few seeming zero-sum issues into actually common ground issues and then steer towards something both parties can accept as you march towards the finish line closing. The difficult issues normally surface when the lawyers and tax professionals first get involved. Sometimes additional difficult issues surface during due diligence. and that really turns on whether the buyer already knows the target same industry, for example, like the back of its hand, or is going to be getting up to speed through due diligence.

24:15And occasionally, some amazing things surface during due diligence. Not often, certainly not always, but you do 100 deals. I've seen some astonishing things come up during due diligence. When you say astonishing, you mean like surprises. Yes. I would love to get examples. I feel like this is what you don't learn in textbooks, but if you can share some examples of surprises you've seen in diligence. Yeah. I'm going to give five examples. The first two came to light when lawyers and business people plowed through the data room. The third, fourth, and fifth issues, probably not the sort of things you would ever find in a data room.

24:56They were uncovered through the use of private investigators. So first, the two data room examples. In one case, the target company had grown through a roll-up strategy, buying companies in an industry from entrepreneurs. And in order to keep the entrepreneurs head in the game and get those roll-up acquisitions closed, they had handed out little deal by little deal bespoke equity or equity incentive packages. And I was representing the buyer. And when we saw how pervasive these arrangements were and how bespoke they all were, our client financial buyer threw up its hands because it was very difficult to model how much they would get as the PE buyer versus the entrepreneurs in terms of future value created.

25:52It was almost impossible to model. So that was one, and that literally killed that acquisition. Another one was where the target company was a manufacturer, and by license from a third party, it had the right to use a well-known trade name on its heavy machinery. During due diligence, the buyer learned that the extremely important license to use the trademark would evaporate on a change of ownership, especially because the buyer competed with the third party that had licensed in the well-known brand. That one got solved, but it was critical to the value. A lot of the value of the target would evaporate if it lost its right to use the well-known trademark on its heavy machinery.

26:45So those were two data room examples. The three learned through using very sophisticated private investigators in each case. One case, we discovered massive bribes of foreign government officials, extensive trading with enemies of the state on the OFAC list. Needless to say, that killed that deal. Another stranger one was where the target had sizable operations in a third world country. And we learned through a private investigator that the foreign government had silently appropriated the operations in that country. And the operations in that country were a sizable fraction of global operations for the target.

27:32I silently appropriated them. They had repopulated the board so that government had a majority of the board. They had replaced the in-country general manager and had silently appropriated the economics of the entire operation in that country. Again, that's the sort of thing that kills deals, and you're never going to learn that in a data room. And then the last example, in some ways, a stranger still, we learned, again, representing the buyer, entering a new industry and a new geography, that the entrepreneur of the target, someone on whom they'd be completely dependent if they bought it, entered the new industry and the new geography, had a gambling problem.

28:18He had bet and lost huge sums at the horse races and was heavily indebted to the mob. So that killed that deal. Wow. I realize due diligence feels like drudgery, but every so often you find something so important that it goes to whether or not the deal should go forward or not. It's funny, like the surprises, how the majority of them came from the PI. Can you walk me through? Like, I'm not familiar with it. How do you utilize a PI? Is it a common practice that you're doing on these deals? The nature of being a public company? Like what's driving that? All the well-known big law firms that specialize in major M &A transactions, some of them have private investigators on staff, employees of the law firm.