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Looking for trouble

Did you know that a quality of earnings analysis can act as a stress test for firms considering investing in troubled companies? Dennis Graham explores this and more in an interview with Middle Market Growth editor, Deb Cohen.

Q
When considering an investment in a troubled company, what is different about a Quality of Earnings analysis?

A
In this case, the typical Quality of Earnings analysis becomes a stress test, looking not only at a company’s revenue history, but digging deeper into its past performance. How did the company weather previous downturns? How quickly did it rebound from a decline in sales or customers? Were the effects short and sharp, or long and gradual?

We can use the information gathered to develop a forward-looking financial model that includes a borrowing base calculation, collateral analysis and, perhaps, even a liquidation analysis. This model can be used to stress test how the company could perform post-close. We run different scenarios to better understand the impact of changes to costs, revenue, pricing, margins and other parameters. This helps to better gauge the risk of the investment.

Q
How important is the current customer base analysis in troubled acquisitions?

A
It’s critical. Not all customers are good for business—especially in troubled situations. When we evaluate the company’s customer list, we consider factors like profit margins and time dedicated to high-maintenance customers. Has the company taken on customers that produce negative margins or are bad for the bottom line?

On the tactical side, we make sure the company has more than one point of contact within the business. Who in the customer’s organization interacts with its customer base? It’s often surprising how much a “bad customer” or a “bad customer relationship” can cost a business.

Q
How can an investor leverage data analytics for a potential acquisition?

A
Data is the new oil. While some buyers miss opportunities or encounter risks by leaving untapped data in the ground, smart buyers mine deeper into financial due diligence to reveal the hidden story. And beyond the company’s data, buyers can tap into a reservoir of other data sources, including databases listing a competitors’
customers and publicly available demographic data.

Q
Do you have an example of how troubled company due diligence makes a significant impact?

A
We worked with a PEG client who made an add-on acquisition of a company that was struggling because, although it had great customers, customer relationships were poor. We helped the buyer dig into the details of the company’s relationships from a financial, analytical and strategic perspective. Once the deal closed, the buyer implemented a new strategy that developed new relationships with key customers, broadened its interface beyond purchasing, proactively learned about the customer’s challenges and provided solutions. This strategy helped the customer see the company not as a commodity, but as a strategic business partner.

Read the original article from Middle Market Growth here >>


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Dennis Graham

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