Move guide
Test the record and the seller's plan
Your report suggested a move on at least one of these two questions:
- how the target has performed, and whether it is a good business on its own;
- whether the seller's plan follows from the record.
This move guide takes the target's last three years apart and tests the base year for one-offs. It asks whether you would buy the target with no synergies. Then it bridges the seller's plan, driver by driver, to the record and to the market.
1. When it applies
Use this move guide if your report placed either question at "Red flag" or "Doubtful".
| Question | Where it may sit today | Where this move guide aims |
|---|---|---|
| How has the target performed, and is it a good business standalone? | Red flag: "Performance has deteriorated, explained or not, and nobody has priced it; standalone, we would never buy it." Doubtful: "Headline growth masks weak underlying performance, a cost windfall held in price or a base year nobody has adjusted; standalone quality is assumed from the synergy excitement." |
Supported: "Multi-year performance decomposed, the base year tested for one-offs, and the target passes a PE-grade quality screen on its own merits." |
| Does the seller's plan follow from the record? | Red flag: "The seller's plan grows at a multiple of the market and of its own record, and nobody can say what changed." Doubtful: "The plan outruns the run-rate, and the explanation is our synergies or their levers, not the drivers." |
Supported: "The plan is bridged driver by driver to the last three years and to market growth, with a named cause for every step above either." |
If both already sit at "Supported" or higher, skip this move guide.
Both are warning questions on the strategic buyer check. A low answer on either moves the report's verdict toward "Slow down". The standalone question is the floor: a "Red flag" there caps the verdict.
2. What to do
Four steps. They take three to four weeks.
- Take three years of performance apart, driver by driver. Volume, price, mix, input costs and overheads. Test the base year for one-offs.
- Screen the target on its own, as a fund would, before any synergy enters the model. Would you buy it with no synergies?
- Bridge the seller's plan to three years of history and to market growth, driver by driver. Every step above the record or the market needs a named cause.
- Re-base volume to the market wherever the plan has no way to win share. Price the standalone case on the drivers you believe.
Table A below holds the bridge.
3. What to produce
One table.
Table A. The plan, bridged
| Driver | History (% a year) | Market (% a year) | Seller's plan (% a year) | Named cause for any gap | Our case (% a year) |
|---|---|---|---|---|---|
| Volume | |||||
| Price | |||||
| Mix | |||||
| Input costs | |||||
| Overheads |
A gap with no named cause goes back to the market rate in your case.
4. A worked example
Illustrative. Written for this move guide. It describes no client.
A medical-devices group is looking at a maker of surgical consumables. The seller's plan grows revenue at twice the market, every year for five years.
The record.
- Three years of growth came mostly from price. The base year held a large one-off order from a hospital network that will not repeat.
The quality screen.
- Taken alone, without that order, the target still earned a good return and turned profit into cash. The group would buy it standalone, at a lower price.
The plan.
- The plan's volume growth had no mechanism behind it. The group re-based volume to the market and kept the seller's price assumptions, which matched the record.
Four weeks on.
- 1 one-off taken out of the base year
- Yes to buying it with no synergies, at a lower price
- 1 driver re-based to the market
On a retake, both questions could be answered at "Supported".
What it looked like in our work
From our own work. Figures changed.
For a buyer of a building-products manufacturer, our due diligence took the target's margin gain apart. Its unit prices had risen faster than its input costs. Almost all of the gain in earnings margin came from that gap.
- Earnings margin, year 112%
- Gross margin gained+10%
- Operating costs fell, as a share of revenue+1%
- Earnings margin, year 423%
Earnings before interest and tax as a share of revenue, in percentage points.
| Year 1 (%) | Year 4 (%) | |
|---|---|---|
| Gross margin | 21 | 31 |
| Earnings margin | 12 | 23 |
Over nine-tenths of the margin gain was gross margin: prices held while input costs fell. Competitors and wholesalers could compete that away, so the buyer's case could not count on keeping it.
5. Effort and dependencies
- Chief financial officerTakes the record apart and runs the quality screen.
- Deal leadBridges the plan to the record and the market.
- Financial due diligence teamTests the base year for one-offs.
What you need
- Three years of management accounts, by driver.
- The seller's plan, and the market model from testing the market.
How long
- Three to four weeks.
What gets in the way. We have seen these in our own work:
- Growth with no mechanism. A building-products manufacturer's plan grew volume well ahead of the market, with no reason it would win the share. The plan was re-based to the market.
- What good looked like. In a carve-out from a loss-making parent, the subsidiary's record was separated site by site from the parent's losses.
6. How will you know it worked?
The test is whether the case would stand with no synergies, on drivers you have checked. Retake the check when Table A is full. Each of these should be true when you answer:
| Question | You can answer Supported when | A document alone does not count if |
|---|---|---|
| How has the target performed, and is it a good business standalone? | Three years are taken apart, the base year is clean, and the target passes a quality screen on its own. | The screen was run after the synergies were in the model. |
| Does the seller's plan follow from the record? | The plan is bridged driver by driver to the record and the market, with a cause for every step above either. | The bridge exists, but the gaps are explained by "our synergies". |
The worked example is illustrative.
Think we've used your work without proper credit? Tell us and we'll fix it.