Investment Bank Sidesteps Deal After Decision Quality Analysis Uncovers Major Flaw in Potential Acquisition

Situation Analysis

The management team of a leading investment bank’s M&A practice was satisfied with its traditional approach to analyzing acquisition transactions, which had been used successfully for decades.  The M&A practice director, however, was searching for ways to further differentiate the unit’s approach and value to clients from those of its competitors. The traditional approach to M&A involved strict financial analysis with an emphasis on capital requirements and balance sheet impacts. But the practice sought to supplement this traditional approach with a more in-depth analysis of income statements, including a deep dive into all sources of value and risk. With that goal in mind, the director commissioned a pilot project to run a head-to-head, real-time analysis for a specific acquisition target, and then compared the results.

Discovery & Solutions

The investment bank performed its traditional work, while Strategic Decisions Group conducted a Decision Quality (DQ) analysis using both publicly available data, as well as the bank’s proprietary information from the client organization. The DQ analysis was unique insofar as it incorporated a “bottom-up” view of the underlying drivers of value for the transaction. It explicitly took into account future market uncertainty, customer acceptance, and execution risk. Notably, a source of value touted by the traditional analysis was shown by the DQ analysis to be important, but not the top driver of value. Additionally, SDG’s analysis identified, quantified, and prioritized risk factors that the bank’s traditional analysis had not flagged. In other words, the SDG approach delivered superior results and insights through quantifying sources of value and sources of risk that were critical to the M&A decision that had not previously been identified by the firm’s traditional approach.

Results & Impact

The traditional analysis showed the greatest source of value growth was an emerging, high-growth product line that offered very attractive margins. However, the DQ analysis showed that although the emerging product line did contribute value, the greatest source of value—and risk to value—was the market share and contribution margin from a mature product line. In effect, the incremental growth (or loss of share) and margin protection (or decline) of a cash cow business was the biggest issue for management to keep its eye on the ball.  Until the emerging product line achieved a critical mass, the company was dependent on the cash cow business.

Both analyses were completed in the same tight timeframe, with one notable difference between the two: SDG’s DQ analysis revealed a significant flaw in the pitch document created by the investment bank to represent the company for sale. The story that was portrayed in the pitch document was not supported by SDG’s DQ analysis. Not only did the traditional analysis fail to reveal this issue, but the problem was so severe that the investment bank decided to immediately withdraw from the deal, thus avoiding a potentially value-destroying acquisition.