Making informed investment decisions

Several studies indicate that investors identify sound due diligence as one of the most important factors in achieving a successful M&A deal. However, what elevates financial due diligence from a bare necessity to a critical success factor?

Avoiding unpleasant surprises

Contemplating a potential investment, it is vital to look for weaknesses in performance measurement, changes in cost structure, dyssynergies or creative accounting. A working capital analysis is not a checklist with several standardised tests. It is crucial for identifying oddities in working capital trends. Advisors attempt to calculate the expected impact of the transaction on working capital. Analysing net debt involves also finding risks that may not even be captured by financial statements. Underinvested fixed assets or unreported contingent liabilities may backfire if not identified prior to the transaction closing.

Interim performance reports of Czech SMEs are often affected by the limited scope of the monthly closing procedures. Consequently, interim results may not be indicative of full year results. When dealing with long term contracts, proper revenue recognition should be considered due to the inherent limitations of the Czech Accounting Standards. Apart from that, treatment of leases is commonly discussed in relation to cross-border transactions, as all leases are expensed under Czech accounting standards, which differ from IFRS or US GAAP standards. 

Trends reshaping M&A in the Czech Republic

The M&A activity in the Czech Republic remained on relatively high levels especially during the first three quarters in 2022 despite economic slowdown in Europe caused by the high inflation and the increase in interest rates coupled with energy crisis. The preliminary data from Merger market indicates the overall deal count in 2022 was 80 (decrease by 15% compared to 2021).

With a 71% share in small to medium-sized transactions, closing accounts are generally the preferred mechanism for determining prices in the Czech Republic. In the pre-pandemic period, however, the locked-box mechanism gained some popularity in the SPAs, as the Czech Republic became a “seller’s” market, putting more emphasis on making the purchase price as certain as possible. However, the economic uncertainty caused by COVID-19 restrictions and currently worsening economic environment calls for more flexible purchase price arrangements, such as earn-outs. These may often be the only way to overcome deadlock in negotiations, particularly when the gap between sellers’ price expectations and bidders’ risk appetite is too wide. Earn-outs are thus currently being widely adopted, though it is unclear whether this trend may persist once economic/business stability is restored.

Not many changes in the origin of key bidders

Not many changes in the origin of key biddersLocal deals comprised more than half of all dealsin 2016-2022. US investors were the most active foreign investors (six deals in 2022) togetherwith German (six deals in 2022). In the long run, German investors are the most active due to close commercial ties between the Czech and German economies. Although US investors were particularly active in 2022, investments from non-EU countries (incl. UK) are still rather rare and make up approx. 20% share (in volume) in Czech acquisitions over the past five years. The M&A market is dominated by strategic players as financial investors were involved only in 26% of total acquisitions in last 5 years.

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Michal Kokoř
Manager
Deloitte Advisory

Martin Skála
Senior Associate
Deloitte Advisory