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Feature: Dizzying Growth for Online Due Diligence

Investment Dealers' Digest
by: Avital Louria Hahn
November 29, 2004

The optimistic view for mergers and acquisitions in 2005 is that deal levels are going to be moderately better. But [IntraLinks] Inc., a New York company that provides online M&A due diligence, is experiencing something else entirely. It is boldly forecasting a 180% increase in its own business for the first half of 2005 over this year's first half.

[IntraLinks] is so bullish, explained Matt Porzio, [IntraLinks]' vp of M&A, because of the themes playing out in the M&A market these days: the growing participation of hedge funds and other financial buyers in the M&A market, the increasing number of auctions, and buyers' heightened scrutiny of deals.

Financial buyers, for example, are accounting for a greater portion of buying overall, Porzio said, and these shops often do not have enough people to fly around the world and scrutinize document rooms. Moreover, with the entry of hedge funds into the buyers' role (Kmart Holdings Inc.'s $11 billion acquisition of Sears Roebuck Inc., for instance, was masterminded by Edward Lampert and his hedge fund vehicle, ESL Investments Inc.), the trend will only increase, Porzio said.

"Similar to what you are seeing with the buyout firms, hedge funds have a lot of capital but not enough people for due diligence," he said. Accordingly, he added, hedge funds, [private equity] firms and buyout funds are pushing for due diligence to go online. And so far this year, [IntraLinks]' service has been used in 370 M&A auctions, up from 152 last year and 50 in 2002.

The privately held company, backed by a group of [private equity] firms that includes [Rho] Capital Partners, Euclid Partners, Apax Partners and Soros [Private Equity] Partners, was set up in 1996 to provide online platforms for syndicated loans. Only after establishing its loan business did it apply the technology to M&A, Porzio said.

The timing certainly seems ripe for virtual data rooms. "In the post-Sarbanes-Oxley world, there is more shareholder activism and more pressure to hold auctions," said Andy Shpiz, senior analyst at Mellon HBV Alternative Strategies, where he runs a merger arbitrage fund-noting, of course, that "at auction, you get a better price."

One recent example is the European arm of Pfizer Inc., which sold 60 noncore assets in June for about $175 million. The software does not eliminate the need for an investment bank, but is used alongside one. In fact, it was Merrill Lynch & Co., Pfizer's banker, that recommended using [IntraLinks], Porzio said. Pfizer had eight virtual data rooms for the potentially chaotic process.

Without [IntraLinks], "this would have been a costly, time-consuming process for our deal team and would have delayed the completion of the sale by many weeks, given the number of parties participating," said Betty Dhaenens, director of business development for Pfizer Consumer Healthcare in Europe. "Managing these different levels of access to paper data rooms would also have created a logistical nightmare."

In a traditional M&A auction, companies for sale prepare a slew of documents for display to buyers who fly in from around the world. These document rooms can only accommodate one potential buyer at a time, with due diligence typically taking about a week, Porzio explained. If six buying teams need to view the material, that's six weeks of due diligence.

By contrast, online viewing can be done simultaneously by numerous buyers anywhere in the world. Each gets a secure password and access, and auctions can be done within a week, he said, shaving about a month off the process, on average, not to mention the cost savings. The cost of an online auction can range from low five figures on up, depending on such factors as the amount of material and number of buyers, he added.

"People are beginning to take due diligence a lot more seriously," Porzio said. "It is not good enough to make a transaction on the golf course. You are seeing more auctions and fewer negotiated transactions."

The idea of "knowing your buyer and knowing your process" also is becoming more prevalent, Porzio said. To find the best buyer at the best price, sellers and M&A bankers are casting a wider net. At the same time, sellers want to find out who is serious and who is not. To do that, sellers can monitor how many times buying teams logged on, which documents they viewed, and how long they studied them. A seller can tell, for example, if a competitor simply scanned the customer list and logged off.

In addition, if a buyer who purports to be serious does not show the effort to go along with the talk, the seller can point that out, Porzio said. "Do they pay the lawyer to go into the data room?" If a buyer does, that indicates seriousness. Sometimes surprises occur-when, for example, a strategic buyer who was not considered serious suddenly spends a lot of money having accountants and lawyers view the data.

With due diligence taken more seriously, companies also resort to more experts-what Porzio likes to call the "Sweden factor:" Instead of flying in a scientific expert from, say, Sweden, and paying the airfare and hotel costs so he or she can view documents for a day, a Swedish scientist can now sit at a desk in Stockholm and simply log on.

At the end of the process, the seller gets a DVD that contains all the details of who viewed which documents, and when. One buyer once tried to shave $10 million off the price at the last minute, claiming he had just learned certain facts. The seller viewed the auction history and saw that the buyer had viewed details of the issue early in the process, and called his bluff. The buyer raised his price.

Even for [IntraLinks], the optimist, not every forecast is so rosy. After projecting 180% growth in the first half of next year, it anticipates less startling growth in the second half. That's because M&A volume improved in the second half of this year. So, by comparison, Porzio said, the company expects its growth rate in the second half of 2005 to be a measly 80%.

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