How Operational Due Diligence Provides Value to Investors

Operational Due Diligence is about establishing confidence in your manufacturing target's operational capabilities. This confirmatory role has value in and of itself but more often than not Operational Due Diligence uncovers facts that can increase or decrease deal value - sometimes materially. Examples of how this happens are outlined below:

Fatal Flaws
The identification of fatal flaws while rare can create a deal breaking condition and result in the avoidance of making an investment where a pass should have been taken.

Evaluation of capacity availability to support projected growth often highlights critical short falls in true realizable capacity. Capacity shorfalls can be a fatal flaw, depending on the industry sector, but if its not fatal it will invariably mean that more capex is needed to reach the projected revenues or it could mean than revenue projections will need to be reduced to reflect realizable capacity.  Both of these can diminish deal value to an investor.

Evaluation of CAPEX plans results in critical deal related findings in a number of ways: 

  • Insufficient capital may be budgeted to sustain operations and this may indicate more Maintenance and Repair expenses are likely in future periods. This has particular relevance in Income Trust investments.
  • Examination of capital project justifications may indicate that projected benefits are over or understated; both conditions are found routinely in such reviews. Both may result in adjustments to the projected financial performance and the adjustments can be material.
  • Overstated capital projects become candidates for delay or cancellation thus affecting future cash flows.

Cost Reduction/Operational Improvement Plans
Evaluation of projected operational cost savings initiatives often results in restatement of expected benefits upward or downward.  This has implications for expected financial performance and cash flows.

Evaluation of Operational potential can uncover significant opportunities for improved cost performance of the operations. It is important to note that during due diligence it often difficult to do a deep enough dive in this area to identify major opportunities.

Gross Margin Analysis
Evaluation of Costing approaches and Gross Margin impacts of Capex projects and cost down initiatives can result in the need to restate the expected performance either upward or downward.