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Delivering sustainable solutions in a more competitive world
EHS Due Diligence AssessmentsAdding Value, Managing RiskEHS Due Diligence AssessmentsAdding Value, Managing Risk
Taipei, TaiwanAgora Hotel
Taipei, TaiwanAgora Hotel
Mark ErringtonMark ErringtonAsia Pacific Practice Leader M&A Due Asia Pacific Practice Leader M&A Due Diligence Advisory Services ERM GroupDiligence Advisory Services ERM Group20 September 200620 September 2006
2006 Business Integration Forum 2
International PerspectiveERM Forums - October 2005 - June 2006
October 2005Seville, SpainOctober 2005Seville, SpainApril 2006
Scottsdale, Arizona
April 2006Scottsdale,
ArizonaJune 2006Shanghai,
China
June 2006Shanghai,
China
2006 Business Integration Forum 3
Context: Similar to peers from AP, different to peers in North America/Europe Business climate a year from now
-40%
-20%
0%
20%
40%
60%
80%
100%
CompanySales
YourBudget
YourStaffing
CompanySales
YourBudget
YourStaffing
Column 5up a lotup a littledown a lotdown a little
Beijing 2005 Phoenix 2006
2006 Business Integration Forum 4
“Significant challenges and changes in your company in the next three years”
1. Increased pressure to apply common EHS standards to all operations globally
2. Increased pressure on companies to be held responsible for supplier behavior
3. Regulatory change and inconsistent enforcement of regulations in Asia4. Increases risks associated with global low-cost strategy5. Dealing with plant safety issues6. Being responsible for more and working with less resources
2006 Business Integration Forum 5
National Gov’tRegulators
Purchasing
Localcommunities
Local Gov’tRegulators
Board/CEO
Suppliersin Asia
Joint venturepartners
Linemanagement
Humanresources
Customersin Asia
Customersoutside Asia
NGOs
Other Local Gov’t Officials
Finance
GlobalEHS
Legal
Commercial Focus
Civil Society Focus Government Focus
Corporate/Financial Focus
EHS Team
2006 Business Integration Forum 6
In summary
• Many issues to manage
• Budgets are getting cut back, staffing is decreasing
• Constantly evolving EHS regulatory environment
• High public profile of EHS issues – Inconvenient Truth
• Litigious culture – EHS is class action territory - Erin Brockovitch
• This is very risky stuff
• EDD sit along side all other types of Risk Management Due Diligence you would do on a transaction (Financial, Commercial, IP, IT, Human Capital)
• EHS liabilities touch all parts of a company
2006 Business Integration Forum 7
The Business Case for EHS Due Diligence
2006 Business Integration Forum 8
The Business Case for EHS Due Diligence
• Just Closing the Deal Doesn’t guarantee success
• 60% of merged companies fail to meet expectations and provide lower than average shareholder returns
• Executives are left figuring out how to mitigate the liabilities
2006 Business Integration Forum 9
The Business Case for EHS Due Diligence
• ProfileHigh profile (CEO to the supermarket)Corporate EHS functions under pressurePublic relations – NGOs, media, even Hollywood, class actions
• Financial Risk ManagementProper valuation of the assetAdequate reserves for contingent liabilities (FRS12, Fin 47)Appropriate representations, warranties, indemnitiesEstablish baseline conditions at entrance to ownership/leaseSatisfy a lending syndicates risk thresholdsManaging post merger costs
• Business ContinuityCompliance assurance – Fines, prosecutions, legal actionsProduction assurance – Shut down costsAchieving the optimum value from indemnities
• Exit Strategies – Vendor DDRealising value from redundant real estate assetsCreating a low liability business:
» to maximise value of non-core asset sales and ensure a clean exit » or for further capital raising
2006 Business Integration Forum 10
Deal Stage OngoingOperations
Post M&AIntegration
Activity
Integrating EH&S Issues into Business Planning and Performance
Pre-M&APlanning
Benefit
M&AAssessments
Risk Management
Operating Efficiency
Risk Management
Operating Efficiency
Further improvements in efficiency & management of long term
risk
Using M&A assessment to plan, prioritise, integrate EHS systems and develop strategy
Using M&A assessment to plan, prioritise, integrate EHS systems and develop strategy
Understanding and quantifying EHS risks during due diligence
Understanding and quantifying EHS risks during due diligence
Identifying internal and external stakeholder needs, linking EHS & business goals
Identifying internal and external stakeholder needs, linking EHS & business goals
Ensuring compliance
Managing riskContinuous
improvement
Focused transaction
management system
Early warning alarm and
negotiating tool
2006 Business Integration Forum 11
Risks you need to look for
2006 Business Integration Forum 12
Traditional EHS Risk Issues• Site History – contaminating industries, previous reports
• EHS prosecutions - accidents, pollution incidents, regulator interviews
• Site Setting – Neighbours, sensitivity and vulnerability (geology and hydrogeology)
• Housekeeping• Processes and Material Use• Chemical Use and Storage• Aboveground storage tanks and belowground storage tanks • Contaminated Land – soil and groundwater, spills
• Solid and Liquid Waste - duty of care
• Waste Water – WWTP discharges, storm water run off, septic tanks, dry drains
• Air quality - dust, noise
• Utilities - Water supply wells
• Hazardous materials - asbestos-containing materials (ACM), PCBs, lead, radon, radiation, sources
• Biological contaminants – mould, e coli, cryptosporidium, anthrax
• Healthy and Safety - injury and illness logs, worker exposure
• Legal – third party claims, worker claims, property blight
2006 Business Integration Forum 13
Non-Traditional Financial Risk Issues
• EnvironmentalGreenhouse gas emissionsCarbon tradingWEEEROHSDeferred maintenance & trainingCompliance
• Social/EthicalEnvironmental justiceWorking conditionsDisplacementChild laborWorker health & safetyEquitable wages
2006 Business Integration Forum 14
Some Sources, Pathways, Receptors
SurfaceSource
Leaching/Percolation
Groundwater Transport GroundwaterMigration
Inhalation ofIndoor Vapors
Ingestion,Absorption, &InhalationfromSurficial Soils
Inhalation ofAmbientVapors &
Particulates
SubsurfaceSource Vapor Intrusion
IngestionofPotable Water
FishLarvae Shellfish
Fish
Buried waste
2006 Business Integration Forum 15
How to determine the problems
2006 Business Integration Forum 16
EHS Assessment - Interactions
EHS Due EHS Due DiligenceDiligence
FinancialFinancial•• Contingent liabilitiesContingent liabilities•• Valuation inputsValuation inputs•• Cash flow sensitivity analysisCash flow sensitivity analysis•• Indemnification valuesIndemnification values•• Performance assurancePerformance assurance EH&SEH&S
•• Facility statusFacility status•• Liability validationLiability validation•• Forecasted budgetsForecasted budgets•• BenchmarkingBenchmarking•• Voluntary corporate Voluntary corporate
commitmentcommitment•• Program risksProgram risks•• Corrective actions plansCorrective actions plans•• Performance planningPerformance planning--actionsactions•• EH&S IntegrationEH&S Integration
LegalLegal•• Historical indemnityHistorical indemnity•• Deal indemnity termsDeal indemnity terms•• Corporate risk Corporate risk •• Insurance recoveryInsurance recovery
Executive Management/BoardExecutive Management/Board•• Strategic compatibilityStrategic compatibility•• Strategic risksStrategic risks•• Catastrophic riskCatastrophic risk
Plant ManagementPlant Management•• Operational constraintsOperational constraints•• Corrective actionsCorrective actions•• Performance assurancePerformance assurance
2006 Business Integration Forum 17
Levels of Assessment (Phased)
IntelligenceIntelligenceGatheringGathering
•• DatabaseDatabase•• Environmental Environmental
ReportsReports•• Aerial PhotosAerial Photos•• Agency File Agency File
ReviewsReviews•• Covert DriveCovert Drive--bysbys
and Inspectionand Inspection
Due DiligenceDue DiligenceScreeningScreening
•• Focused Focused questionnairesquestionnaires
•• Telephone Telephone InterviewsInterviews
•• File Room File Room ReviewsReviews
FullFullDue DiligenceDue Diligence
Site VisitsSite Visits•• ComplianceCompliance•• Operational Operational
CapacityCapacity
Level of EffortLevel of Effort
Info
rmat
ion
Qua
lity
Info
rmat
ion
Qua
lity
and
and
Ris
k M
anag
emen
tR
isk
Man
agem
ent
2006 Business Integration Forum 18
Get you advisors involved early
• Before: We are being called upon long before due diligence begins:Strategy for Vendor Due DiligenceInitial stages of planning acquisition approach (esp VCs)
• During: We sit along side the other key advisors at the centre of dealsData room review & costing of potential liabilities at 1st and 2nd roundInitial Site Visits (esp for Financial sector)Full Phase 1 covering E, OHS, Process Safety, Business Integration.Technical input to Sale & Purchase Agreements at each auction round
• After: We continue to work with parties long after deal is completePreparation of Exit StrategiesFollow claims according to SPAConduct vendor due diligence for exit (completing the life cycle)
2006 Business Integration Forum 19
Levels of Assessment (Phased)
• Phase IBackground data reviewData roomQuestionnaireSite visit – walkover, audit, staff interviews
• Detail determined byMateriality is the method used to reduce the level of detail on a project
» Based on size of transaction and risk threshold of the client» Does not exclude pertinent observations, simply defines which findings are to
be included in reportingLimited Compliance – limited to material issues, based on our judgments regarding potential capital costs or penaltiesManufacturing portfolio – US$50k – process complianceGas station portfolio - US$100k – S&GWPower station portfolio – US$1m - S&GW, WWTP, Air, permittingRefinery portfolio – US$1m+ (plus aggregates) - S&GW, WWTP, Air, permitting
2006 Business Integration Forum 20
Levels of Assessment (Phased)
• Phase 2 – More detailAssessment soil and groundwater contamination (Sampling)
• Phase 3 – RemediationClean upPermittingEHS Management system
2006 Business Integration Forum 21
When you know what the problems are how do you get the solution?
2006 Business Integration Forum 22
To get the most value, you need:
Business application of the technical information.
Formulation of results in a format suitable for assimilation by management and financial teams
Support for those teams throughout the negotiation process.
Support during the agreement process – SPA, indemnity clauses, following up claims
2006 Business Integration Forum 23
Quantification of liabilities
• Site management budgets (approved or not)
• In business capex (liaison with financial advisors)
• Existing Compliance, Good MP, Future Compliance
• Cost Scenarios: Best case, Worst case, Most likelyMost LikelyReasonable Worst Case
2006 Business Integration Forum 24
Quantification of liabilities
• What the issues are • Cost – (degree of confidence - low range if enough detail)
• Timescale for expenditure and probability • Possibility of it ever being realised
Regulators degree of toleranceSensitivity, vulnerability of environment (H/M/L)
In Summary – What, why, how much, when and likelihood of spending event. For complex multi-site deals this is important
2006 Business Integration Forum 25
Cost-Risk Analysis to prioritize corrective actions -Agreeing the financial solution with the vendor or post acquisition action planning
A
B
C
D
UST
$4M
$3M
$2M
$1M
Remediation Air Wastewater Asbestos
CostCost(front)(front)RiskRisk
(rear)(rear)
2006 Business Integration Forum 26
Cash Flow Projections for Projected Remedial Spending
(Cash Flows In U.S. Dollars)Year 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
"n" 0 1 2 3 4 5 6 7 8 9 10 11Undiscounted Discounted
Components Cash Flow Cash FlowAssessment $30,000.00 30,000 30,000Investigation $67,961.17 63,063 70,000Risk Assessment $38,834.95 36,036 40,000Feasibility Study $48,543.69 45,045 50,000Agency Negotiation $19,228.96 17,206 10,000 10,100Permitting $19,417.48 18,018 20,000Remedial Design $58,252.43 54,054 60,000GW Treatment System (capital) $384,107.83 346,969 250,000 150,000GW Monitoring (15 years)* $71,280.20 53,216 10,000 10,500 11,000 11,500 12,000 12,500 13,000GW Treatment System O&M (X yea $277,397.67 216,175 50,000 50,500 51,000 51,500 52,000 52,500Replacement costs during Operation $48,543.69 45,045 50,000Agency Cost Recovery $43,689.32 40,541 45,000Dismantling Costs/Site Restoration $97,087.38 90,090 100,000Miscellaneous (describe in notes) $49,757.28 47,973 25,000 25,500
Total 1,254,102 1,103,431Notes:
All cash flows are represented in inflation adjusted terms using 3% inflation rateUndiscounted cash flow column it a total of all cash flows discounted at the 3% inflation rateDiscounted cash flow column it a total of all cash flows discounted at the 11% Cost of CapitalDiscounting begins with 1999 as year 1. 1998 costs are undiscounted.
2006 Business Integration Forum 27
Reserve Assessment: PRA Monte Carlo AnalysisReserve Assessment: PRA Monte Carlo Analysis
Cumulative Distribution Increases the Likelihood that Remedial Costs Will Not Exceed a Given Amount
2006 Business Integration Forum 28
Negotiations and Agreements
2006 Business Integration Forum 29
Negotiations and Agreements
• SPA – indemnity clauses
• Escrow accounts
• Insurance - financial solutions to get liabilities off balance sheets and prevent deal stoppers
• Assigning reliance
2006 Business Integration Forum 30
Timing for Assessments
2006 Business Integration Forum 31
Costs of typical liabilities
Costs to determine them
2006 Business Integration Forum 32
Thank You