From Due Diligence to Deal Value

Converting Intelligence into Advantage when investing in power assets

To secure quality due diligence at the right time is priceless, but it can be hard. Harder still is converting such intelligence into tangible deal value while remaining an attractive buyer. Looking beyond price adjustment for risk, significant value often lies buried within contractual nuances. These may only pay out years later, or in specific circumstances, but are still worth pursuing.

Following our previous insight on offshore wind valuations https://tinyurl.com/offshore-wind-deals this article looks at tools and the tactics to make the most of your due diligence intelligence and unlock that value.

The Practice of Conversion

Your due diligence identifies the risk, but that is only half the job. It is up to you now to deal with each material finding. What value is at stake? What will you prioritise? What negotiating lever will secure your best outcome? Not every finding warrants a price chip or a heavily renegotiated clause. Choosing the best response takes skill.

long-term value is won or lost by investors in how they use their intelligence tactically for their negotiation.

Primary Value Levers

The most direct tools for translating diligence into value feel familiar: (i) price adjustment, (ii) control and governance rights, and (iii) drafting to modify risk allocation.

Price adjustment is simple and effective. Faced with a quantifiable risk, a liability, a capex exposure, a revenue underperformance, investors reduce their bid price. This does not use up negotiation chips (trade-offs) and works well when the risk is specific and evidence based. On the other hand, it worsens your attractiveness as an investor in a competitive process and does not deal with risks that do not fit easily into your valuation tools.

Control and governance rights through reserved matter mechanics, positive consent rights or direct access and participation are very important in safeguarding your investment. On the other hand, the opportunity to veto or be in deadlock does not necessarily address the underlying behaviours and performance of the joint venture (“JV”). Nor will it fix structural mechanics in service agreements. By the time you get to exercise your veto in practice, you may not realistically have much option depending on the bigger picture and balance of power in execution.

Drafting adjustments. Targeted changes to specific contract provisions are often best to address structural imbalance and can save on adjustment to price. However, contracts are multi-layered so one or two drafting edits may not suffice. Indeed, a seller’s well-prepared  documentation may need substantive restructuring to deal with layers of asymmetry. This will meet significant resistance from a seller because it is time consuming, difficult, and costly.

Secondary Value Levers:

Concession trading can become quite binary when those primary levers dominate. Both sides end up trying to manage the clock to their advantage. This is where different, more qualitative levers can drive value in subtler ways. These focus on absences, behaviours, and future proofing. And because they live in the margins, they may not even impact headline valuation.

Negative space: Satisfying value can be found in the exposures that the contracts do not address. An investor’s focus will inevitably land on the wording in front of them. Equally important is what the contracts remain silent on. Negative space analysis asks what does this contract not contemplate, and what does that mean for me by default?

Behavioural clauses and frameworks are normally underrepresented in contracts. Yet they can be powerful. Good drafting can shape the culture of a joint venture and particularly how JV partners behave towards one another when difficult situations arise. They can also proactively address areas of director conflict in interest which can arise between duty to the JV versus duty to a parent shareholder. Without these, the JV might become inefficient in its future decision making.

Futureproofing also matters in infrastructure. Given the number of low-probability but high-impact risks (regulatory change, technical disruptions, geopolitical stress to name a few), it seems likely that infrastructure assets will encounter situations that put severe strain on contractual relationships. Anticipatory diligence and scenario mapping can highlight the inflexibility of most contracts together with their relative inability to adapt to change over the lifetime. Such inefficiency costs. Anticipating it and setting measures to proactively address future scenarios is valuable.

These are just three tools at the investor’s disposal to drive additional long-term value.

A Cautionary Example

Consider a JV investment process which delivered all the normal diligence reports and risk analysis. The first problem arose from red lining the contracts from the last, similar asset assessed. Insufficient attention was given to new industry and regulatory risks to the asset. The red-line exercise therefore missed an important compliance point and a connected liability exclusion in the service contracts. The investor will not know about these until they appear as variation orders in execution as a shared JV cost.

The second problem for the investor was only bringing highly talented lawyers and investment professionals to the negotiation room. During critical concession trading, their diligence specialists who understood the nuances of the technical and commercial risks were not present. Unfortunately, this meant leaving value on the table as the liability for a material portion of services remained with the JV.

Conclusion

Like so much in infrastructure investing, focus, prioritisation, and rigour pay off. This should extend to conscious, tactical planning for how you will convert your findings into negotiation positions, and into robust and enduring contract language.

You can differentiate yourself through your discipline to securing value from your intelligence: mapping findings to levers, levers to tactics, and tactics to specific drafting outcomes. Attending to negative space as well as positive risk. Using contracts to shape how the JV will behave, not just what it will do. And, where possible, building in the flexibility that long-lived assets will inevitably require.

The value of good diligence lies not just in the report. It is in what you do with the intelligence.

A Tactical Checklist: Converting Diligence Findings into Negotiation Actions

Each of these are interesting topics in themselves. I intend to follow up with future insights on each in due course.

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