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Understanding Integrity Risks in Mergers, Acquisitions, or Divestments

THE CHALLENGE

The energy industry is characterised by large investments, major technological challenges, and significant commercial and political complexity, exposing owners to financial, safety and environmental risk. It is well understood that a degree of diligence, whether at portfolio, project or asset level is required to quantify this risk and ensure that both the vendor and buyer are protected from any nasty surprises or hidden liabilities.

Moreover, there is a recent trend of divesting aged assets to ‘new era’ operators who promise to operate a leaner, more commercially viable business model for asset life extension. This has invariably resulted in capital intensive assets changing hands and receiving a new lease of life at what would otherwise have been the end of their design life. The question is, do traditional approaches to environmental and financial due diligence recognise this?

I was lucky enough to ponder these questions during a recent integrity assessment of a chemical plant for one of our customers. The purpose of the audit was to review significant integrity risks at the facility as part of an investment transaction. But is this approach typical of how due diligence is done? Here are some thoughts to consider before ‘going MAD!’

WHAT DOES DUE DILIGENCE MEAN AND WHAT DO WE ASSESS?

The concept of due diligence is far from new. The legal term originally comes from the USA, where the process is referred to as ‘reasonable investigation’ in the US Securities Act of 1933. Due diligence in commercial transactions has also been going on long before that. The interesting thing in my view is that the process is usually interested in financial and legal liabilities, rather than demonstrating the performance, reliability, and integrity of physical assets. The reality is that both are needed.

Forbes [1] published a summary of the most significant legal and business due diligence activities the buyer will undertake in a typical M&A transaction involving a privately held company. Despite an extensive list of 21 requirements and expectations, the concept of asset condition gets little more than a passing mention, recommending that the purchaser satisfies themselves as to ‘the condition of tangible assets’ without further guidance as to what that means, and how the purchaser may satisfy themselves that the major capital equipment items have an adequate and quantified remaining life.

The facility I visited recently consisted of several aged storage tanks and production vessels that if they failed, would have rendered the plant effectively inoperable. Thankfully both the operator and the investor understood this challenge and the scope of the due diligence audit was focussed heavily on physical integrity demonstration of these items, and the possible risk of a major repair / replacement programme.

THE SKILLS AND EXPERIENCE OF THE DUE DILIGENCE TEAM ARE CRITICAL

If my theory that due diligence processes have typically been seen as an accounting or legal transaction is correct, then the team make-up and third-party providers are often dominated by accountants, financiers, and lawyers. The problem is that a single discipline does not have all the answers – the accountants are not engineers and vice versa. Some of the most successful due diligence assessments I have seen comprise teams with both. Site-based inspection and engineering review by skilled discipline engineers can competently assess asset condition and remining life, while the financiers can bring this to life with capital projections for ongoing operations, reinstatement / insurance costs and a quantified decommissioning liability.

WHAT CAN THE ENGINEER BRING TO A DUE DILIGENCE TRANSACTION?

Anyone considering a due diligence project should ensure that the team they appoint can competently:

• Physically inspect and provide an accurate engineering assessment of current asset condition
• Provide detailed fitness for service assessments of known defects
• Provide technical guidance on mechanical damage and corrosion mitigation in aged assets
• Estimate remaining life based on an in-depth identification of current and future damage mechanisms
• Provide risk-based guidance and practical operational knowledge on the operation, maintenance, inspection, and repair of such assets
• Assess the management systems, procedures and technical codes that have been applied to the asset in the past and review the suitability of these for the future

Please feel free to contact us if you are MAD for a discussion on how AIE can deliver expert and independent engineering analysis to your due diligence transaction.

Learn more about our MAD approach and how we assess due diligence.

 

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REFERENCES

[1] https://www.forbes.com/sites/allbusiness/2019/03/27/comprehensive-guide-due-diligence-issues-mergers-and-acquisitions/?sh=38d383ab2574