To some, this may appear as a rather precarious discussion to have, as what we see thru the media does not always depict a full story. And there’s almost always several sides to the Iran chronicle.
Nevertheless, one can gather from the gist of the current news and media that Iran is bracing itself for significant change. No doubt, the country is seeing the brunt of it right now. But inevitably, Forex rates may in fact start to stabilize soon-which is always an encouraging sign for economic development.
Promises & bravado aside, foreign stake and ownership have truly become more transparent and realizable. FIPPA (Foreign Investment Promotion & Protection Act) provides clear and easy to follow guidelines for company setup, delivers protection against expropriation and nationalization, and simplifies & accelerates repatriation of profits and capital abroad. Hence, despite the momentary cold feet that many multinationals are experiencing, there is no doubt in anyone’s mind that M&A opportunities in the country are immense. Whether your business is focused on agriculture, mining, hospitality, healthcare, energy, technology, or MTS/MTO manufacturing, there are certainly opportunities for the taking. And more often than not, these opportunities appear to be worthwhile to pursue.
Moreover, Imports have practically become redundant; in fact, it is quite surprising why imports ever worked in the first place. The fallout from imports has always been damaging and risky ie: limited forex options & international credit terms, LC and wire transfer restrictions, logistics, Days in Inventory (DII), Out of Stocks (OOS) etc. The list goes on. In addition to bureaucracy and red tape associated with customs and clearance, high duties, and most importantly logistics and Cash Flow Cycle Time have all been undeniable hindrances to imports, let alone a deterrent. Which is all the more reason why local manufacturing is the logical approach for any multinational or multilocal.
Consequently, as previously mentioned there appear to be a plethora of M&A prospects in the country, and this in part due to the fact that the country has been shunned for many years, particularly by major multinationals who could under normal circumstances provide a boost to the local economy and businesses within.
On the hindsight, the past several years have proved to be a windfall for many local businesses who have faced minimal challenge from competitors; and in essence, have had an open road to success.
Examples are FMCG dynamos, some of which operate more than 3000 distribution vehicles, but who are yet to recognize methodical and financial implications of applying elementary KPIs such as Time to sell, Drop Size, DII, Truck utilization and the likes. As a result, a dearth in challenging competition has only wired local firms-some gradually being morphed into formidable powerhouses-nonetheless, often running wild, handling the customer and consumer with little or no reverence, and basically doing what they please.
So, what could motivate a local business to consider a M&A? Afterall, with all this autonomy and unconventionality, there seems to be quite a lot of money-spinning going around. Why would anyone in their right mind even consider joining hands, or even contemplate selling a well-oiled cash machine?
In fact, the rational could be remarkably simple and ingenuous. Sharper business minds, of course have little doubt that a turnaround is imminent; there are a multitude of reasons for this conviction—socio-economic issues topping the list. But even traditional minded business owners fully recognize that the country has been deprived and shirked for many years. And not just referring to roads and infrastructure; rather, all the knowledge and principally Industry Best Practices that have been left unexpressed and contained by multinationals.
Hence, smart entrepreneurs have little doubt that upending the competition and maintaining an edge will require immediate and sustainable change. This superiority, however, can only be possible upon the adaptation and successful implementation of relevant industry best practices—something local companies have not been adequately exposed to for quite some time.
With this prelude, let’s take a closer look at some of the risks and challenges associated with the M&A process in Iran.
Identification and Analysis: Assuming we have engaged in some preliminary exploration to identify M&A candidates—whether having been approached directly or surveyed the market for potentials, and before taking the decision to look at Top-Line or Bottom-Line numbers, it is critical to note several key characteristics of Iranian businesses:
First, due to the prolonged dispossession and inability by companies to invest, this new Capex spending binge is by no means short term, as many companies have only recently begun to invest in new machinery and equipment. Existing equipment are either outdated, capacity capped, or in derelict shape due to extended usage and inappropriate maintenance; the latter being a direct consequence of heightened sanctions.
As a result, many FMCG companies have to a great extent become capital intensive. Even in the event that companies manage to successfully acquire machinery necessary to fuel growth, many are still chapters behind their successful overseas foes, and will have to continue investing in more advanced manufacturing and particularly packaging technology, just to reach parity with multinationals or other regional competitors.
Hence, analysis of EBIT or EBITDA will not get us very far at all. In fact, even a FCFBT analysis may only cover small grounds, as we have yet to uncover the true effects of ROIC and the trends over the years which affect our cash flow. Naturally, once we have a closer and more cognizant view of the above, we should be able to confidently propose a more realistic EV for the business, and even possibly include a transaction premium where necessary. To summarize, it is crucial to get our finance specialists to work in collaboration with the seller’s team. This will undoubtedly deliver a closer and more diagnostic look at the trends, which will in turn enable us to rather contentedly distinguish simulated prospects from golden goose money makers—and fortunately, the latter are a plenty. We’ll touch on Valuation, and Valuation Adjustment risks and options later on. But first, let’s take a quick look at Due Diligence routes.
Due Diligence: Contrary to the common belief, DD should not prove to be a heinous task after all. At least one of the big four audit firms (EY) has an active presence in Iran, and another operates in affiliation. Naturally, this will create a more consoling environment for finance individuals who may sometimes undesirably get immersed in hair splitting attention to detail.
Nevertheless, here are several grey areas which should be attended to with care:
Authentication and Valuation of Assets has always proven to be a delicate and sometimes scheming task. However, since the nationwide centralization of real estate deeds into an integrated national network in 2021, authentication of assets and their status has become routine and free of fraud.
Accordingly, Valuation has grown into a more simplified task and price comparison is easily achievable.
Crucial to note that companies regularly adjust book value of assets to account for inflation and real estate price increase; hence, utilizing the services of a reputable audit firm is nonpareil in order to ensure that price adjustments are per market norms, and verifiable.
Financial Statements: Many companies have made the decision to switch to single book accounting—although for those who opt to keep a second set of books, it does not necessarily refer to any illegal practice, and they may be simply retaining two books in order to ease preparation of management
accounts vs. official. However, almost all companies are using one or possibly two well established ERPs or integrated software to maintain and generate data. And regardless of whether the software is operating under web or directly via decentralized servers, access to data is generally single source and easily verifiable. Goes without saying that a warning sign is what we could refer to as LDI (Low Data Integrity); that is when a company claims to have two sets of accounting books and no record of their official numbers which they claim on the M&A financial statements.
Whilst performing DD, some audit companies determine to temporarily place auditors on the ground over a specified period of time. In essence, when related to FMCG companies these auditors make a daily count of trucks exiting company warehouses. If required, these numbers are then extrapolated to compare with projected assessment of sales volume; naturally, seasonality is almost always factored in.
Though this may appear to be a cumbersome task, in principle it provides significant information and validity. Similarly, access to accounting records such as daily cash, checks and DSO, procurement contracts and DPO, and inventory levels are sometimes performed in a similar manner to the above—by temporarily stationing auditors on the ground and comparing actual transactions with ERP records.
Legal and Taxation DD is relatively less problematic, as any possible damages may be shielded thru well thought out Warranties and Indemnities clause. Noteworthy to add that warranties and indemnities are not widely employed in Iran, and sellers may be wary of and frown upon the idea.
Nevertheless, most M&As in Iran will probably be comprised of share sale rather than the sale of assets; hence, warranties should be as extensive as possible to cover all aspects of the business. As common practice, we must make all attempts to avoid reducing seller warranties and compel the seller to flush out material and intelligence which has not yet been revealed. Additionally, we should push for Indemnities, particularly for those contained in disclosure letters received from the seller.
Whether the seller is entirely opting out of the business or choosing to remain a shareholder, typically, they will want to take some of the recently acquired cash and invest in other areas of focus. Accordingly, employing escrow accounts, which are largely unheard of in Iran will be extremely difficult to enact.
However, other viable options are available which could be presented by the auditors—commonly, the use of inland bank guarantees or real estate deeds are an acceptable norm. With regards to real estate deeds, it is important to have the entire deed or a relevant portion signed over to the buyer and notarized at a public notary. Considering the accuracy of real estate valuations and the predominance of similar transactions, this is an adequately safe option we should accept with open arms.
On the surface, Operational DD may pose as one of the most grueling tasks; but far from impossible when performed thoroughly. Specifically for FMCG M&As, it is critical to get a scrupulous involvement from Ops teams on both sides.
Naturally, once the new organization is up and running, all efforts will be put in place to improve productivity throughout. Implementation of best practices should be at the center of all priorities, restructuring will be an imminent aftermath, and cost savings will be anticipated thru all modules.
Nevertheless, it will be extremely helpful if we have a thorough understanding of frontline operations activities. Bear in mind that sanctions have had a direct and negative impact on supply and logistics; hence, incongruence is expected throughout. But it is important that we predict a timeline, and understand how soon we are able to fill in the gaps in order to ensure there is a smooth operation, post signing.
For starters, we need to identify whether or not there is an ERP in place, or if we are using an MRP at the plant level which is harmonized with other sales and finance software. Do we have written SOPs? Do we have hourly production recordings or an end of shift compilation report? The former being crucial, particularly if at some point in time we are aiming to impose Pareto Analyses, separately analyze operations and technical downtimes, and capture unaccounted production time. Do we have SMS communication/advisory for logistics notifications, such as gate traffic, dock time & dispatch, and arrival of raw mats? Though a vast portion of Operations issues will be addressed in detail during the transition phase, ignorance is certainly not the right approach. Fortunately, local companies are always excited to boast about their achievements, and will have minimal objections when it comes to glamorizing their feats.
Furthermore, it is critical to recognize that one of the biggest challenges is maintaining desired inventory levels. When market is cash driven, supply and demand are to some extent reversed—and this retrogresses back through the entire supply chain.
So, we have to get key stakeholders involved in the process; over communication in its most expressive & consequential form, alongside slightly expanded and augmented delegation matrix. And with the aid of MRP developer devise Live SMS advisory at manufacturing plants in case non is in place.
Thus, it is all the more important to sink our teeth deep into the operations and request as much information as possible. Bear in mind that operations initiatives which some of us take for granted, may only be touched at the very surface, as managers tend to prefer reviewing macro vs micro details.
The same level of prudence could be applied to other modules, including sales and HR. For example, to locals HR is mostly Admin and GR; employee contracts, and so forth. Granted, HR has made tremendous progress over the past 10 years, and this is evident in large and small organizations alike. Centralization of HR function, devising designations & grades and using HRIS local software are all accomplishments which have been well undertaken. Even tasks such as Recruitment, Budgeting & Planning, Employee Induction & Orientation, Training & Development and Employee Retention have experienced improvements.
Nevertheless, when it comes to more intricate HR involvements such as performance development reviews, balance scorecards, career development plans, and even multiskilling at the factory floor, though not implying that they’re non-existent, they are rather stroked at the very surface.
Even multinationals who have had a sturdy presence in the country have generally managed high level HR from regional offices outside the country. Thus, top notch caliber and competence essential to running such magnitude and potential of a market has not always been exploited to the fullest.
Moreover, due to sanctions and a fear of OFAC, reviews and supervision of the market in some cases, may have been trivial and shallow—where senior managers prefer to look at macros only, and stay away from anything they fear ‘Legal’ could frown upon. Naturally, in Iran’s sanctioned environment, opportunities and options have become rapidly restricted and regulated, and Legal departments have moved into the spotlight as every decision seems to have started to revolve around them. Ultimately, some businesses whose dealings encompass multinational or oversees partners, have had to abruptly undertake new rules and regulations, some falling under an entirely different set of codes. During this evolution, adhering to structure has sometimes become unwelcome.
As a result, accountability is often harder to come by, and this is a caveat which can be sensed within different modules of many local organizations.
Having said that, for those of us who almost always see the glass half full, we can only envision opportunities. And we’re talking about vast unchartered territories where a progressive multinational executive will only eat for breakfast. Specifically referring to HR, and in preparing the organization for the transition it is a good idea to obtain an in depth understanding of existing practices.
We’re not only referring to introducing appraisals—9 Block Grid, Balanced Scorecards, Succession Planning and Accountability—but most importantly, enhancing team caliber by recruiting, training and retaining key functional talent for positions which were previously concealed with no accountability.
On a positive note, literacy and education in the country are quite impressive, with 55% of the work force comprised of women, and an almost comparable number of university graduates being women … talent is a plenty; and if one has the slightest affinity with the culture, they’re soon to notice that learning capability and even competence is effortlessly at par with the immediate region—MENA.
Therefore, tasks such as designing work flows to develop dependency with other departments, creating respect for each other’s work and ultimately achieving mutual trust should be at the top of HR’s to do list.
But dependency is only good if we can safely maintain regular spot audits, as too much reliance may sometimes lead to team fraud and racketeering. And though local understanding of Internal Controls, is Internal Audit (the former generally being unavailable), setting up a solid Compliance Team who possess an unyielding attitude towards auditing and SOP integrity, can’t be stressed enough.
Innately, Valuation and Valuation Adjustment techniques will be attended to by our finance experts. But regardless of whether they propose Market Capitalization, DCF (Discounted Cash Flows) or simply an analysis of Book Value, it is still essential that we take several fundamental steps to mitigate our investment risk. And in any event, our final Valuation is subject to satisfactory results of the Due Diligence.
Given that the functional currency of most transactions will be the Iranian Riyal, The Purchaser is ultimately agreeing that it is investing in a local Iran business which strictly operates on the local currency. Consequently, and irrespective of the US Dollar/Euro estimate of FCFBT (Free Cash Flow Before Tax) or other valuations, Seller is committing to deliver results denominated in IRR (Iranian Riyal) as per financial documents submitted to Purchaser; and this is sometimes prone to deterioration, given inflationary nature of the economy.
But again, there is no reason to fret on the subject. First, most reputable businesses in Iran tend to somehow correlate IRR budgets to projected and conceivable USD/Euro bottom line numbers. This, of course is conventional practice. The point for contention, however, is whether profitability projections are reliable and in harmony with inflationary trends. Naturally, our finance experts should utilize their sharp-edged proficiency and knowledge to wrangle with the seller, dispute and mitigate risks.
Additionally, our legal team can draft a Valuation Adjustment clause within the Heads of Terms accord, which can later be instated into the share purchase agreement. For example, on FCFBT valuation we can include a clause for a pre-agreed percentage deviance from Max and Min FCFBT over a certain number of years after closing of transaction, whereby downward adjustment is calculated and paid by seller to buyer, and vice versa for upward adjustment. Again, we shall leave the calculation technique to the experts; but what’s important is that we have a mechanism in place to safeguard our interests, especially in the unlikely event that assessments for profitability and valuation submitted by the seller are off track.
Undoubtedly, a final agreement scrutinized by finance and legal experts will contain a myriad of safeguards, including loans and indebtedness at time of closing, working capital sufficient to cover all regular business needs in raw materials, supplies and services procured from third parties, and necessary funds to operate the business at the Production Capacity.
Clearly, big risks mean big rewards, and this is precisely why Emerging Markets have always been a lucrative target for multinationals. But the setting may be even more attractive for Iran.
Driven primarily by oil exports and a rise in oil prices, the country experienced considerable growth over the past several years. Moreover, government support to fuel growth, in terms of loans and subsidies has been on-going and has only reached a hiatus due to heightened sanctions. In essence, the transition to a full-fledged capitalist economy started years ago, post conclusion of the Iran-Iraq war, and gradually slackened the years following 2013.
Nevertheless, what many of us may be oblivious to is that sanctions have only had an indirect effect on a small segment of industries—initially, those entirely dependent on imports of raw materials essential to function. However, even the most dependent companies managed to identify contingency plans and escape routes; not necessarily to crosscut sanctions themselves, but majorly in the direction of effectively managing their logistics and particularly cash flow cycle time. Fundamentally, sanctions have mainly affected companies with vital mismanagement issues; companies who did not have the knowledge and/or exposure to attract talent that could provide remedy and alchemy.
Even though foreign investments in Iran economy have been negatively affected, largely due to political uncertainties, there is little doubt that opportunities for the taking are immensely rewarding—perhaps unmatched anywhere else in the region.