Maximize an M&A transaction’s value by scrutinizing operating expense

There is a lot to consider when approaching an M&A deal, regardless of whether the deal is strategic or purely financial. Often overlooked in this equation is business costs analysis for day-to-day operations, which includes utilities.

“When looking at an M&A deal, the first things we look at are utilities and the costs to operate a facility,” says Roger Zona, president and founder of TPI Efficiency. “In some instances, these can be the largest business expenses outside of payroll. Understanding operating costs and the underlying agreements can often make or break a deal.”

Smart Business spoke with Zona about negotiating operating expenses as part of an M&A event.

Why are operating expenses important to an M&A deal?

Manufacturers, for instance, have a large portion of monthly expenses tied-up in their energy costs. For some industrial businesses, the energy they use in production can represent as much as 70 percent of all expenses. That makes negotiating for the best rates critically important.

What should a buyer do once it is discovered operating expenses are out of line with current market rates?

Look at utilities, telecommunications, copiers, even cleaning supplies. Any large recurring expense should be scrutinized. If current operating expenses are poorly aligned with market cost, the M&A deal should be structured to exclude previous contracts. Ideally, the buyer will add a line item to the purchase terms giving them the option to exit any established contracts at their discretion. If that can’t be accomplished, the deal will need to be scrutinized much more intensely to compensate for the burden of poorly negotiated agreements.

Another important area to explore relates to preventive maintenance and service contracts. If these agreements are not in place or have expired, life expectancy of the equipment should be questioned. Failure to properly maintain equipment can reduce operating efficiency dramatically, reducing longevity by greater than 50 percent.

What can potential buyers learn about a company by studying its operating expenses?

Scrutinizing utility contracts and other large recurring monthly expenses can uncover patterns of behavior and how the owner approached other aspects of the business — whether they were reactive or proactive, for instance.

With long-established companies, it is not uncommon to find cooperative or noncompetitive agreements in place because of the relationships of previous ownership or management with a vendor. The new owner doesn’t have loyalty to those vendors, so there’s no need to pay more because of someone else’s previous cooperative relationship.

The discovery of poorly negotiated contracts should raise red flags, encouraging a buyer to dig deeper for other overlooked areas that could haunt their balance sheet.

Who should be involved in examining operating expenses during an M&A deal?

Utilizing consultants familiar with operating agreements along with your legal and accounting team is always advised. Experienced consultants that know what they’re looking for will bring your attention to caveats and offer great assistance during the discovery period. Additionally, a consultant can often help reduce your accounting and legal fees by pointing these teams in the right direction.

Ultimately, it is important to understand all contracts associated with an M&A deal. It can help a buyer understand how the business was run previously while giving an indication of the business’s true value. Without such scrutiny, a buyer may believe he or she is making a good deal. The reality, however, is that the buyer is underwater from the start.

Insights Energy Solutions is brought to you by TPI Efficiency Consulting

Fixed all-in contracts for energy have proven costly to large consumers

The energy buying strategy most manufacturers and large energy consumers use to save money, ironically, can be more expensive.

“Energy can be purchased in a variety of ways,” says Karl Shaw, COO at TPI Efficiency Consulting. “Most often it’s purchased at a fixed price for every kilowatt hour of energy. The approach might work for a pizza shop, but not for a manufacturer whose energy spend is a sizable portion of its annual expense budget.”

According to Shaw, manufacturers with a fixed pricing strategy are committing to a price for energy and capacity costs for the next two to three years.

“What these buyers fail to do is use market signals to purchase energy as they would other commodities to get better prices.”

Deregulation of the electricity industry a few years ago expanded the available energy suppliers from one to nearly 100. Now it’s possible to use advanced energy purchasing strategies as a cost-saving mechanism. Most manufacturers aren’t aware these choices exist.

Smart Business spoke with Shaw to learn more about advanced energy purchasing strategies and the impact they can have for large energy users.

How effective is fixed pricing as part of a cost-saving strategy?

Between 2010 and 2015, a fixed price contract was usually the most expensive way to purchase electricity. Locking in a fixed price left companies no way to capitalize on future declining prices. Manufacturers ultimately spent between 10 and 15 percent more on electricity bills.

What are advanced buying strategies and how can they help customers using 1 million kilowatt hours or greater annually?

Among the advanced buying strategies, one of the simplest but often misunderstood, is called ‘block and index.’ The strategy involves buying a portion or block of energy based on the percentage of the user’s monthly consumption. The remainder of energy is purchased at spot market pricing. Customers have flexibility with this approach, allowing them to capitalize on market dips and lower costs over the contract term. They also take advantage of cost savings from demand reductions initiatives such as LED lighting upgrades, HVAC or efficiency projects.

How are advanced buying strategies implemented? Should they be managed internally, or is this service better outsourced?

Implementation is simple. There are minimal contracts to execute with the supplier. Choosing when to buy based on seasonality or market trends is more difficult. It requires a full-time staffer monitoring markets and gathering real-time information.

The approach doesn’t make sense for most companies to execute on their own. This is where working with an energy consultant that monitors the market for thousands of customers is invaluable. Not only do consultants help make purchasing decisions, they also keep users informed of regulatory changes and other issues affecting long-term energy prices.

What misconceptions make large energy users hesitant to employ anything but a fixed-price strategy?

Energy users mistakenly believe there’s more risk with advanced buying strategies. They worry the market will trend up, prices will spike and they’ll lose the opportunity to lock in a low price. These strategies, when informed by an experienced adviser, take all market influences and expectations into account. Purchases are managed to protect the energy buyer during volatile times and take advantage of lower prices.

Exploring advanced buying strategies creates an opportunity to save money on electricity costs. Companies already using an alternative supplier to save money are positioned to easily take the next step and reduce costs by pursuing an advanced buying strategy. It’s a matter of exploring all options instead of subscribing to the simplest one.

Insights Energy Solutions is brought to you by TPI Efficiency Consulting

Illuminating best practices when seeking energy efficiency solutions

Many companies seeking to reduce their overall energy expenses turn to green technologies — LED light bulbs, solar panels, building envelope improvements. But reducing consumption through technology may be a costly solution.

“The first and easiest step toward reducing your energy expenses is to reduce the cost of the power you’re using today,” says Roger Zona, president and founder of TPI Efficiency Consulting. “Companies can reduce their overall costs for energy by 5 to 20 percent simply by negotiating a favorable rate and term.”

Understanding the true baseline of overall energy expenses, he says, is a prerequisite to calculating the potential return on investment (ROI) of green technologies and energy efficiency investments.

Smart Business spoke with Zona about understanding and negotiating operating expenses.

What’s the first step for companies exploring energy efficiency projects?

The first step should always be to clearly define your goals for the project. While reducing consumption may reduce operating expenses — paying for fewer kilowatt hours (kWh) will reduce monthly expenses — it doesn’t account for the cost to implement green technologies, which are great for sustainability efforts but won’t always lead to cost savings.

Even if greater sustainability is the mission, companies are missing a key component in determining which products make the most sense if they don’t first review and make choices that reduce their base energy costs. Once a company’s energy costs are the lowest they can be, then it can be determined which technologies make sense to accomplish company goals.

How are baseline costs established?

Establishing accurate baseline costs can be tricky and time consuming. It requires identifying accurate hours of operation for each facility, a general understanding of how much energy each facility’s fixtures and appliances should be consuming based on operating specifications, a concrete knowledge of the company’s energy rates and all its components, and the energy contract terms and conditions. All of these items can be hard to define and sometimes complicated to interpret, which is why businesses typically utilize a consultant when developing these baseline figures.

The most important information to define with electricity before evaluating the financial viability of energy efficiency technologies is the ‘all in’ cost per kWh. That’s done by taking the total electricity invoice charges divided by the number of kWhs used in that particular billing cycle.

Why is establishing this baseline through the examination period so significant?

Companies should not commit to an investment in efficiency technologies without knowing they’re being as efficient as possible. Faster-evolving technologies require a shorter ROI period. LED lighting technology, for instance, is changing about as fast as the next version of the iPhone. If the ROI periods are longer than five years, the technology will have improved greatly in that time, which will reduce the relative cost effectiveness of the investment.

How can companies align green technology investments with their businesses goals?

When an organization is reviewing energy solutions with the goal of reducing overall expenses, green technology investments tend to jump out as a quick fix. If a company is paying 14 cents per kWh, solar panels may reduce consumption enough to become a viable solution for reducing total energy expenses long term. But if a company could simply reduce the cost per kWh to 10 cents or less, solar paneling may no longer make sense if overall cost reduction is the only goal.

What should companies understand before making an investment in green technologies?

Companies that have green initiatives as part of their company mission may have a different threshold on ROI than companies simply looking to reduce operational expense. It’s never wasteful, however, to reduce operating expense before determining which green technology to invest in.

Insights Energy Solutions is brought to you by TPI Efficiency Consulting