The common expectation for all merger and acquisition deals is that the combination will increase shareholder value for the acquirer. Ironically, many M&A deals fail, destroying shareholder value instead of creating it. It can be very difficult for company boards to determine whether a deal is worthwhile.
Prioritizing a disciplined, thorough valuation analysis is critical to help boards identify and avoid bad deals and guide them through negotiating and structuring deals that make better financial sense.
Assume a public company has identified a potential target. The target operates in the same business and serves similar customers. The expected cost savings may be compelling given an overlapping distribution network and because staff redundancies can be eliminated from the acquisition target. This is a classic example of a synergistic deal.
Establishing Acquisition Target Value
The first step in the valuation process is to establish the market value of the target without regard to buyer-specific synergies. Although acquirers are ultimately interested in analyzing the valuation of the combined company, establishing the market valuation of the target on a standalone basis should be done first for two reasons:
- To provide perspective on a baseline valuation the board of the target company might expect to realize.
- To establish a reference point the buyer can analyze and evaluate how much synergy it brings to the table.
There are several generally accepted approaches for establishing the value of an acquisition target. For this exercise, assume the acquisition target is a private company.
The two most common approaches for private companies are discounted cash flow, comparable company and comparable acquisition analyses. The financial advisor will triangulate the various pricing indications to establish an overall baseline valuation range for the target, serving as a useful benchmark to the acquirer in determining a preliminary offer value. For additional detail on the valuation approaches, read more here.
Establishing Acquirer Value
The next phase is to assess the value of the acquirer pro forma for the acquisition. This is different than the market valuation analysis because the review is done from the perspective of a specific buyer and what the value of the acquisition is to that specific buyer. This value may be different for each potential buyer in the market, with the most highly synergistic buyer able to offer the highest purchase price.
There are many factors to evaluate before determining the viability of the deal:
- Amount of expected synergies
- Costs associated with realizing those synergies
- Amount and type of purchase consideration
- Trading multiples for the acquirer’s stock
The acquirer is in a good position to negotiate with the seller after establishing both the market value of the target and the value of the target to the specific buyer.
No board of directors goes into a deal with the intent to destroy value, and yet that happens in many deals. In many instances, a greater emphasis on a disciplined, thorough valuation analysis, as outlined above, can make the difference in helping a board of directors make the right choice.