First of all, thanks Rohit C for annotating my previous blog on McK Attack!
In this post I am going to document some generic pointers about M&A valuation cases. Please do send your annotations as well.
Problem Statement: Firm A wants to acquire firm C. There is another firm B which also wants to acquire firm C. All three are from cement industry How much should A be willing to pay ?
Approach and Methodology:
Why is this acquisition important?
à The answer should tell you something about the motivation behind acquiring B. It could be any combination of the following
a) Strategic: ex. A will gain access to unexplored markets; A will thwart a future competitor by buying out B (which Cisco often does); A will gain technology which B has developed; A will gain scale which might be an important factor; A may be doing it just because it doesn’t want C to do it.
b) Operational: A may be able to reduce redundancy in distribution, supply or production systems; A may learn best practices from B and use it in its existing factories; A may achieve economies of scope by improving its supply chain to do cross docking of different raw materials (used in A and B)
c) Financial: A may get a lot of tax cover if B is currently loss making or has huge debt
d) Opportunistic: A may just be getting B cheaper due to some distress sale
How will you value the acquisition?
à Value the standalone value of B (target) using
a) Discounted Cash Flow - FCFE, FCF
b) Transactions multiple – comparing with other similar acquisitions that may have happened in the recent past
c) Accounting Multiples
à Value the PV of synergies that may be generated by acquiring B
à Value the PV of losses that you might incur if C acquires B
Add all the three up to get to the maximum value that you are willing to attribute to B.
Further, you should go into the details of the exact sources of the synergies and whether or not they are realizable.
Finally, you should somehow account for the cost of a failed acquisition. This could be accounted for by reducing the expected cash flows in the future. Note that increasing the discount rate is not a good idea for this (think why ?).
Include all the above factors to arrive at the maximum valuation.