1. M&A’s overlooked Pitfall
“The False Negative”
Usha Rani J(15/060)| Anshul Kumar(15/071) | Dwip Sengupta (15/086)
Group 14, Sec A, MACR

2. Bank X’s Valuation Plight
Lost  series of lost bids to key competitors in a consolidating industry
Practices setting of maximum price based on DCF
Opportunities
Point of Concern: Did the management lack the courage to make deals? Or did
the analysis miss some important factor?
Recent Failure Had gone after the local assets of a struggling global player
Bid $800Million and was outbid by $40Million by rival
Detailed financial models were constructed, all synergies considered
Implication Possibility: deal being undervalued – Pitfall of FALSE NEGATIVE
Alternate Implication: The firm did well by being outbid
How can an acquiring company feel more confident that it is systematically
not undervaluing transactions?
With the continued reliance on acquisition as an engine for Corporate Growth, it is necessary
to evaluate deals in a way that reveals a more complete and accurate value

3. Theme: The False Negative
The False Negative M&A Pitfalls The False Positive
Deals that get away Deals that should not have happened
Is looking at the current core operations(as practiced by Bank X) enough to find the value of the target?
Answer: NO
Valuing the full potential of a target
• will avoid the false negatives
Considerations
for Success of
Combination of two frameworks to avoid false positives & false negatives
M&A
• Three Horizons Strategic Model (done by Mc Kinsey)
• Opportunity Engineering
Other Considerations
Integration into buyer: Cultural, processes, management etc
Pressure to make deals pay off quickly

4. Three Horizon Model
Strategic Horizon 3
planning in Represent the opportunity for future growth
Show great promise but are uncertain
three time Suffer a high mortality rate & may not turn commercially viable
horizons
Horizon 2
Represents operations generating fast growing revenue
Profit
No large contribution to the current profitability
Potential to become H1 operations in the medium future
Horizon 1
Current Core Operations of a company
Produces cash flows to sustain operations & invest in growth
Time
True value of a target can be determined only when the future potential along with
current core operations is taken into consideration

5. Methodology
• Assign the assets of the firm into horizons(H1, H2,
H3)
• Value the assets
– Represent three different time frames and uncertainty
and so are to be valued differently
– H2 and H3 have higher levels of uncertainty and so NPV
is not enough to value
• Opportunity value(OV) captures the potential with range
estimates
• OV provides a positive view and NPV a negative view and a
combination will be a balanced approach
• Not a traditional approach but intuitively done
“More horizons a target reaches ,the stronger and
more valuable it is”

6. Valuation: incorporating Future Potential
• H1 assets
– Generally straight forward and can be done using discounted
cash flows (NPV)
– Appropriate as there is little uncertainty
• H2 assets
– Could be done using estimates
• But discounting using higher rates or cutting cash flows is done
– But uncertainty might also result in windfall (OV)
• Not captured by NPV
• H3 assets
– Calculated entirely using OV
– Also Abandonment value (AV)-selling part or full
• Can be valued as a put option-online option pricing method
• Total Value=NPV+OV+AV

7. Bank X’s Mistake: The False Negative
The Bank X had the option of selling of the target if the things didn’t go well
Even selling the target at a loss had a value because Bank X would get some of
its investment back
If the Bank sold off the target at $500 million (Purchase price of $800 million),
Abandonment value (AV) is created. In this case the AV can be calculated using
online option pricing calculators that value financial put options
The AV on selling of the target at $650 million would be roughly close to $49
million
Using this $49 million, raising their target price to $849 million from the current
$800 million, it would have eclipsed the $840 million (the winning bid)
The major problem was exclusive reliance on the NPV method . This caused Bank X to
overlook or underestimate the potential value hidden in the target’s H2 and H3 businesses