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  • 1. Business Valuation & Synergy Trap Session 4 Abhimanyu September 13, 2009
  • 2. Other Approaches Business Valuation
  • 3. Methods • Market Approach – Current Market Prices, Historical Market Prices, Price to Earnings, Price to Revenue, Price to Book Value, Price to Enterprise Value • Comparable Transactions/Relative Valuations – Comparable International and Domestic Transactions. • Sum-of-parts Method September 13, 2009 Corporate Restructuring | Session 4 3
  • 4. Market Approach • Key issues – Representative comparative companies – Time period – Variables to be considered • Among the common variables used are – P/E, P/BV – M-Cap/Revenue, M-Cap/EBIDTA • Important to compare apples to apples September 13, 2009 Corporate Restructuring | Session 4 4
  • 5. Comparable Transactions • Key issues – Representative comparable transactions – Time of consummation – Applicable markets and their dynamics • Usual variables – EV/Revenue, EV/EBIDTA – P/E, P/BV • Important to segregate and eliminate company specific premiums and discounts in the valuation September 13, 2009 Corporate Restructuring | Session 4 5
  • 6. Sum Of Parts Method Land Parcel 100 acres EPC Company With All Own Equipment Toll Road Under BOT New Venture Into Generating Toll Fees Nuclear Energy September 13, 2009 Corporate Restructuring | Session 4 6
  • 7. Sum Of Parts Method Land Parcel 100 acres EPC Company With All Own Equipment Asset Valuation (FMV) Asset Valuation (FMV) Revenue Generation Potential Add Company Premium/Discount Toll Road Under BOT New Venture Into Generating Toll Fees Nuclear Energy Discounted Cash Flow Negotiated Depending on Stage of Development September 13, 2009 Corporate Restructuring | Session 4 7
  • 8. Sum Of Parts Method Land Parcel 100 acres EPC Company With All Own Equipment Asset Valuation (FMV) Asset Valuation (FMV) Revenue Generation Add SCRP, Liquidity Potential Add Company Premium/Discount Premium & New Venture Into Toll Road Under BOT Control Generating Toll Fees Nuclear Energy Premium Depending Discounted Cash Flow Negotiated on Stage of Development September 13, 2009 Corporate Restructuring | Session 4 8
  • 9. The Synergy Trap Acquisitions & Their Pricing
  • 10. The Synergy Trap • Essentials for an Acquirer: – Should not pay “too much” – The deal should make “strategic sense” – Corporate cultures need to be managed carefully • The problem is: – How do we predict up front whether a company is overpaying for an acquisition? • Acquisitions are capital budgeting decisions September 13, 2009 Corporate Restructuring | Session 4 10
  • 11. The Synergy Trap (Contd.) • Dreams of synergy may lead to lofty acquisition premiums. • A quantifiable post-merger challenge is embedded in the price of each acquisition. Higher the premium, greater is the challenge. • Using the acquisition premium, we should be able to calculate what the required synergies must be. • This calculation may often show that the required performance improvements are far greater than what any business in a competitive industry can reasonably expect. September 13, 2009 Corporate Restructuring | Session 4 11
  • 12. The Synergy Trap (Contd.) • A McKinsey & Co. study found that 61% of the acquisition programs were failures because the acquisition strategies did not earn a sufficient return on the funds invested. • A BCG study found that during the pre-merger stage, 80% of companies did not even consider how the acquired company would be integrated into operations following the acquisition!! • Thus, a bad acquisition is one that does not earn back at least its cost of capital. September 13, 2009 Corporate Restructuring | Session 4 12
  • 13. The Synergy Trap (Contd.) • When an acquirer pays acquisition premium, he/she has two business problems to solve: – to meet the performance targets the market already expects; – to meet the even higher targets implied by the acquisition premium. • Hence, Synergy can be defined as “increases in competitiveness and resulting cash flows beyond what the two companies are expected to accomplish independently” September 13, 2009 Corporate Restructuring | Session 4 13
  • 14. The Acquisition Game • Acquisition is a business gamble where the acquirer pays up front for the right to control the assets of the target firm and earn, hopefully, a future stream of cash flows. • But while the acquisition premium is known with certainty, the payoffs are not. • NPV (of playing the acquisition game) = Synergy- Premium. September 13, 2009 Corporate Restructuring | Session 4 14
  • 15. Losing In The Acquisition Game • When Novell acquired WordPerfect for $1.4bn, they did not calculate what WordPerfect was already required to accomplish given the first bid for WordPerfect by Lotus for $700mn. • Novell lost $550mn of market value on announcement of acquisition. • Microsoft has, since then, continued to gain market share and ultimately Novell sold WordPerfect (less than two years after acquisition) to Corel at a loss of over $1.2bn! September 13, 2009 Corporate Restructuring | Session 4 15
  • 16. Empirical Evidences of Acquisitions • Some studies concluded that related acquisitions were better than unrelated acquisitions; • Some show that unrelated acquisitions were better than related acquisitions; and • There is a third group which show that the relationship just did not matter! • But most of these researchers assumed that acquisition prices are highly correlated with potential value. September 13, 2009 Corporate Restructuring | Session 4 16
  • 17. Problems with Past Research • Because many researchers have assumed that the premiums represent fair prices in the beginning, a failed acquisition was dubbed as the result of “managerial problems” such as culture clashes, leadership failures etc. • The practical problem with this approach is that it does not realistically address whether the acquisition strategy could have worked even in the absence of implementation problems. • It is wrong to assume that if the management problems were not there, all or any of the synergy promised by the premium would occur. September 13, 2009 Corporate Restructuring | Session 4 17
  • 18. Post-Acquisition Integration • Nelson and Lagges, Principals with A. T. Kearney advised, “During the first year, it is important to combine two cultures and organizations, but it is fatal to get bogged down in heavy operations integration. Start out by picking the low hanging fruits.” • However, it is observed that for an average acquisition premium of over 40%, it is crucial to understand that the possible performance improvements should also be worked out initially. This is because each year of delay would cost heavily! September 13, 2009 Corporate Restructuring | Session 4 18
  • 19. Justifying Acquisition Premium • The synergy (or Required Performance Improvement) as indicated by the acquisition premium has to be estimated up front. • The process of such estimation would show how difficult it is to justify the premium! • Any delay in realizing synergy would further put the acquisition premium at risk. September 13, 2009 Corporate Restructuring | Session 4 19