Financial management presentation 1

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How to value the synergy in an acquisition

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  • This presentation pre-supposes a lot on the part of the viewer - without even defining who is eligible to view and does not even reflect the truly original points of view about synergy. For a person such as this commentator who was before this ppt quite unaware of the the topic was not able to make out what this ppt is for. Don't take it in other terms but always make your ppts 1) from audiences points of view - explain it that even a two-year old can understand, 2) objectives of the ppt, 3) and be completely original. Some lines seemed coming straight from Wikipedia. Learn, Educate and well, never stop learning.
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Financial management presentation 1

  1. 1. Presented by: Ankit Gupta, 6B Anmol Chopra, 7B Prachi Mukhija, 33B Rumjhum Shukla, 42B Vipul Agarwal, 50B
  2. 2. What is Synergy in M&A Context <ul><li>may be defined as two or more things functioning together to produce a result not independently obtainable </li></ul><ul><li>Corporate synergy refers to a financial benefit that a corporation expects to realize when it merges with or acquires another corporation. This type of synergy is a nearly ubiquitous feature of a corporate acquisition and is a negotiating point between the buyer and seller that impacts the final price both parties agree to. </li></ul><ul><li>This magic ingredient has allowed acquirers to pay billions of dollars in premiums in acquistions. </li></ul><ul><li>Tata Steel paid a 100% premium to Corus Plc market price in landmark 2006 acquistion. </li></ul>
  3. 3. Breaking down the Acquisition Price Acquisition Price of the Target Firm Market Price of Target firm prior to acquisition Book Value of Equity of Target Firm
  4. 4. <ul><li>Operating Synergies </li></ul><ul><li>Allow firms to increase their operating income from existing assets, increase growth or both </li></ul><ul><li>Economies of scale that may arise from the merger, allowing the combined firm to become more cost-efficient and profitable </li></ul><ul><li>Greater pricing power from reduced competition and higher market share, which should result in higher margins and operating income </li></ul><ul><li>Combination of different functional strengths </li></ul><ul><li>Higher growth in new or existing markets </li></ul>
  5. 5. <ul><li>Financial Synergies </li></ul><ul><li>With financial synergies, the payoff can take the form of either higher cash flows or a lower cost of capital or sometimes both. </li></ul><ul><li>A combination of a firm with excess cash (and limited project opportunities) and a firm with high-return projects (and limited cash) can yield a payoff in terms of higher value for the combined firm </li></ul><ul><li>Debt capacity can increase </li></ul><ul><li>Tax benefits can arise </li></ul><ul><li>Diversification (also the most controversial form) </li></ul>
  6. 6. <ul><li>Valuing Synergy </li></ul><ul><li>Quite controversial as synergy is quite nebulous and intangible to be valued. </li></ul><ul><li>But if one is ready to pay a price for synergy valuation is warranted. </li></ul>
  7. 7. <ul><li>But two questions which need to be answered when valuing synergies? </li></ul><ul><li>What form is the synergy expected to take? </li></ul><ul><li>When will the synergy start affecting cash flows? </li></ul>
  8. 8. <ul><li>Steps in valuing Operating Synergy </li></ul><ul><li>Value the firms independently </li></ul><ul><li>Estimate the value of the combined firm </li></ul><ul><li>Value the combined firm with synergy </li></ul>
  9. 9. Valuing Cost Synergies All Figures in lacs <ul><li>Assumptions </li></ul><ul><li>Both Firms have the same cost of capital, expect the same growth in future and earn the same operating margin. The riskfree rate is assumed to be 4.25% and the risk premium is 4%. </li></ul><ul><li>Both firms will be in stable growth after year 5 growing 4.25% in perpetuity and earning no excess returns. </li></ul>
  10. 10. <ul><li>The valuation is done using the DCF framework </li></ul><ul><li>The after-tax return on capital is multiplied with the reinvestment rate to get the expected growth rate. </li></ul><ul><li>After year 5 operating income and revenues are expected to grow at 4.25% which will make the reinvestment rate to be 57.82%. </li></ul><ul><li>Based on this FCFF to firm for 5 years and the terminal value is calculated. </li></ul><ul><li>Further the expected free cash flows are discounted at the cost of capital to get the present value of the firm. </li></ul>All Figures in lacs
  11. 11. All Figures in Lacs. Assume that the combined firm will save 15 lacs in operating expenses each year pushing up the combined firm’s pre-tax operating income by 15 lacs .
  12. 12. Errors in valuing Synergy <ul><li>Subsidizing Target Firm Stockholders </li></ul><ul><li>Wrong Discount Rate </li></ul><ul><li>Mixing Control & Synergy </li></ul>
  13. 13. Dubious Synergies <ul><li>Accretive Acquistions – The PE ratio rationale </li></ul><ul><li>Quick Growth – The Growth illusion </li></ul>
  14. 14. Conclusion <ul><li>Even there is sufficient evidence of synergy in the aggregate across all acquisitions most mergers fail in delivering any synergy. Stockholders usually end up overpaying for synergy in most acquisitions. </li></ul><ul><li>Managerial Hubris </li></ul><ul><li>Bias in the estimation Process </li></ul><ul><li>Failure to plan for Synergy </li></ul>
  15. 15. References <ul><li>http://www.amazon.com/Valuation-Building-Value-Private-Companies/dp/0471411019 http :// www.gazhoo.com/doc/200905172359506671/Synergy+Valuation </li></ul><ul><li>http:// www.clerestoryconsulting.com/mergers/ma-alert.pdf </li></ul><ul><li>http:// www.investopedia.com/university/mergers/mergers2.asp#axzz1ewFXISRL </li></ul>
  16. 16. Thank You Questions?

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