Complete Guide to Building an Acquisition Strategy and Valuation Methodologies

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For a business any business looking to engage in acquisition activity it is critical to understand what your strategy is. Acquisition and investment is more than a financial exercise, there has to be a strategy intent as well.

This document is in three main sections to help formulating an acquisition strategy:

1. Identifying the Acquisition Target and Process
2. Diligencing the Target
3. Evaluating Other Strategic Considerations

Followed by a overview of valuation methodologies commonly used to value targets:

1. Public Market Comparables
2. Merger Market Comparables
3. DCF
4. Pro Forma

This powerpoint is designed to give a good foundations and building blocks for those interesting in learning more about the above techniques.

Published in: Business, Economy & Finance

Complete Guide to Building an Acquisition Strategy and Valuation Methodologies

  1. 1. Acquisition Strategy and Valuation Methodologies
  2. 2. IDENTIFYING AN ACQUISTION TARGET A There are various aspects to consider when searching for an acquisition target Key Aspects of Value to an Acquiror Competitive Advantage • Strong market position through large, stable user base or other competitive edge • Expertise in a particular division or area • Target's strengths can be leveraged throughout Acquiror's organization Important Market Segment Robust Financial Performance • Operates key commercial platform with potential for strong cash growth • Healthy business with track record of strong cash flows and resilient earnings • Market is of key strategic importance in the value chain • Strong top-line growth trajectory • Target's products or services can catalyze growth of Acquiror's existing businesses • Disciplined cost management Access to New Geographies • Target has established positions in new or high growth markets where the Acquiror is not present • These new markets are relatively difficult to expand into organically Ideal Acquisition Target 2
  3. 3. IDENTIFYING AN ACQUISTION TARGET A Aligning Acquisition Strategy to Seller Process Competitive Auction • Formal process with organized disclosure on business sold via information memos and management presentations — Auctions usually have a longer timetable — Higher chance that Acquiror’s interest may be leaked to public • When drawn into a competitive auction, Acquiror can avoid a bidding war by positioning each bid strategically in two-tiered processes — E.g. bid conservatively in first round to learn more about other bidders and preserve valuation flexibility • Acquiror should also conduct an interloper analysis to — Identify potential financial or strategic buyers Negotiated Transaction • Less formal process with: — More flexibility in requesting specific or customized information • Greater access to Target’s management team • In a limited negotiation, Acquiror can: — Push for exclusivity to remove concerns over interloper intervention — Enjoy more room to structure transaction creatively – E.g. Acquiror can decide whether to acquire entire business or carve out specific assets • Limited competition suggests a higher likelihood for Acquiror to capture pre-emptive value — Assess their ability to pay — Estimate rivals’ ability to achieve synergies with Target — Evaluate impact to market landscape if Target falls into competitor’s hands Strategic positioning in a buyside approach can vary significantly depending on whether Seller is running a competitive auction or engaged in exclusive negotiations with Acquiror 4
  4. 4. DILIGENCING THE TARGET B Diligencing the Target entails reviewing the market, financials and the business… Key Areas Details • • Market Overview Size and scope of markets Key economic drivers • Expected regulatory changes that could change competitive landscape • Key competitors — Historical, current and anticipated — Strengths/weaknesses vs. peers • • Historical audited financials • Projected financials and near-term • Variance between historical budgets and actual performance • Capital structure and expected maturities • Marketing and customer acquisition strategy vs. peers • Financials Key performance indicators and expected trends Customer mix — Focus on high or low share customers — Mix of customer demographics Business • Outlook on required capex over next few years — Could changes in technology etc derail those projections? • Cost structure vs. peers 6
  5. 5. CONTENTS 1. Formulating an Acquisition Strategy A. Identifying the Acquisition Target and Process B. Diligencing the Target C. Evaluating Other Strategic Considerations 2. Overview of Valuation Methodologies There are several critical aspects to a well thought-out acquisition strategy for enterprise assets 8
  6. 6. CONTENTS 1. Formulating an Acquisition Strategy A. Identifying the Acquisition Target and Process B. Diligencing the Target C. Evaluating Other Strategic Considerations 2. Overview of Valuation Methodologies There are several critical aspects to a well thought-out acquisition strategy for enterprise assets 10
  7. 7. OVERVIEW OF VALUATION METHODOLOGIES Valuation Methodologies and Key Issues Methodology Key Sensitivities • Trading multiples of comparable companies • Quality of comparables • To determine the relative value of companies within the sector • Market environment • Consistent accounting treatment • Forward-looking multiples • 1 Public data Public Market Comparables • Market of comparable transactions • Quality of comparable transactions • 2 Takes into consideration acquisition premium • Historical multiples • Generally limited public data • Market conditions at time of transaction Merger Market Comparables • Discounted Cash Flow (“DCF”) 4 Pro Forma Analysis Present value (―PV‖) of projected unlevered free cash flows (―FCFs‖) • Quality of financial forecasts (large number of assumptions) • Discounted at weighted average cost of capital (―WACC‖) • Discount rate • Terminal value / perpetuity growth rate • 3 Impact of a transaction (growth, margins, credit rating, etc.) • Affected by financing capital structure • Affected by accounting (purchase price allocation) • Assess whether a transaction is accretive / dilutive to EPS • Not indicator of fundamental value • Near-term vs. long-term impact 12
  8. 8. OVERVIEW OF VALUATION METHODOLOGIES – PUBLIC MARKET 1 1 Financial ratios should be compared across different sectors Benchmarking of Market Multiples – Example Output 2013E EV / Sales 2013E EV / EBITDA Sector 1 Sector 2 Sector 3 14
  9. 9. OVERVIEW OF VALUATION METHODOLOGIES – PUBLIC MARKET 1 1 Overview of the Discounted Future Value Approach Discounted Future Value Approach Overview • Consider the start-up when the business model approaches maturity, and achieves positive EBITDA and longer-target margin targets • The start-up can be valued with a 1-year forward multiple on future financial metrics based on projected future forward multiples • The resulting valuation is subsequently to today to find the present value of the start-up business Illustrative Calculation Methodology Forward 2017 “Steady” EBITDA x 1 Year Forward Multiple = Future Value at 2016 Discount 4 Years Present Value Today at 2013 16
  10. 10. OVERVIEW OF VALUATION METHODOLOGIES – MERGER MARKET 2 Analysing precedent transactions will give a snapshot of multiples being paid Selected Precedent Transactions – Example Output Date _ _ _ _ _ _ _ _ _ _ _ _ _ _ Acquirer _ _ _ _ _ _ _ _ _ _ _ _ _ _ Target _ _ _ _ _ _ _ _ _ _ _ _ _ _ Transaction Value _ _ _ _ _ _ _ _ _ _ _ _ _ _ Period _ _ _ _ _ _ _ _ _ _ _ _ _ _ 18
  11. 11. OVERVIEW OF VALUATION METHODOLOGIES - DCF 3 3 There are three main components of a Discounted Cash Flow Analysis A Determination of Free Cash Flows • B Calculation of Terminal Value • — Sales growth — Margins — Capex — Change in Working Capital C Exit multiple method • Projections (5 – 10 years) Value of business / cashflows post projection period • Value of business in projection period • DCF Analysis Perpetuity growth method (steady state) Calculation of Discount Rate • Incorporates time value of money • WACC vs. Equity discounting • Discount Rate — Acquiror, Target or Sector? — Risk Free Rate — Beta 20
  12. 12. OVERVIEW OF VALUATION METHODOLOGIES - DCF 3B Terminal value serves as proxy for present value of cash flow stream that is to be generated after the projection horizon • Terminal value serves as proxy for present value of cash flow stream that is to be generated after the projection horizon (usually 5 to 10 years) — Ideally when business is in steady state • Calculate PV of terminal value and add to PV of projected cash flows to arrive at a total value for the company • The two principal terminal valuation approaches are: Methodology Benchmarks FCF in Year after Final Year • Industry growth rate WACC – Growth Rate • General economic growth rate • Differentiate real growth vs. inflation TV = EBITDA x Exit Multiple • Current trading multiples • • Mid-cycle trading multiples • M&A multiples TV = Perpetuity Method TV Exit Multiple = FCF5 x (1+g) WACC – g Assumes sale/IPO of business at multiple of final year’s sales, EBITDA, EBIT or other metric • Compare results to check assumptions • Alternatively, calculate terminal value through one method and back out the ―implied‖ assumption for the other method (e.g. implied perpetuity growth of a certain exit multiple) 22
  13. 13. OVERVIEW OF VALUATION METHODOLOGIES – PRO FORMA 4 Pro Forma Analysis is a method of calculating financial results in order to emphasize either current or projected figures Key Inputs to Consider • Mix of financing — Stock vs. cash • Financing Cost (incremental debt to finance the acquisition) — Interest expense on new debt issued — Interest income lost on cash used • Accounting Treatment — Excess purchase price allocated to asset write-up – Depreciated / amortized over how long? • Transaction Costs Considerations • Impact of target to pro forma growth and margin profile — Potential multiple impact — Level of diversification vs. product concentration • Synergy Analysis — Cross-selling opportunity — Cost savings potential — Amount required to breakeven (if dilutive) vs. amount that is achievable • Balance sheet impact — Credit rating — Financing fees, advisor fees — Ability to de-lever — Merger costs — Pro forma ownership • Taxes 24
  14. 14. OVERVIEW OF VALUATION METHODOLOGIES – PRO FORMA 4 4 Company A Acquires Company B – An Illustrative Example Illustrative EPS Accretion / (Dilution) Analysis Sensitivity Analysis Deal Terms 2013E EPS Accretion 10.00 20.0% 12.00 500 6,000 Financing Terms Debt Financing (50%) Equity Financing (50%) 3,000 3,000 Company A Share Price Company A Pre-Deal Shares Outstanding Company A Post-Deal Shares Outstanding 20.00 1,000 1,150 Acquisition Share Price 5.3% Pre-Tax Cost of Debt Company B Share Price (US$) Premium Over Purchase Price Acquisiton Share Price (US$) Company B Shares Outstanding (mm) Implied Takeover Equity Value 10.00 11.00 12.00 13.00 14.00 3.0% 8.9% 7.5% 6.2% 4.8% 3.5% 3.5% 8.6% 7.1% 5.7% 4.3% 3.0% 4.0% 8.2% 6.7% 5.3% 3.9% 2.5% 4.5% 7.9% 6.4% 4.9% 3.4% 2.0% 5.0% 7.5% 6.0% 4.5% 3.0% 1.5% 13.00 14.00 2014E EPS Accretion EPS Accretion / (Dilution) Company A Net Income Company B Net Income Post-Tax Interest Expense @ 4.0% Pre-Tax¹ Pro Forma Net Income Company A Pro Forma EPS (US$) Company A Status Quo EPS (US$) EPS Accretion / (Dilution) 1 2013E Acquisition Share Price 2014E 2,000 500 (78) 2,422 2,200 550 (78) 2,672 2.11 2.00 5.3% 2.32 2.20 5.6% 5.6% Pre-Tax Cost of Debt (US$ mm) 10.00 11.00 12.00 3.0% 9.1% 7.7% 6.4% 5.0% 3.7% 3.5% 8.8% 7.4% 6.0% 4.6% 3.3% 4.0% 8.5% 7.0% 5.6% 4.2% 2.9% 4.5% 8.2% 6.7% 5.2% 3.8% 2.4% 5.0% 7.8% 6.3% 4.8% 3.4% 2.0% Assumes corporate tax rate of 35% 26

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