The document discusses strategic fit and value hypotheses in mergers and acquisitions (M&A). It provides examples of ways to create value through M&A, including undervalued targets, synergies from cost reductions and revenue increases, and financial engineering. It emphasizes that the value hypothesis should quantify and specify how value will be realized through post-merger integration. The "natural owner" concept is introduced as the potential buyer that can realize the highest synergies from a target.

1. M&A TOOLKIT
Strategic Fit:
Value Hypotheses
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2. VALUE HYPOTHESIS:
HOW WILL
1 + 1 = 3?
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3. Every deal will have a “hypothesis” about value creation
WAYS TO CREATE VALUE IN M&A
1) Target is under-valued by owners •Distressed sale
•Stock market imperfect
•Unsophisticated seller Private
Equity
2) Target is under-managed •Poor management incentives focus
•Non-core business
•Wrong CEO
3) Synergy: Reduced costs •Elimination of overlaps
•Economies of scale
•Overheads
•Purchasing Corporate
focus
4) Synergy: Increased revenue •Selling new products to existing customers
•Selling existing products to new customers
•Improved processes
5) Financial Engineering •Reduced cost of capital Private
•Cash tax reduction Equity
focus
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4. The Value Hypothesis lays out how the bottom line will be
boosted post-deal
VALUE HYPOTHESIS FOR DIAGEO BUYING SEAGRAMS
Strategic rationale Achieve a competitive advantage in distribution
for Seagrams deal: and lowest distribution cost position in the USA
Value Hypothesis: “Increase growth by 2% per annum and
increase our margin by 1% by creating a
proprietary salesforce within distributors”
What analysis can you do to justify this
hypothesis before launching the bid?
How can you test this assumptions further in due diligence?
How will you realise the value in post-merger integration?
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5. Good Value Hypotheses pass three tests
CHECKING YOUR VALUE HYPOTHESIS
1) Links directly to the strategic rationale
(no Bait n’ Switch!)
2) Quantifed/Testable/Analysable
3) Specifies the Action in merger integration to realise
the value
Only one (other synergies are icing on the cake)
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6. Good Value Hypotheses pass three tests
EXAMPLES OF VALUE HYPOTHESES
Deal Possible Value Hypothesis Strategic Quantified Describes
Fit PMI action
Volvo-Geely Increase Volvo sales in China to 100k
cars by 2016 through Geely’s distribution
network and relationships
Tata Steel- Reduce costs 5% through overhead
Corus reduction and plant rationalisation
AOL-Time Create $20 billion in new business
Warner revenues from combining TW media
content with AOL’s distribution platform
Instagram- Increase mobile advertising revenue by
Facebook 50% in year 2014 through integrating
functionality and cross-selling platforms
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7. THE
“NATURAL OWNER”
OF A
BUSINESS
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8. The “Natural Owner” question is the toughest valuation test for
screening acquisitions
“NATURAL OWNER” VALUATION TEST
• It is not enough to identify a robust “value hypothesis” for
an acquisition
• The toughest test is “can we add more value than any other
owner”?
• When this is true, you are the “Natural Owner” and can bid
confident you will not be outbid rationally
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9. The “Natural Owner” of a business is the owner who can realise
the highest synergies from the business
90
BUSINESS VALUE
($m)
75 Synergy
30 Value
60 15
Base
Business
Value
Value to old owner Value to us Value to another
company
“Natural Owner”
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10. If we are not the “Natural Owner” of a business, approaching it
risks a bidding war with a temptation for us to overpay
90
BUSINESS VALUE
($m) The “Natural
75 Owner” can
30 Synergy rationally outbid
Value us once the target
60 15 is put “in-play”
Base
Business
Value
Value to old owner Value to us Value to another
company
“Natural Owner”
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11. The “Natural Owner” test should be applied to businesses we already
own, to identify when value can be created by selling a business
VALUE CREATION OPPORTUNITY FROM SELLING A BUSINESS
90
Potential value
creation opportunity
from selling to the
60 “Natural Owner”
Value to us Value to other company
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12. Businesses should evaluate their portfolios and sell businesses to
their “natural owners”
IDENTIFYING THE “NATURAL OWNER”
• Is there a strategic story (e.g. Consolidation, Roll-up, Market
entry, Product range extension, Technology)?
• What are the possible Value Hypotheses?
o What costs could be cut?
o What cross-selling opportunites exist?
• Do they have the financial strength to buy?
• Do they have an appetite for this kind of acquisition?
If YES
How can we position our business to get a good price?
How can we create a strong negotiating process?
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