Valuation of Mergers and Acquisitions
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INTERNATIONAL MANAGEMENT INSTITUTE, NEW DELHI
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Valuation of Mergers and Acquisitions
Mergers and acquisitions (more generally, takeovers) are an important means through which companies achieve economies of scale, face the competition, or respond to economic shocks. For example ,how the $54 billion US chemical major Dow Chemicals is in process of acquiring its rival Rohm and Haas(R&H) for a total consideration of $18.8 billion, can be seen.Not surprisingly, these actions often make the news. Deals can be worth hundreds of millions, or even billions, of dollars. They can dictate the fortunes of the companies involved for years to come. For a CEO, leading an M&A can represent the highlight of a whole career. And it is no wonder we hear about so many of these transactions; they happen all the time.
■ A merger is a combination of two or more corporations in which only one corporation survives and the merged corporations go out of business.
■ Statutory merger is a merger where the acquiring company assumes the assets and the liabilities of the merged companies
■ A subsidiary merger is a merger of two companies where the target company becomes a subsidiary or part of a subsidiary of the parent company
Varieties of Mergers
From the perspective of business structures, there is a whole host of different mergers. Here are a few types, distinguished by the relationship between the two companies that are merging: ■ Horizontal merger - Two companies that are in direct competition and share the same product lines and markets. ■ Vertical merger - A customer and company or a supplier and company. Think of a cone supplier merging with an ice cream maker. ■ Market-extension merger - Two companies that sell the same products in different markets. ■ Product-extension merger - Two companies selling different but related products in the same market. ■ Conglomeration - Two companies that have no common business areas. METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS
Here, I have shown the detailed description of the discounted-cash-flow (DCF) approach and other methods of valuation, such as market multiples of peer firms, book value,liquidation value, replacement cost, market value, and comparable transaction multiples.
The discounted-cash-flow approach in an M&A setting attempts to determine the value of the company (or "enterprise value”) by computing the present value of cash flows over the life of the company. Since a corporation is assumed to have infinite life, the analysis is broken into two parts: a forecast period and a terminal value. In the forecast period, explicit forecasts of free cash flow must be developed that incorporate the economic costs and benefits of the transaction.Ideally, the forecast period should equate with the interval over which the firm enjoys a competitive advantage (i.e., the circumstances where expected returns exceed required returns). In most circumstances, a forecast period of five or ten years is used.
Basics of DCF
The basics of define the following concepts :free cash flows, terminal value, and the WACC.It is important to realize that these fundamental concepts work equally well when valuing an investment project as they do in an M&A setting.
Free cash flows
The free cash flows in an M&A analysis should be the expected incremental operating cash flows attributable to the acquisition, before consideration of financing charges (i.e.,pre-financing cash flows). Free cash flow equals the sum of NOPAT (net operating profits aftertaxes.), plus depreciation and noncash charges, less capital investment and less investment in working capital. NOPAT is used to capture the earnings after taxes that are available to all...
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