Masterminding the Deal

Breakthroughs in M&A Strategy and Analysis

Peter Clark, Roger Mills

• Publisher: Kogan Page
• Year: 2013
• ISBN:
  9780749469535
• Edition: 1
• Topic: Business
• Subtopic: Contabilità finanziaria
• Index: Business

Following a quiet period in global M&A activity, a new boom seems to be underway, but in an age where two-thirds of all merger deals can be said to fail (where deals fall short of the minimum required financial returns to the acquiring company), how can future success be guaranteed? And what can acquirers, and their shareholders and advisers, do to improve the chances of success? Masterminding the Deal looks at performance in two critical areas - merger segmentation (the identification of critical characteristics and attributes separating more successful mergers from the rest) and category-specific synergy diagnosis (the differentiation of synergy benefits - expenses, revenues, tax - to ensure maximum rewards). Through this in-depth analysis, the book provides the managers and advisers of acquiring firms with concise and actionable frameworks to improve and enhance merger performance. Masterminding the Deal will help you to identify and apply the key components of merger success.

03

Criteria: First, get the merger valuation methodology right

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CHAPTER CONTENTS

3.1 You can’t manage what you can’t measure especially when it comes to M&A

3.2 Criteria-setters: preeminence of continuing shareholders of the acquiring firm

3.3 Overview: four alternative merger valuation methods

3.4 Event studies (ES): exceeding the limits of rational market theory

3.5 Total shareholder return (TSR): most appropriate for round turn financial acquirers?

3.6 Value gap (VG): do synergies offset the price premium necessary to acquire the target?

3.7 Incremental value effect (IVE): two-scenario DCF analysis, adapted to mergers

3.8 Reconciling the tier I merger valuation methodologies

3.9 Multiples: critical confirmation role in merger valuation

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Today, the debate about whether qualitative or quantitative criteria should prevail in merger valuation – prevail in terms of the criteria applied to determine whether or not the deal is a success or failure – is a moot point. To the ultimate determiners of those criteria, the shareholders of the acquiring company make their determination. For the owners of the acquiring firm, there is no debate: quantifiable financial returns have been, are presently, and will continue to be their merger valuation criteria of importance.

But which of the several quantitative-financial merger valuations available is best? Each of today’s leading approaches is explored in this chapter, along with multiples.¹ Each approach has strengths and weaknesses. One (event studies, ES) is widely cited by academic M&A researchers but dismissed by merger practitioners. Another (total shareholder returns, TSR) is most suitable for shorter-term owners who make limited changes to the target before attempting to resell the company a few years later. Permanent ownership is out of the question for these financial portfolio round turn buyers.

Partially because of the limitations of ES and TSR and partially because of the growing dominance of discounted cash flow (DCF)-based methods, two other methods emerge as the prevailing merger valuation methods for most acquirers and situations: value gap (acquisition purchase premium minus net realizable synergies) and incremental value effect (DCF company value comparisons, standalone versus combined). Price-to-earnings and other multiples techniques perform an important support role to the VG-IVE combination.

3.1 You can’t manage what you can’t measure especially when it comes to M&A

Managers’ subjective merger motivations are sometimes confused with merger valuation criteria. The two are not the same. Merger motivations explain why the deal happened. Leading merger valuation criteria establish the basis for determining whether or not the acquisition was (or if not yet closed, is expected to be) successful or not.

Motivation – such as enhancing the prestige of the acquiring company’s management – might be of vital importance to the headstrong buyer, who is hopeful that the transformational deal might earn him or her new visibility in the business community and a reputation as an up-and-coming leader. The mid-market acquirer becomes a possible candidate for the top job at a larger firm, provided the deal is not widely perceived as having been a disaster within six months of the close. Other, less subjective motivations might include expanding the acquiring firm’s customer base or enhancing that firm’s standing within its industry. For a mature company looking at the end of its economic life, diversifying into new areas may be sought to keep the enterprise alive.

But regardless of the plausibility of the explanation for pursuing the deal, merger motivations are not merger criteria. A momentarily plausible M&A rationale does not mean that the transaction is a success – that is, that the contemplated or already completed transaction is value-creating for the owners of the acquiring company. Developing a defendable basis for determining merger acquisition or failure – in a phrase, merger valuation – begins with a clear understanding of the difference between mere enticements for proceeding with the deal and systematic methods for distinguishing the value-creating merger from the value-destroying acquisition.

The bromide ‘you can’t measure what you can’t manage’ has been a mantra of operations-oriented management gurus for years. Sometimes the YCMWYCM theme emerges to justify purchase of yet another set of metrics that promise to navigate the company effortlessly towards top performance. The timing of such sales pitches usually must be separated by a few years, lest the buying company’s decision makers remember the mixed consequences of the last set of magic metrics that over-promised and under-delivered.

But that does not mean that YCMWYCM is without merit. When it comes to the company’s most important external investment – the large corporate acquisition – phrases such as ‘you can’t measure what you can’t manage’ may help prevent acquisitions based on emotions rather than analysis. The niche social networking target company suggests a brighter future for easily impressed would-be acquirers in dead end sectors. Problem is, with no expertise in that field and a high acquisition purchase premium (APP) to secure control of that company, probabilities of a successful merger are miniscule.

Merger excuses and motivations should never be confused with merger valuation criteria

The gains to acquirers’ shareholders are usually zero and often even negative.

(Mueller and Sirower, 2003: 374, citing a range of sources)

Examination of managers’ motivations for pursuing deals must be considered in the context of the reality that most mergers fail (MMF; see Chapter 5). Inquisitive researchers’ papers about why managers chase different deals sometimes help to either spot the next M&A fad, or provide a retrospective explanation for prior M&A evaluation and decision errors. Sirower succinctly expresses today’s dominant opinion regarding merger success or failure as follows: ‘Acquiring companies destroy shareholder value. That is plain fact’ (1997: 16).

MMF is today so widely accepted that the debate has moved forward to two related issues: 1) why certain types of value-destructive mergers continued to occur despite broad-based awareness of MMF starting in the late 1980s and growing consistently since that time; and 2) what can be done to reduce percentages of failed mergers in future years.

The contribution of the researchers of merger motivation relate primarily to the question of why the urge to merge persists. Since the time of Roll’s (1986) analysis of the influence of excessive chief executive pride – hubris – on merger decisions by acquirers, a rich array of works focusing on the question ‘Why did they proceed with these deals at all?’ has arisen. Some of those exploring these areas include Brouthers et al (1998), Bruner (2002, 2004), Epstein (2005), Ghosh (2001, 2002)² and Trautwein (1990). Among the explanations identified in these papers are: personal prestige of the acquiring CEO, a desire to expand the buying company’s asset size and ‘market presence’ (generally interpreted as referring to market share and/or negotiating influence with suppliers), or pursuit of a target that suggests a subjectively appealing ‘good strategic fit’.³ Several of these motivations-oriented articles function as forums for authors’ opinions about how they believe mergers should be evaluated, with limited (or in some instances, no) attention to the paramount financial interests of the acquiring company’s shareholders. Epstein (2005) and Bruner (2002, 2004) are especially outspoken in their opinions that reliance on financial merger valuation criteria alone results in an excessively narrow perspective that is both incomplete and potentially misleading.

Insights, provided from the instigators of tomorrow’s failed deals

Surveys of acquisition-active executives are of interest when it comes to motivations-based explanations for the continuing urge to merge. As expected, opinions from executives about their own M&A success tend to be significantly more positive than the MMF norm, as noted by Mueller and Sirower (2003). In part, this can be explained by the inte...