3. Methods
• Market Approach
– Current Market Prices, Historical Market
Prices, Price to Earnings, Price to Revenue,
Price to Book Value, Price to Enterprise Value
• Comparable Transactions/Relative
Valuations
– Comparable International and Domestic
Transactions.
• Sum-of-parts Method
September 13, 2009 Corporate Restructuring | Session 4 3
4. Market Approach
• Key issues
– Representative comparative companies
– Time period
– Variables to be considered
• Among the common variables used are
– P/E, P/BV
– M-Cap/Revenue, M-Cap/EBIDTA
• Important to compare apples to apples
September 13, 2009 Corporate Restructuring | Session 4 4
5. Comparable Transactions
• Key issues
– Representative comparable transactions
– Time of consummation
– Applicable markets and their dynamics
• Usual variables
– EV/Revenue, EV/EBIDTA
– P/E, P/BV
• Important to segregate and eliminate company
specific premiums and discounts in the valuation
September 13, 2009 Corporate Restructuring | Session 4 5
6. Sum Of Parts Method
Land Parcel 100 acres EPC Company With All
Own Equipment
Toll Road Under BOT New Venture Into
Generating Toll Fees Nuclear Energy
September 13, 2009 Corporate Restructuring | Session 4 6
7. Sum Of Parts Method
Land Parcel 100 acres EPC Company With All
Own Equipment
Asset Valuation (FMV)
Asset Valuation (FMV)
Revenue Generation
Potential Add Company
Premium/Discount
Toll Road Under BOT New Venture Into
Generating Toll Fees Nuclear Energy
Discounted Cash Flow Negotiated Depending
on Stage of
Development
September 13, 2009 Corporate Restructuring | Session 4 7
8. Sum Of Parts Method
Land Parcel 100 acres EPC Company With All
Own Equipment
Asset Valuation (FMV)
Asset Valuation (FMV)
Revenue Generation
Add SCRP, Liquidity
Potential Add Company
Premium/Discount
Premium & New Venture Into
Toll Road Under BOT Control
Generating Toll Fees Nuclear Energy
Premium Depending
Discounted Cash Flow Negotiated
on Stage of
Development
September 13, 2009 Corporate Restructuring | Session 4 8
10. The Synergy Trap
• Essentials for an Acquirer:
– Should not pay “too much”
– The deal should make “strategic sense”
– Corporate cultures need to be managed carefully
• The problem is:
– How do we predict up front whether a company is
overpaying for an acquisition?
• Acquisitions are capital budgeting decisions
September 13, 2009 Corporate Restructuring | Session 4 10
11. The Synergy Trap (Contd.)
• Dreams of synergy may lead to lofty acquisition
premiums.
• A quantifiable post-merger challenge is embedded
in the price of each acquisition. Higher the premium,
greater is the challenge.
• Using the acquisition premium, we should be able to
calculate what the required synergies must be.
• This calculation may often show that the required
performance improvements are far greater than what
any business in a competitive industry can reasonably
expect.
September 13, 2009 Corporate Restructuring | Session 4 11
12. The Synergy Trap (Contd.)
• A McKinsey & Co. study found that 61% of the
acquisition programs were failures because the
acquisition strategies did not earn a sufficient return
on the funds invested.
• A BCG study found that during the pre-merger stage,
80% of companies did not even consider how the
acquired company would be integrated into
operations following the acquisition!!
• Thus, a bad acquisition is one that does not earn back at
least its cost of capital.
September 13, 2009 Corporate Restructuring | Session 4 12
13. The Synergy Trap (Contd.)
• When an acquirer pays acquisition premium,
he/she has two business problems to solve:
– to meet the performance targets the market already expects;
– to meet the even higher targets implied by the acquisition
premium.
• Hence, Synergy can be defined as “increases in
competitiveness and resulting cash flows beyond what
the two companies are expected to accomplish
independently”
September 13, 2009 Corporate Restructuring | Session 4 13
14. The Acquisition Game
• Acquisition is a business gamble where the acquirer
pays up front for the right to control the assets of the
target firm and earn, hopefully, a future stream of
cash flows.
• But while the acquisition premium is known with
certainty, the payoffs are not.
• NPV (of playing the acquisition game) =
Synergy- Premium.
September 13, 2009 Corporate Restructuring | Session 4 14
15. Losing In The Acquisition Game
• When Novell acquired WordPerfect for $1.4bn, they
did not calculate what WordPerfect was already
required to accomplish given the first bid for
WordPerfect by Lotus for $700mn.
• Novell lost $550mn of market value on
announcement of acquisition.
• Microsoft has, since then, continued to gain market
share and ultimately Novell sold WordPerfect (less
than two years after acquisition) to Corel at a loss of
over $1.2bn!
September 13, 2009 Corporate Restructuring | Session 4 15
16. Empirical Evidences of Acquisitions
• Some studies concluded that related acquisitions were
better than unrelated acquisitions;
• Some show that unrelated acquisitions were better
than related acquisitions; and
• There is a third group which show that the
relationship just did not matter!
• But most of these researchers assumed that
acquisition prices are highly correlated with potential
value.
September 13, 2009 Corporate Restructuring | Session 4 16
17. Problems with Past Research
• Because many researchers have assumed that the
premiums represent fair prices in the beginning, a
failed acquisition was dubbed as the result of
“managerial problems” such as culture clashes, leadership
failures etc.
• The practical problem with this approach is that it
does not realistically address whether the acquisition
strategy could have worked even in the absence of
implementation problems.
• It is wrong to assume that if the management
problems were not there, all or any of the synergy
promised by the premium would occur.
September 13, 2009 Corporate Restructuring | Session 4 17
18. Post-Acquisition Integration
• Nelson and Lagges, Principals with A. T. Kearney
advised, “During the first year, it is important to combine
two cultures and organizations, but it is fatal to get bogged
down in heavy operations integration. Start out by picking the
low hanging fruits.”
• However, it is observed that for an average
acquisition premium of over 40%, it is crucial to
understand that the possible performance
improvements should also be worked out initially.
This is because each year of delay would cost heavily!
September 13, 2009 Corporate Restructuring | Session 4 18
19. Justifying Acquisition Premium
• The synergy (or Required Performance
Improvement) as indicated by the acquisition
premium has to be estimated up front.
• The process of such estimation would show
how difficult it is to justify the premium!
• Any delay in realizing synergy would further
put the acquisition premium at risk.
September 13, 2009 Corporate Restructuring | Session 4 19
