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Assume two companies are planning a merger the following figures are given:
Stock Price
EPS
P/E
Outstanding
A
100
4
25
100,000
T
50
2.5
20
50,000
shares
Total earnings
MV
400,000
10,000,000
125,000
2,500,000
Steps:
If the market is efficient, the post-merger P/E should adjust to the weighted average of
EARNINGS contributions of both companies. This means:
If investors apply the pre-merger P/E of 25x, then price would increase to 4.2 * 25 = 105
When
evaluating the target from a non-control perspective, we should use the targets WACC.
Finding the terminal value can be found in one of two ways:
(1) Constant growth rate; that is:
(2) Applying a multiple at which the analyst expects the average company to sell
at the end of the first stage.
each share must exceed the current stock price in order to entice shareholders to
relinquish control of the company to an acquirer.
Where PRM is the takeover premium (as percentage of stock price), DP is the deal price
and SP is the stock price.
The following example shows a very simplified illustration of the method. Assuming that
the ABC Company is trying to analyze the fair value of XYZ in order to determine the
acquisition price, using comparable company analysis, ABC has determined two
comparable companies and the following valuation variables:
Valuation
Variable
Current
Company 1
Stock 20
Price
EPS
BVPS
We can find the following multiples
Company 2
15
2
8
1.67
5
Multiple
Company 1 Company 2
Mean
P/E
20/2 = 10
15/1.67 = 9
9.5
P/BV
20/8 = 2.5
15/5 = 3
2.75
If XYZ has EPS of 2.5 and BVPS of 7 then applying the mean multiples:
Variable
Target
Mean
Company
Multiple
EPS
2.5
9.5
2.5 * 9.5 =23.75
BVPS
7
2.75
7 * 2.75 = 19.25
The mean stock price is then 21.5; Now, we need to add the takeover premium. We
estimate it from 3 transactions (recent takeovers) in companies in the same industry
Target
Stock
Company
Target 1
Takeover
20
Price
Before Takeover
Price
25
Takeover Premium
(%)
25%
Target 2
Target 3
15
30
20
36
MEAN
33.33%
20%
26.11%
Therefore, the estimated takeover price for the target is 21.5 * 1.2611 = 27.11
Third: Comparable Transaction Analysis]
Similar to comparable company analysis except that the analyst uses details from recent
takeover transactions for comparable companies to make direct estimates of the target
companys takeover value. For this approach, we compare multiples actually paid for
similar companies in other M&A deals. Therefore, there is no need to estimate the
premium.
he following example shows a very simplified illustration of the method. Assuming that
the ABC Company is trying to analyze the fair value of XYZ in order to determine the
acquisition price, using comparable company analysis, ABC has determined two
comparable acquired companies and the following valuation variables:
Valuation
Variable
Acquisition Price
EPS
BVPS
1
20
2
8
15
1.67
5
Acquired
Company 1
2
P/E
20/2 = 10
15/1.67 = 9
9.5
P/BV
20/8 = 2.5
15/5 = 3
2.75
If XYZ has EPS of 2.5 and BVPS of 7 then applying the mean multiples:
Variable
Target Company
Mean Multiple
Estimated
Stock
Price
EPS
2.5
9.5
2.5 * 9.5 =23.75
BVPS
7
2.75
7 * 2.75 = 19.25
If the analyst determines equal weighting for each multiple (50% for each) then the
mean stock price is then 21.5. If the analyst thinks that earnings are more important
determinant of value, he could assign a weight of 60% to it and 40% to book value and
the estimate stock price will be 0.6 * 23.75 + 0.4 * 19.25 = 21.95
Bid Evaluation
Assessing the targets value is important but it is insufficient for an assessment of the
deal.
When evaluating a bid, the pre-merger value of the target company is the minimum
value that target shareholders should expect. The maximum that acquirers should pay
on the other hand is pre-merger value of target company plus expected synergies or
else there will be reduction in value.
Acquirer
15
(in 75
millions)
Pre-merger market value (in 1125
millions)
The expected synergy = 90 million
Option 1: Cash offer of $12 per share
Target
10
30
300
PT = 12 * 30 = 360
Option 3: Mixed offer of $6 plus 0.4 shares of As stock per share of Ts stock
Q:
The target firm has 10 million shares outstanding at a price of $9.00 per
share. What should the offering price be?
The acquirer estimates the maximum price they would be willing to pay by dividing the
targets value by its number of shares:
Max price
4.5
Cash flow
9.9 7.8 13.8
17.1
Find the appropriate
discount rate
Determine terminal
value
TV2006 = CF2006(1 + g) /
(kS g)
1.
Synergy: it refers to the concept that the whole of the combined company will be worth more
than the sum of its parts. Cost synergies typically achieved through economies of scale and
revenue synergies are created through cross-selling of products, expanded market share, and
= $17.1 (1.06) /
(0.142 0.06)
=$221.0 million
Growth: Companies can grow either by making investments internally (i.e. organic growth)
or by buying the necessary resources externally (i.e. external growth faster to be done and
less risky because of familiarity with business)
3.
Increasing market power: when a company increases its market power through horizontal
mergers, it may have greater ability to influence market prices. Taken to an extreme, horizontal
integration results in a monopoly
4.
5.
Diversification: If diversified, the variability of the conglomerate cash flows is reduced (at
least to the extent that cash flows are uncorrelated). Although this may seem like a rational
motive, it has been challenged: (1) in a well-functioning markets, shareholders can diversify
their own portfolios and (2) the desire to diversify makes companies lose sight of their major
competitive strengths
6.
7.
8.
Tax considerations: It is possible for a profitable acquirer to benefit from merging with a
target that has accumulated a large amount of tax losses
9.
10.