MERGER ANALYSIS: VALUING THE

TARGET FIRM & BID PRICE

PERTEMUAN 6.2:
Prof. Dr. Kamaludin

Kamaludin Valuing the Target Firm & Bid

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 TOPIK
1. Valuing the target firm
2. Setting the bid price
3. Analysis of the change capital structure to value equity.

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 Valuing the target firm

1. Market multiple analysis:

PER (price earning ratio)
II. Discounted cash flow analysis:
a. The corporate valuation model
b. The free cash flow to equity (FCFE) atau equity residual
model
c. The adjusted present value (APV)

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 Discounted cash flow analysis
1. The corporate valuation model (CVM): adalah penilaian total
perusahaan yang berupa present value dari free cash flow (baik debt
holder atau stock holder) yang menggunakan discounted WACC.
2. The free cash flow to equity (FCFE): nilai ekuitas adalah present
value dari projected free cash flow equity, yang menggunakan
discounted ROE.
3. The adjusted present value (APV): nilai operasi perusahaan adalah
discounting dari projected free cash flow + interest taxe shield
arising, dimana discounted menggunakan unlevered cost of equity.

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 The APV Model
 V_operation = V_unlevered + V_tax shield
 Unlevered value of firm = PV of FCFs discounted at unlevered
cost of equity, rsU.
 Value of interest tax shield = PV of interest tax savings at
unlevered cost of equity.
 Interest tax savings =Interest(tax rate) = TSt .

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 Value of operation:

N
HVN

t =1
FCFt +TS t
(1+ rsu ) t
+
(1 + rsu ) N

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 Note to APV
 APV is the best model to use when the capital structure is
changing.
 The Corporate Valuation model is easier than APV to use
when the capital structure is constant—such as at the
horizon.

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 Steps in APV Valuation
1. Project FCFt ,TSt , horizon growth rate, and horizon
capital structure.
2. Calculate the unlevered cost of equity, rsU.
3. Calculate WACC at horizon.
4. Calculate horizon value using constant growth corporate
valuation model.
5. Calculate Vops as PV of FCFt, TSt and horizon value, all
discounted at rsU.

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 APV Valuation Analysis (In Millions)

Free Cash Flows after Merger Occurs

2004 2005 2006 2007

Net sales $60.0 $90.0 $112.5 $127.5

Cost of goods sold (60%) 36.0 54.0 67.5 76.5
Selling/admin. expenses 4.5 6.0 7.5 9.0
EBIT 19.5 30.0 37.5 42.0
Taxes on EBIT (40%) 7.8 12.0 15.0 16.8
NOPAT 11.7 18.0 22.5 25.2
Gross investment in opr. Cap. 0.0 7.5 6.0 4.5
Free Cash Flow 11.7 10.5 16.5 20.7

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 Interest Tax Savings after Merger

2004 2005 2006 2007

 Interest expense 5.0 6.5 6.5 7.0
 Interest tax savings 2.0 2.6 2.6 2.8

 Interest tax savings are calculated as

 interest(T). T = 40%

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 Discount rate for Horizon Value
 At the horizon the capital structure is constant, so the
corporate valuation model can be used, so discount FCFs at
WACC.

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 Contoh: perhitungan rsL(ROE). rsU, dan WACC

 Diketahui tingkat bunga bebas risiko 7%, keuntungan pasar

11%.
 Perbandingan porsi hutang dan ekuitas: 20 : 80.
 Beta premerger 1.3
 Kupon obligasi dengan tarif 9%.
 Tingkat pertumbuhan 6%.

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 Discount Rate Calculations
rsL(ROE) = rRF + (rM - rRF)bTarget
= 7% + (4%)1.3 = 12.2%
rsU = wdrd + wsrsL
= 0.20(9%) + 0.80(12.2%)
= 11.56%
WACC = wd(1-T)rd + wsrsL
=0.20(0.60)9% + 0.80(12.2%)
= 10.84%

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 Horizon, or Continuing Value

 Horizon value = (FCF2007 )(1 + g)

WACC − g

$20 .7(1.06 )
0.1084 − 0.06

= $453.3 million.

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 What Is the value of the Target Firm’s operations
to the Acquiring Firm? (In Millions)

2004 2005 2006 2007

Free Cash Flow $11.7 $10.5 $16.5 $ 20.7

Horizon value 453.3
Interest tax shield 2.0 2.6 2.6 2.8
Total $13.7 $13.1 $19.1 $476.8

$13.7 $13.1 $19.1 $476.8

VOps = (1.1156)1 + (1.1156)2 + (1.1156)3 + (1.1156)4

= $344.4 million. Valuing the Target Firm & Bid

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 What is the value of the Target’s
equity?
 The Target has $55 million in debt.
 Vops – debt = equity
 344.4 million – 55 million = $289.4 million
 = equity value of target to the acquirer.

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 Would another potential acquirer obtain the
same value?
 No. The cash flow estimates would be different, both due to
forecasting inaccuracies and to differential synergies.
 Further, a different beta estimate, financing mix, or tax rate
would change the discount rate.

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 Data:
 Assume the target company has 20 million shares
outstanding.
 The stock last traded at $11 per share, which reflects
the target’s value on a stand-alone basis.
 How much should the acquiring firm offer?

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 Perhitungan:
 Estimate of target’s value = $289.4 million
 Target’s current value = $220.0 million
 Merger premium = $ 69.4 million

Presumably (kelihatannya), the

target’s value is increased by $69.4
million due to merger synergies,
although realizing such synergies has
been problematic in many mergers.
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 ANALISIS:
 The offer could range from $11 to ($289.4/20 )= $14.47
per share.
 At $11, all merger benefits would go to the acquiring firm’s
shareholders.
 At $14.47, all value added would go to the target firm’s
shareholders.
 The graph on the next slide summarizes the situation.

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 Change in 25 - 29
Shareholders’
Wealth
Acquirer Target

$11.00 $14.47
Price
Paid for
0 5 10 15 20 Target
Bargaining Range =
Synergy

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