of Valuation Merger Target
Corporate Financial Decisions Timothy A. Thompson
Basics
Valuation of merger target is from the perspective of acquiring companys shareholders Net present value of acquisition is the ,,value of the target to acquirer" minus the ,,effective cost"
Value of target to acquirer
Value of the target to the acquirer is made up of:
Stand alone value of the target plus Value of improvements at target made by acquirer management plus Value of pure synergies between target and acquirer
Valuations must make a capital structure assumption
WACC model or APV model
The valuations (stand alone, improvements, and synergies) must make a capital structure assumption Be careful!
The capital structure assumption should not be reflective of the financing used to buy the target per se, but should reflect the degree to which owning the target incrementally affects your debt capacity
What?!
For example, suppose you bought the target with debt
If you are using WACC to value target, the weights should reflect the debt capacity of the target, not 100% debt If you are using APV, the tax shields should only reflect the contribution of the target firm towards affording those tax shields
What is the ,,effective cost"?
Acquirer pays cash ($100M) Acquirer must raise the cash ($100M)
Cash price is the effective cost of the acquisition Assume borrow the money from government with a subsidized Assume rate
sell shares of combined firm ($100M)
Loan is $100M, but PV of loan payments is $95M ,,Purchase price" is $100M, but acquirer makes $5M NPV on loan. ,,Effective cost" of acquisition is $95M ,,Purchase price" is $100M, but suppose shares are actually worth $60M. NPV on share sale is $40M. ,,Effective cost" of acquisition is ,,$60M".
Deal NPV and NPV to original shareholders
Original target shareholders And new purchasers of stock or debt
Deal NPV is the NPV of the deal to all capital contributors If new securities are not zero NPV
Decision should be made from perspective of original target shareholders Actual NPV = Deal NPV NPV of financing issues
This is a redistribution among capital providers
Valuation of Merger Target
Value of synergies Value of improve ments ,,Purchase price"
Value of Target to Acquirer
Stand Valone value of target
NPV to acquirer shareholders
NPV of financing issues Value of synergies
Value of Target to Acquirers Stand Sharealone value of holders target
Value of improve ments
,,Purchase price"
V
Where was ,,effective cost"?
The ,,purchase price" minus the NPV of financing is the ,,effective cost" Real world situations
Debt plus warrants or equity of private firm (like John Case) Debt may be cheap to ,,make it up on equity" Subsidized loans Using overvalued stock to make acquisitions