Valuation for acquisition and mergers.docx

1、Valuation for acquisition and mergersValuation for acquisition and mergersChapter 10Valuation for acquisition and mergersStudy guideProblem of overvaluationEstimate the potential growth level of a firmss earningAssess the impact of acquisition upon risk profile of the acquirerUse different models an

2、d procedures to value different types of acquisitionType 1*, type 2*, type 3*Valuing high growth start-ups 11. Overvaluation problemWhen a company acquires another company, it always pays above its current market value.Possible reasons for M&A not enhancing shareholders valueAgency theory: the o

3、vervaluation problem is determined by the degree of the agency problem prevalent in the acquirer and the ability of the targets shareholders to extract this premium.Empirical evidences show there is normally a fall in the price of the bidder and an increase in the price of the target during an acqui

4、sition, indicating a transfer of value from the acquirer to the target.Miscalculation of the potential synergies or the overestimation of ability of acquiring firms management to improve performance.NPV of M&A=Synergy- premiumMethod 1:Method 2: 2. Estimate growth level3 ways to estimate the grow

5、th rate of earnings of a company:Historical estimateLength of estimation period have to be decided subjectivelyGrowth rate may be volatileAnalyst forecastsAnalysts regularly produced forecasts on the growth of a companyCompany fundamentals: growth rate is determined by ROE and retention rate (P310 Q

6、&A)3. Impact of M&A upon risk profile of acquirerType 1 acquisition does not disturb the acquirers financial or business riskType 2 acquisition affects the acquirers financial risk but not its business riskType 3 acquisition affects both the acquirers financial risk and its business riskBusi

7、ness risk of combined entityAsset beta of combined firm is the weighted average of the betas of the target firm, the predator firm and the synergy.Leveraged equity beta of combined firmCost of equity is given by CAPMWACC can then be derived4. Type 1 acquisitionMethods to value target firm:Book value

8、-plus modelsMarket relative modelsCash flow models, including EVA, MVABook value-plus modelBasing on the balance sheet as the starting point in the valuation process.Value per share= net asset value / number of ordinary shares= (total tangible assets- short and long-term liabilities- preference shar

9、es) / number of ordinary sharesMarket relative modelsP/E ratioMarket value per share= EPS P/E ratioA suitable P/E ratio should be decided, taking market expectations, risk and status (quoted or unquoted company) into consideration (*p314 Q&A)EPS could be historical or prospectiveTobins Q ratioma

10、rket value of a firm/total asset value of the firmQ=1 is a cut-off pointHigher-Q firms usually buy low-Q firmsMarket value of a target company=M/B ratiobook value of assetsFree cash flow modelsStep 1: calculate FCFStep 2: forecast FCF and terminal valueStep 3: calculate WACCStep 4: discount FCF at W

11、ACC to obtain value of the firmStep 5: calculate equity value by subtracting value of debt* p316 Q&AStep 1: calculate FCFEStep 2: forecast FCFE and terminal valueStep 3: calculate cost of equityStep 4: discount FCFE at cost of equity to obtain equity value EVA approachEVA= NOPAT- WACCCapital emp

12、loyed =(ROIC-WACC)Capital employedNOPAT=EBIT(1-T)Capital employed=operating current assets -non-interest bearing current liabilities+ net fixed assetsROIC=NOPAT/ Capital employed *capital employed at the beginning of the yearAdjustments on intangibles, accounting depreciation and amortization, etc.P

13、317 4.5.1 exampleValue of the firm= value of invested capital + present value of EVAP319 4.5.3 exampleMVA approachMVA= market value of debt + market value of equity (book value of debt +book value of equity)Shows how much the management of company has added to the value of capital capital contribute

14、d by capital providersIf book value and market value of debt are the same, then it measures the value added to equityMVA=Present value of EVASometimes expressed as a market to book ratioDividend valuation basisAn equilibrium price for any share on a stock market is the future expected stream of inco

15、me discounted at suitable cost of capitalDividend growth model:Valuation methods compared2007-6-4(d): limitation of PE and CF based methods5. Type 2 acquisition using APV (p321 example)Step 1: calculate FCFStep 2: forecast FCF and terminal valueStep 3: calculate unlevered cost of capitalStep 4: discount FCF and terminal value at unlevered cost of capitalStep 5: calculate interest tax shieldStep 6: discount interest tax shield at pretax cost of debt to obtain PV of interest tax shield Step 7: calculate APV6. Type 3 acquisitionSteps for valuing a typ