What is a Good Deal in Mergers and Acquisitions

Good Deal in Mergers and Acquisitions

A good deal in Mergers and Acquisitions are more preferably been used as a growth strategy by companies over any other strategy.This is further supported by favorable market conditions, cheap capital available and booming stock markets.
Not all M&A deals are successful. In fact a majority of the deals have not been able to realize the growth that was expected when the deal was closed.
One of the biggest reasons for the high failure rate is the acquirer overpaying for the deal.Even if the target company is a great strategic fit for the acquirer, overpaying for the deal reduces the additional value generated from the deal.
There are cases where acquirers have been successful in generating additional value from their acquisition strategy which had increased the shareholders value.

Good Deal in mergers and acquisitions where the acquirers were successful

  1. It is important that the acquirer have a deal team inhouse which are able to come up with their internal valuation for the target company rather than depending on the bankers.It would not be prudent to ask the banker to do an independent valuation as there is a conflict of interest here as bankers would be getting a commission fee based on the closure of the deal and its deal value.

Small deals are more successful than large deals

  1. Small deals are generally found to be more successful than the large deals.Small deals are counted as the deal values where the market cap of the target company is less than 1/6th of the acquirer.
  2. The reason why Small deals are found to be more successful than Mergers of Equals is because of the low cost of integration and efforts required in integrating the target company with the acquirer. In addition, cultural conflicts and issues are found to be more rampant and frequent in large deals as against smaller deals.

Stock vs Cash Deals

  1. Stock Consideration are found to be more successful for small deals and cash consideration are more successful for larger deals.
  2. The reason is because as small deals are found to be more successful, there is lesser chance of stock dilution post acquisition for small deals.In larger deals, there is a far higher probability of acquirer stock price to decline post announcement which can have an impact on the capital to be received by target stockholders.

Public Deals vs Private Deals

  1. Acquisitions involving public companies are far less successful than private companies.This is because the acquirer needs to pay a premium above the market price of the target company.In most of the cases, market price of the target company itself was overvalued and it is less prudent for acquirer to pay a premium for a stock price which itself is over valued.
  2. The time taken to close the deals for public companies are more longer than Private companies.This is due to the tender offer to be floated to get approvals of shareholders after the target board has approved the deal.
  3. Carveouts done by public companies to spinoff their non core assets are also a worthy buy for acquirers as these assets are priced at bargain price which helps the acquirer in preventing from overpaying.

Valuation of the Target company

  1. The valuation of the target company is very critical to the success of the acquisition.When floating an initial bid price, the acquirer should have valued the target company along with synergies and control premium that the acquirer will have as a result of the acquisition.

The key steps for the valuation should be:

  • Find the standalone value of the target company based on the financials provided and the projections that the target company makes.The acquirer should validate the earnings projections to check if these future cash flows estimated are achievable.
  • Post the stand alone valuation, the acquirer should take into account the control premium that the acquirer shall exercise over the target company post acquisition. This gives the power to acquirer to tweak the financials, investment and dividend strategy of the target company by divesting projects which are not value additive as well as changing the capital structure of the target company in order to have a lower cost of capital.
  • Once the standalone value of the target company with control premium is accounted, then the acquirer can project growth and cost synergies that can be realized as the result of the acquisition.
  • It is also necessary that the acquirer negotiates on the final purchase price.For realizing synergies, the acquirer needs to bear integration costs and effort, so the acquirer needs to negotiate with the target firm for this efforts put, especially when more efforts are required to be put by the acquirer to generate the additional synergies.
  • It is generally observed that cost synergies are much more easier to act upon and realize than growth synergies.It is also difficult to assign a value to growth synergies as amount of cross sell revenues that can be generated purely depends on the strength of the customer relationships and if the customers has a requirement for these additional offerings.Hence growth synergies are generally qualitative.
  • Successful acquirers also hold their deal teams and business leadership accountable for the outcome of the deal. In some cases, bankers and consultants have claw back provisions where a certain components of their fee is linked to the success of the deal.

Be ready to walk away

  1. Acquirers should be ready to walk away from the deals when they perceive that the deal is overvalued.
  2. It is not prudent for the acquirer to be involved in the bidding war with its competitors to acquire the target as these wars generally are found to be detrimental to the final shareholder returns.It is better for the acquirer to recede from such deals.
  3. Acquirers should not tweak their valuations to support the ask price of the targets.This places additional pressure on the integration team to achieve the synergies.

Conclusion

  1. A good deal in mergers and acquisitions are challenging and arduous.Sometimes the focus is on closing the deal rather than closing a good deal.
  2. Some deal types and structures have yielded more success to the acquirers than others.Large deals especially Mergers of Equals are found to be challenging due to high integration costs and high possibilities of cultural differences arising post closing.
  3. Valuing a target is crucial to a deal success in order to prevent the acquirer from overpaying.It is recommended that the valuation is done by the inhouse teams rather than relying on bankers due to the conflict of interest.


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