Strategic aspects of

acquisitions
Merger/Acquisition
Car Producers
Tyre Producers Car Industry Media Industry

 Horizontal
 Vertical
 Conglomerate
Key reasons for acquisition
Organic growth VS Growth by Acquisition

Advantages of organic growth

• In line with stated objectives.
• Less risky
• Less Cost
• Avoids Integration problems

Advantages of growth by acquisition

• Quickest way to enter
• Fewer competitors.
• Reduces the risk of over-supply
• Increase market power
Synergy may be defined as two or more entities coming together to produce a
result not independently obtainable.
Types of Synergy

Revenue synergy Cost synergy Financial synergy

• Market power/eliminate • Economies of scale • Accumulated tax losses
competition • Economies of scope • Elimination of
• Economies of vertical inefficiency
integration • Corporate risk
• Complementary diversification
resources
Reasons why mergers/acquisitions fail

• Lack of due diligence

• Failure to integrate effectively
• Inability to manage change
• Window dressing
• The fit/lack of fit syndrome
 Culture differences and
integration difficulties
Impact on corporate
governance

02 03 04
Capital structure of
the combined entity.

Impact on board Corporate aspects of mergers

structure

01 05
Loss of key
personnel from
target company

06 The role of
regulations
The regulation of takeovers – General Principles

An independent valuer should

1 support valuations of assets

The profit forecasts and the

2 accounting polices used should be
examined and reported on by
qualified accountants.

3 Directors should act in the best

interest of the shareholders

Shareholders must be given all

4 the relevant information

5 All shareholders must be treated

equally.
Specific examples of regulation

Sell-out Squeeze-out Principle of

rights rights equal treatment
Right to the All group of
Minority
Right to the
Majority share shareholders must be
share holders treated equally
holders
Defences against hostile takeover bids
Market Capitalization

Market Based 1
P/E ratio
Market to book ratio

Cash Based
Dividend Valuation
Free Cash flow 2

Book Value
Asset Based
Market Value
3
CIV
The dividend valuation model (DVM)

A company has just paid a dividend of

20¢. The company expects dividends to
grow at 7% in the future. The company’s
current cost of equity is 12%.
Required: Calculate the market value of
the share.
The dividend valuation model (DVM)
The free cash flow method A company prepares a forecast of future free cash flow
at the end of each year. It is assumed that the planning
horizon is three years – i.e. returns are likely to grow
each year for the first three years after which they will
grow at 0.9% pa into perpetuity.
The following data is available: Free cash flows are
expected to be $2.5 million in the first year, $4.5
million in the second year and $6.5 million in year 3.
The stock market value of debt is $5m and the
company’s cost of capital is 10%.

Required: Calculate the current value of the firm and

the value of the equity.
The free cash flow method
Asset based valuation methods
The business is estimated as being worth the value of its Net Assets.
Net Assets = Total Assets – Total Liabilities – Preference Share Value

Monetary assets: book value

Tangible assets:
• Replacement value( if purpose is going concern)
• Realizable Value( if purpose is of disposal)
• Book value( if above values are not available)
Intangible Assets: consider if market value is available
Calculated Intangible Value (CIV)

1) Calculate a suitable competitor’s (similar in size, structure etc.)

return on assets

2) Calculate the company’s value spread

3) Assuming that the value spread would be earned in perpetuity,

the Calculated Intangible Value (CIV) is found as follows:
– Find the post-tax value spread.
– Divide the post-tax value spread by the cost of capital to find the
present value of the post-tax value spread as a perpetuity (the CIV)

4)The CIV is added to the net asset value to give an overall value of
the firm.
CXM operates in the advertising industry. The directors are keen
to value the company for the purposes of negotiating with a
potential purchaser and plan to use the CIV method to value the
intangible element.

In the past year CXM made an operating profit of $137.4 million

on an asset base of $307 million. The company WACC is 6.5%.
A suitable competitor for benchmarking has been identified as R.
R made an operating profit of $315 million on assets employed
in the business of $1,583 million.
Corporation tax is 30%.

Required: Calculate the value of CXM, including the CIV.

The form of consideration for a takeover
What form of consideration should be offered?
If a cash offer is to be made, how should the cash be raised?

Rights issue
Debt

• The company's
advantage of gearing
using (measured
debt in this
situation
using market
is the
values)
low cost
is not
of servicing
adversely
the debt.
affected.
• But
However,
earnings
raising
per share
new debt
(EPS)finance
will fall
willnew
as increase
sharesthe
arebidding
[Link]’s
gearing.
Key issues relating to forms of consideration

Position of the target

biddingcompany’s
company
shareholders
and its shareholders

•• Certainty
Dilution inofcontrol
Value
•• Retention
Impact onof financial
intereststatement,
in Combined
[Link]–
• Tax
effect
Planning
on Gearing, EPS etc.
Valuation of
Cash flow based 1
debt (Vd)