THE MERGERS AND ACQUISITION MARKET. AN OVERVIEW. INTRODUCTION TO COMPANY

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THE MERGERS AND ACQUISITION MARKET. AN
OVERVIEW.INTRODUCTION TO COMPANYS VALUE AND
VALUATION TECHNIQUES.DCF AND COMPARABLES
Lesson 12
Corporate Finance
Castellanza, 24th November, 2010
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Business valuation definition of value

• Market value is a general estimate of what a
  business would sell for in the open market. It is
  independent of a particular investor
• Investment value is the value of the business to
  a specific investor. It would reflect synergies,
  a tax rate specific to the investor, and policies
  the investor is likely to implement
• Fair value is used in certain legal cases and
  the method is defined by statute

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How to realize an acquisition

• Analysis and definition of the industry and the
  target co.
• General screening of the co.s
• Specific analysis of the most interesting co.s
• Priority in contacts
• Way of contacting
• First approach

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Methods

• Assets
• Revenues
• Comparables Market approach
• Discounted Cash Flow (DCF) Analytical approach
• Each approach has advantages and disadvantages
• Generally there is no right answer to a valuation
  problem.
• More an art than a science!

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Comparables (Multiples)

• Multiple Enterprise value / most important
  element to value (EBIT, EBITDA, Sales)
• Compute the average of the multiple of the
  companies of the sample
• Multiply the average multiple obtained for EBIT,
  EBITDA or Sales of your company

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Discounted Cash Flow (DCF)
DCF capitalizes the cash flows the firm is
expected to generate Strenght reflects actual
benefits that investors care about better than
other methods Weakness relies heavily on
projections. Valuations are only as good as these
projections
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Discounted Cash Flow (DCF) (contd)
Ft Wf ? TV (1
k)t W companys value Ft Cash Flows
k discount rate n number of periods
considered TV terminal value of the company
n
t 1
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Cash Flows

• Cash Flows to Firm
• Cash Flows
• Cash Flows to Equity

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Cash Flows to Firm

• The FCF are the expected cashflows to the firm,
  i.e., the residual cashflows after meeting all
  operating expenses and taxes, but prior to debt
  payments, discounted at the WACC.
• EBIT
• -/ Change in Net Working Capital
• Depreciation, amortization
• - Investments
• Divestments
• Taxes
• Free Cash Flow to Firm

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Cash Flows to Equity
The CF to Equity are the expected cashflows,
i.e., the residual cashflows after meeting
operating expenses, tax obligations and interest
and principal debt payments and reinvestments
needs, at the cost of equity (ke), i.e., the rate
of return required by equity investors in the
firm. EBIT /- Change in Net Working
Capital Depreciation, amortization - Investments
Divestments - Interests Expenses - Principal
payments - Taxes Free Cash Flows to Equity
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Terminal value

• Fn / (k-g)
• TV
• (1 k)n1
• Because businesses are typically long-lived
  assets and detailed cashflows forecasts beyond 5
  yrs tend to be more fiction than fact, most
  analysts project cashflows for a finite period
  and then assume some normal terminal value at
  the end of that period
• g sustainable growth rate (usually long-term
  expected rate of inflation)

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Business Case 1 - Valuations

• How time can be critical
• Overview
• 1 case original business plan
• 2 case revised business plan
• Conclusion

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Business Case 1

• Alpha company operates in the Italian real estate
  sector.
• The following tables shows the flows deriving
  from the company business plan, as follow
• original business plan before the market drop
  (2007)
• revised business plan to show the expected
  flows after the crisis (2008)

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2
To suit the new scenario, the revised business
plan postpones the expected in-flows until 6
months
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Business Case 1

• 1 case original business plan

Projections
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Business Case 1

• 2 case revised business plan

Projections 6 month postponed
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Business Case 1

• Conclusion

1 case original business plan
2 case revised business plan
The equity value drops by 41
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Business Case 2 - Valuations

• Exchange ratios in a merger
• Overview
• The project
• Conclusion

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Business Case 2

• Overwiev
• Both the Companies operates in the same sector
• We are going to analyse a project of merger
  between Company A and Company B.

Company A Company B
Capital stock 37.000 (/000) 32.000.000 (/000)
Shares 37.000 32.000
Face share value 1 (/000) 1 (/000)
Revenues 249.592 (/000) 162.340 (/000)
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Business Case 2

• The Project
• The merger process is supposed to be structured
  on a valuation process based on general criteria
  of rationality, demonstrability, objectivity and
  stability.
• Methods choice on the basis of the business
  nature and investment plans the Unlevered
  Discounted Cash Flow method has been adopted.
• Values determination according to UDCF method,
  the consultant has considered it right to
  identify, instead of a precise value, a range of
  values of the share conversion ratio.

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Business Case 2
A sensitivity analisys has been made on the
basis of different assumptions, i.e. -the
potential companies prospecitve capacity to
generate benefits in terms of NOPLAT (Net
Operating Profit Less Adjusted Taxes) -different
debt ratios related to WACC (Weighted Average
Cost of Capital).
Company A (/000)
NOPLAT 7.8 7.8 5.9 5.9
WACC 6.1 5.7 6.1 5.7
Firm Market Value 82 91 59 66
Number of shares 37 37 37 37
Value of shares 2,2 2,4 1,6 1,7
Company B (/000)
NOPLAT 5.1 5.1 4.1 4.1
WACC 6.7 5.7 6.7 5.7
Firm Market Value 73 86 62 73
Number of shares 32 32 32 32
Number of shares 2,2 2,7 1,9 2,2
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Business Case 2

• Conclusion
• On the basis of the valuation process with the
  UDCF method the share conversion ratio was
  supposed to be in the sequent range
• A market approach method (market multiples
  method) has furthermore been adopted to validate
  the share conversion ratio

Conversion ratio 0.98 0.91 0.82 0.78
Conversion ratio 0.80 0.78 0.77 0.76
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Business Case 2

• Pursuant to the camparison between the different
  methods of valuation the board of directors
  suggested to consider a share conversion ratio
  between a minimum of 0.80 and a maximum of 0.85.

0.98
0.91
0.82
0.80
0.78
0.78
0.77
0.76
Flow approach Unlevered Discounted Cash Flow
Market approach Multiples