Definition:
Mergers and Acquisitions (M&A) is the process of identifying synergies and creating value by combining or divesting businesses, while Private Equity (PE) invests in businesses to grow, combine, divest or flip for profit.
- What it is: There are many relationships that can exist between businesses. Mergers, acquisitions, and private equity investments are just the start of the many forms of strategic alliances and relationships. Mergers and Acquisitions and Private Equity investments are often considered for the purpose of growing a business, but you can grow by building (Internal Growth), buying (M&A and PE), or borrowing (Strategic Alliances). The process of finding acquisition candidates or divestiture buyers is based on identifying synergies that are available to the buyer that are not available to the divesting entity. Defining hard (cost) and soft (growth) synergies are a critical part of the analysis.
- What does it do: Companies acquire new businesses to grow revenues, obtain technology, market presence, gain critical mass, reduce competition, or invest in future markets and profits. Private equity is a specialized version of M&A as they are betting on future growth and technology with the intention of divestiture or IPO. The divestiture is the mirror image of Acquisition and should be treated as an integral part of an M&A strategy.
Uses:
- How is it used: M&A and Private Equity analysis are used when a company wants to add capabilities, technologies, market position, revenues, cash flow, profits, or other resources that are held by another company. They can add those resources by buying the company, or invest in it or forming an alliance. While the most commonly discussed option is an acquisition, it is much more common for companies to form alliances to access the resources they need. The analysis to determine if a company should acquire, form an alliance or divest is encompassed in the M&A and Private Equity Analysis.
- Where: There are many places where these types of analyses are employed, below are just a few:
- Acquire a competitor: To increase scale, reach critical mass, enter new markets or geographies, or just reduce competition, a company may decide to buy a competitor.
- Private Equity: Private equity investors select early-stage companies that they think have the potential to grow into something much larger and create significant market value that they can harvest through divesting the business. It is understood in the industry that most private investments will break even or lose money. The hope is that the few big winners will make up for the investments that lose. So the analysis is built around defining the businesses with the most potential for large growth.
- Expand Geographically: Buying a company that participates in your business but in different geography allows a company to expand geographically with a foothold in place in the new geography
- Enter new markets: Buying a company that participates in the desired market creates an entrance and the opportunity for the company to grow in that new market
- Complementary Products: Buying or creating an alliance with a company that has complementary products can expand your customer base through cross-selling and reduce the cost of sales and marketing by having more products to offer to the same customer base.
- Diversification: A company can feel vulnerable to the ups and downs of their market and industry. By diversifying into new markets and industries they can spread the risk and reduce their reliance on a single industry or market
- Acquire access to technology: Through Alliance or acquisition, a company can gain access to the technology, knowledge, and application of another company. This can speed up their entry into a industry or market and can accelerate the growth of revenues and profits
- Vertical Integration: Companies can move upstream (buying suppliers) or downstream (buying customers) to try and gain scale and absorb profit pools in the value chain
- Taxation Optimization: There can be taxation advantage of acquisitions by buying someone that is losing money as an offset, or other tax-advantaged actions
- Acquire Resources: By buying, merging or forming alliances a company can add physical assets (e. g. manufacturing sites), technology development (e. g. labs and scientists), market position (e. g. marketing and sales resources), Name recognition (e. g. acquiring a brand), Capital Assets (e. g. equipment and offices) and many other forms of resources
- Why: Many people believe that the fastest way to new growth and profits is through acquisition and alliances versus creating organic growth by building their own businesses.
Limitations:
- Where it shouldn't be used: There are many trends in business and it is common to have a bubble form over technology or industry. As the bubble forms, businesses become overvalued. It is common for the market value of a business that is in a bubble to drop approximately 90% on average when the bubble bursts. Be careful of fads and overpaying for a business that is in an industry bubble.
- Any restrictions: There is a legal restriction to buying a business where the reduction in competition in the market will harm customers in the markets. So there are regulatory approvals that must be gained prior to the approval of the merger or acquisition.
- Warnings: Studies have shown that between 50% and 80% of all acquisitions fail to create value for the acquiring company. Many reasons have been postulated for this phenomenon, and some of the most common are:
- The acquiring company overestimated the soft (growth) synergies they expected to gain from the acquisition
- The acquiring company fails to show the discipline to capture the available hard (cost) synergies that were identified in the analysis
- The selling company overestimated their future growth and represented that optimist forecast in their due diligence, and therefore the acquisition price was far too high for the actual value the company would create in the future
- The president of the acquiring company is often considered to be too anxious and negotiates to get the acquisition target even when the price is far above the price that was recommended for the analysis. This drive to complete the acquisition at all costs, often causes the seller to be over-motivated and the acquirer to lose money in the acquisition process.
Demonstrations:
Step-by-step process:
Identify the Strategic intent: With any M&A, Private Equity purchase, or Divestiture you need to have a clear picture of what you are trying to accomplish. What will be accomplished through the M&A activity, what are the goals, and what will be the anticipated outcomes for the company? To determine whether you should Build, Buy or Borrow, see the following document for some of the things you should consider related to alliances vs. acquisitions: Alliances and M&A
- Set the M&A Criteria: What are the resources to be gained, will it be a vertical or horizontal merger or acquisition, size of a company, location, markets or industries, etc.
- Search for acquisition targets: Searching for target candidates can be accomplished through industry directories, industry organizations, competitive analyses, and other forms of searching for a company that meets the criteria that you have set. There are a number of databases in the HBLL or whatever College library you are using that have many filtered lists of companies that may meet your criteria (see Secondary Research/Library Resources) as well as tools such as Bloomberg Analysis and Capital IQ. There should be some initial filtering of the list as you compare each company to the M&A criteria that were previously established for this process. Then a target list of acquisition or merger candidates is created.
- Perform Valuation Analysis on selected targets: Each target candidate needs to go through a valuation process. There are a number of valuation approaches that can be used to determine if the target candidate has the potential to create value for the acquiring or merging organization, and at what price. It is most common to use several valuation techniques and triangulate the target price by comparing the outcomes of the various valuations methods. Some of the most common valuation methods include:
- Price-Earnings Ratio (P/E Ratio): With the use of this ratio, an acquiring company makes an offer that is a multiple of the earnings of the target company. Looking at the P/E for all the stocks within the same industry group will give the acquiring company good guidance for what the target's P/E multiple should be.
- Enterprise-Value-to-Sales Ratio (EV/Sales): With this ratio, the acquiring company makes an offer as a multiple of the revenues, again, while being aware of the price-to-sales ratio of other companies in the industry.
- EBITDA Multiples: Many valuations will look at multiples of EBITDA (a surrogate for cash flow). These multiples can range from near 4 times EBITDA to as much as 15 times EBITDA and more when high growth is anticipated in an industry.
- Divestiture analysis.ppt
- Bloomberg Analysis
- Capital IQ
Net Present Value (NPV) Analysis
- Decision Analysis
- Financial Modeling
- Comparing Alternatives
- Industry Analysis Using Porter's 5 Forces
- Asset valuation: A simple balance sheet analysis can determine the value of the existing assets. In this valuation, you are assuming no goodwill or value of a market position. In this reality, you are just buying the assets of the company. (see Capital IQ)
- Asset valuation: A simple balance sheet analysis can determine the value of the existing assets. In this valuation, you are assuming no goodwill or value of a market position. In this reality, you are just buying the assets of the company. (see Capital IQ)
- Historical earnings valuation: An analysis of the value of the company based on historical earnings. This can be found through reporting services and the companies' 10K filings and annual reports (e. g. Bloomberg Analysis). There is a danger in only looking backward. There may be many changes anticipated in the near future that could significantly change the earnings in the future and the future growth trends compared to what has happened in the past.
- Negotiation and Due Diligence: Once you have compared your alternatives and selected a candidate, you need to negotiate and complete due diligence. In due diligence, you ask for information from the candidate and complete your analyses again with the private information from the company, and look for what information you did not have as you created the initial valuation.
- Financing, Purchase, and Implementation: There are a number of resources that cover the different financing and implementation processes that are possible. Many of these issues are covered in the additional resources at the bottom of this page.
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