Strategic Analysis for Mergers and Acquisitions

Mergers and acquisitions (M&A) are a part of corporate strategy looking to expand into new markets or geographies or territories and gain a competitive edge, or acquire new technologies, new products and services and new skill sets. M&A may increase value for the acquirer by creating an important value driver known as synergies (ways to increase profit/earnings through an acquisition), among other reasons. synergies can arise from an M&A transaction for a variety of strategic motives. They are as follows: 

  • Grow and diversify sources of revenue by the acquisition of new, strategic and complementary product and service offerings (revenue synergies)
  • Expand production capacity through acquisition of workforce and facilities (Operational Synergies)
  • Boost market share and economies of scale (revenue synergies/cost synergies)
  • Reduce and mitigate financial risk and potentially lower borrowing costs or loans (financial synergies)
  • Uplift operational efficiency and expertise (operational synergies/cost synergies)
  • Expand Research & Development (R&D) expertise, programs and results (operational synergies/cost synergies)
There has been an increased uncertainty about the economy in recent years making internal growth strategies relatively unattractive for many corporations around the globe, and that is why mergers and acquisitions have become an increasingly important part of corporate growth strategy to build more value for shareholders.Despite all of the strategic rationales and considerations, many acquisitions fail to create value for the acquirer’s shareholders. After all, shareholder value depends not on premerger market valuation of the target company but on the actual acquisition price the acquiring company pays compared with the selling company’s cash flow contribution to the combined company. Therefore, it is imperative that companies do their strategic valuation analysis before making any decision to acquire the target company.

Strategic Steps in the M&A Valuation Analysis

In M&A, the process of the acquisition valuation analysis focuses largely on three stages: planning, search and screen, and financial evaluation.
To begin with, the acquisition planning process starts with a review of corporate objectives and strategies for various strategic business units (SBU). The acquiring company should rely on its strategic growth objectives and its potential directions for corporate growth and diversification in terms of corporate strengths and weaknesses and an assessment of the company’s social, economic, political, and technological environment. This strategic valuation analysis produces a set of acquisition objectives and criteria which help the company identify the target company with more focus.
Specified criteria often include statements about industry parameters, such as projected market growth rate, degree of regulation, ease of entry, and capital versus labor intensity. Company criteria for quality of management, share of market, size, profitability, and capital structure also commonly appear in acquisition criteria lists.
The second step which is the search and screen process is a systematic approach to compiling a list of good acquisition prospects or target companies. The search focuses on how and where to look for candidates, and the screening process selects a few of the best candidates from literally many possibilities according to M&A objectives, strategies and criteria developed in the planning phase.
Last but not least, finally the financial evaluation process comes into play. A strategic valuation analysis should enable the board and management to address and cover the following M&A imperatives and considerations strategically:
  • The maximum price that should be paid for the target company;
  • The principal areas of risk and opportunities;
  • The earnings, cash flow, and balance sheet implications of the acquisition; 
  • The best way of financing the acquisition; and
  • The realization of M&A synergies.

Strategic Company Self-evaluation

During the financial evaluation process, it usually and strategically involves both a self-evaluation by the acquiring company and the evaluation of the target candidate for acquisition. The process itself is possibly to conduct an evaluation of the target company without an in-depth self-evaluation first, in general this is the most advantageous approach.The scope and detail of corporate self-evaluation varies according to the needs of each company being evaluated.

There are two fundamental questions posed by a corporate self-evaluation: (1) How much is the acquiring company worth? (2) How would its value be affected by each of several scenarios? The first question involves generating a “most likely” estimate of the company’s value based on management’s detailed assessment of its objectives, strategies, and plans. The second question calls for an assessment of value based on the range of plausible scenarios that enable management to test the joint effect of simulated combinations of product-market strategies and environmental forces.

Company self-evaluation can be considered as an economic assessment of the value created for shareholders by various strategic planning options and promises potential benefits for companies. In the context of the acquisition market, self-evaluation takes on special significance and can create many advantages for the M&A.

Many acquiring companies usually use and value the purchase price for an acquisition at the market value of the shares exchanged. This practice is not economically sound and could be misleading and costly to the acquiring company. A strategic valuation analysis for an exchange-of-shares acquisition requires sound valuationsof both buying and selling companies. If the acquiring company believes the market is undervaluing its shares, then valuing the purchase price at market might cause the company to overpay for the acquisition or to earn less than the minimum acceptable rate of return.

On the other hand, if the acquiring company believes the market is overvaluing its shares, then valuing the purchase price at market might obscure in offering the seller’s shareholders additional shares while still achieving the minimum acceptable return. Therefore, an in-depth strategic valuation analysis is needed in the M&A process.

Strategic Valuation Analysis of Acquisition

Firms commonly use multiple combinations and sequences of quantitative and qualitative methods to evaluate business acquisitions.  A correct valuation analysis that accurately determines a target's price can be a key factor in determining if a deal will be a good one or a bad one for the acquiring company.Based on M&A experience, realizing value is not always straightforward actually, it may often take 2-3 years for companies to get full returns or to realize its M&A value creation.

In the process of valuation analysis, there are primary and secondary valuation drivers. The first driver is a premium valuation which is a valuation well in excess of that of a company’s current valuation or in excess of the company’s peer group on a relative basis which is achieved through the combination of the right positioning of the companyand an effective M&A sale process (the second driver).

M&A process generally put together merger models to analyze the financial profile of two combined companies. The primary goal of the process of valuation analysis is to figure out whether the buyer’s earnings per share (EPS) will increase or decrease as a result of the merger. An increase in expected EPS from a merger will create an accretive acquisition, and a decrease in EPS will result in a dilutive acquisition.

A M&A valuation analysis consists of the following key valuation outputs:
  • Analysis of accretion/dilution and balance sheet impact based on pro forma acquisition results;
  • Analysis of synergies (revenue, operational and cost);
  • Type of consideration offered and how this will impact results (i.e., Cash vs. Stock);
  • Goodwill creation and other balance sheet adjustments;
  • Transaction fees.
Some M&A valuation methods and analyses used to establish a fair value for a target company in an M&A transaction may include:
  • Comparable Company Analysis
  • Discounted Cash Flow (DCF) Analysis
  • Accretion/Dilution Analysis
  • EBITDA Multiples
  • Revenue Multiples
  • Book Value

Mergers and Acquisitions (M&A) Process and Imperatives

Mergers and acquisitions (M&A) process involves a number of key legal, business, human resources, intellectual property, and financial considerations. To successfully navigate M&A deals, it is imperative that companies should understand the dynamics, issues and motives that frequently arise during the deal process.

Research shows that in deals where M&A strategies and best practices in merger management are employed, total shareholder returns rise at least some percentage points above deals without these practices.The M&A process has many steps and imperatives and can often take anywhere from six months to several years to complete. The following chart clearly demonstrates the acquisition process from start to finish (Corporate Finance Institute/CFI Education Inc., 2021).


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