Monday, April 19, 2010

PVs of M&A - Premiums and Synergies Analysis

There was an interesting perspective for Mergers and Acquisitions in the CFA course readings. Rather than look at accretion / dilution, there was the alternate perspective of looking at doing a sort of NPV analysis of M&A and seeing who benefits and what the implications are.

Example: Look at two companies A (Acquirer) and T (Target). The companies are all equity and have 100 shares each. However, A is valued at $1000 and T is valued at $400. Synergies (defined as the PV of all future cashflows) is valued at $200. The premium is $100 and the deal is all cash. What is the value of the combined entity, C?

C = A - Outflows + Inflows

Outflows = T + Premium
Inflows = T + Synergies

C = A - (T + Premium) + (T + Synergies) // T's cancel - makes sense, lose T in cash, but gain T in value by way of acquisition

C = A - Premium + Synergies
= $1000 - $100 + 200
= $1100

For the original share holders of A, the new stock price would be:
$1100 / 100 shares or $11, a $1 increase in value!

Note that T shareholders got $500 for their 100 shares or $5 each, also a $1 increase.

This is an interesting result, the actual value of T doesn't really affect the value of A. This alternative focuses more on two of the most important financial points of information on an M&A deal: Premium and Synergies. Because A and T split the synergies evenly through the premium, they both benefit the same. This result holds for any porportion of split between A and T shareholders based on the portion of the Synergies represented by the premium.

Another way of looking at it is this: Synergies are the value created in an M&A deal. The Premium represents what is picked up by the current owners of the target, T, where as what remains (Synergies - Premium) represents the value picked up by the original shareholders of A (the acquirer).

While this is a unique perspective, it also lends itself to another interesting result:

Continuing the example from above, the stock price for A is $10 ($1000 EV / 100 shares) and the acquisition price for T is $5 (($400 + $100) / 100 shares). A plans to acquire T by issuing T's current owners 1 Share of A for every share of T (giving away a "$10" dollar share for two "$5" dollar shares). We get an interesting result. Suddenly, the Value of A is different:

C = A + Outflows - Inflows


Outflows = 0
Inflows = T + Synergies = $400 + $200

Suddenly, value of C is $1600. Wow! Seems like we got something for nothing. But wait a second! We need to issue more shares to T's owners. How many? Well:

$500 EV / $10 per share = 50 shares.

So what is the new price per share of A? Well:

$1600 / 150 shares = $10.67 / share

Why is it lower? Where did the creation of value go? Well because A "gave away" some of their share of the synergies by paying T shareholders with PRE-merger valuations of their shares. Essentially, they gave T share holders some of their share of the synergies BEYOND the premium paid upfront in A's stock.

Note that T's former owners are now holding $10.67 for every two shares or $5.33 for each of their T shares or a $1.33 premium per share (@100 shares, thats $133). Notice anything interesting? The total synergies are the same ($67 for A shareholders + $133 for T shareholders = $200 total synergies), but T has taken a bigger slice. In the theoretical space, it is a zero sum game.

Why would A do this? A may not have enough cash on their balance sheet to entirely swallow T (they'd need T's full value in cash). Also, perhaps they are not entirely confident on being able to realize the synergies in the deal and are looking to share the risk with T's shareholders. Giving away stock might also incentivize some of T's current shareholders (aka current management) to stay, align their interests and realize the synergies.

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