Introduction to Corporate Finance

21: Mergers, Acquisitions and Corporate Control

When considering whether to attempt to acquire a target, the acquirer must determine what to bid

for the target. This bid price is tied to an assessment of the bidder’s fair market value. This determination

is typically made using one or more of the following valuation methods briefly summarised below.

It is important, of course, to keep track of whether you are determining the equity value or the total

company value (or enterprise value) of the target. Total company value equals the value of the target’s traded

securities, so in simplest terms company value equals equity value plus debt value. Therefore, if we know

debt value, it is easy to convert from equity value to company value (by adding debt value to equity value)

or vice versa. Rather than the total company value, investment bankers and other financial professionals

often determine enterprise value. Enterprise value is roughly company value minus the dollar value of excess

cash, where excess means cash that is not needed to operate the company efficiently.^12 That is, enterprise

value is the value of the company’s underlying operations. Given how difficult it is to determine which

cash is excess versus which is needed for operational purposes, enterprise value is usually determined by

subtracting all of the target’s cash. This concept will be discussed further in the next section.

21-3a MERGER VALUATION METHODS

Next, we discuss the following common merger valuation methods:

■ Discounted cash flow: As discussed in earlier chapters, DCF values a company based on the present

value of expected future cash flows, often discounted at the weighted average cost of capital.

■ Public comparables: Observable market values of comparable companies, typically publicly traded,

are used to estimate the market value of the target.

■ Precedent transactions: The premiums (or discounts) paid in recent acquisitions that involve the

target’s competitors, or other companies exhibiting similar characteristics, are used as a benchmark

for the premium above (or discount below) market value that an acquirer might be expected to pay

for the target in a similar transaction. Precedent transactions are often implemented via multiples,

as explained below.

As an example, the following excerpts were included in Sun Microsystems’s preliminary merger proxy

statement following the definitive agreement to be acquired by Oracle:

■ ‘Credit Suisse calculated [Sun’s enterprise] value as a multiple of certain financial data for selected

technology companies’ in similar technology sectors.’

■ ‘The calculated multiples included Fully Diluted Enterprise Value as a multiple of Revenue, EBITDA

and [operating income] ... The [comparable] companies were selected because they had publicly

traded equity securities and were deemed to be similar to Sun in one or more respects including the

nature of their business, size, diversification, financial performance and geographic concentration.’

■ ‘Credit Suisse also calculated the net present value of Sun’s free cash flows using Sun’s management

forecasts [of cash flows] ... In performing this analysis, Credit Suisse applied discount rates ranging

from 10.50% to 13.00% based on Sun’s estimated weighted average cost of capital.’

■ ‘Credit Suisse also calculated the premiums paid in selected technology [precedent] transactions

since January 1 2007 ... four weeks and one day prior to the announcement of the technology

transactions.’^13

12 More specifically: Enterprise value = Equity value + Debt + Preferred shares + Minority interest – Cash.
13 SEC preliminary merger proxy statement. http://www.sec.gov/Archives/edgar/data/709519/000119312509107681/dprem14a.htm

Which valuation method

typically yields the highest

valuation?

enterprise value

The total value of the

company (including debt,

equity and other securities)

that would need to be

purchased to control the

whole target entity

thinking cap

question