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