Wednesday, September 19, 2012

Sometimes the Best Deals are Those You Don't Attempt

Last week we wrote about 14 keys to acquisition success noting that each of the keys was worthy of extended discussion.  This week we begin that discussion, devoting one day of each week to providing more detail on one of the points we were making about acquisitions.  The first key was:

1.     Sometimes the best deals for your shareholders are those you don’t attempt or complete.

The point here is that not all deals increase shareholder value.  If, after detailed analysis and planning, a deal still doesn't make strategic and financial sense, don't do it.  It may be the best acquisition decision of your career.

The maximum an acquiring firm should pay is the net present value of the deal to their firm.  That is, estimate the present value of the cash flows after the acquisition and then subtract the cost you are paying for the company.  The result is your net present value.  In theory, you should pursue any deal where the NPV is positive.

In view of this logic, why would an acquiring company ever pay more than this estimated value?  The reasons are many, but a partial list includes the following:

  •   The acquiring firm overestimates the synergies, imagining that the target firm is worth much more under their management.  Solution: always ask yourself -why are these synergies unique to our firm and why haven't they been bid away?

  •  The bidding management wants to acquire for the wrong reasons.  For example, the bidding management views size as a reason to acquire, ignoring the impact on shareholders.

  • The bidding management gets caught up in 'deal fever' determined to win at all costs. The phase 'at all costs', obviously, implies a 'win' for the ego of bidding management and a loss for their shareholders. Often this happens after the deal is underway.  A potentially acquiring firm sees an 'opportunity'' escaping because 'someone else is willing to pay more for the firm'.  The acquiring firm ignores the fact that a) another firm may benefit more from increased synergies or b) the other firm is also overpaying.  The result is escalated premia and shareholder loss.

Bottom line: carefully analyze the strategic and financial implications of doing or not doing a deal.  But also recognize that the best deals for your shareholders can be those you walk away from.


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