Friday, January 11, 2013

Value is Estimated, Price is Paid

Today's blog continues our more detailed analysis of each of the 14 Keys to Acquisition Success.  We are at Point 10.

10.  Value does not equal price.   As our friend Bob Bruner has noted, Price is what you pay, Value is what you estimate.

This one is simple.  And fundamental to success.  And often overlooked.
When anticipating a deal, we estimate value.  It is an imprecise science involving discounted cash flow, price multiples, and comparables.  Each estimate requires judgement and our projection about the future.  True value is unknown and only realized with time.

This is, of course, at the core of business enterprise: risk and return.  Risk is inherent in business decisions - it is at the heart of opportunity.  But we need to be compensated adequately for the risks we take.  And the crucial, immediate key to that compensation is in the price we pay at the very beginning of a deal.

If the payment is in cash and doesn't involve earnouts or other contingent payouts, the price we pay is known, and even if payment is in stock or other securities, they can generally be converted to cash.  So a known price is paid in exchange for uncertain value.  There is no better or easier time to create or destroy value than when bidding for a potential target.   

The moral of the story is to be careful, very careful about estimating value.  It is easy to make mistakes.  To repeat: there is no better (easier) time to create (destroy) value than when setting the price.  Tread carefully. 

Joe's recent blog about the HP - Autonomy  deal noted is a good example: "The Autonomy deal - priced at 11X revenues, 24X EBITDA, 3X assets, and a 60%+ pre-bid stock price premium - was DOA at close."  Even without misrepresentations it would be hard to recover from such a rich payment.


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