Monday, June 9, 2014

Chance Favors the Prepared Mind

M&A is opportunistic. You cannot buy if the availability of suitable targets is poor, the prices are too high or the sellers are unwilling to sell. These factors are dynamic. Thus, potential acquirers must be prepared to move quickly when opportunities present themselves. For example, during the financial crisis a large number of motivated sellers at modest prices appeared. Buyers like Warren Buffett executed attractive transactions during the period.

Being prepared means the following:

1)     Knowing what you want to achieve: what is your end game - a financial or strategic transaction? If    strategic-what is the strategic rationale basis-consolidation, market share or products?
2)     What are the key target characteristics: size, location or performance?
3)     Buyer capability: do you have the skills to execute and operate?
4)     Financial resources: have sufficient debt capacity and liquidity to acquire?
5)     Strength of character: hard to be buying when everyone else is selling. Most managers are pro-     
         cyclical. Yet the best deals tend to be made in the worst of times e.g. Wells/Wachovia.

Equally important is making sure you are the Best Owner of the target. Best owners can obtain the highest risk adjusted cash flows from the target’s assets. No business has a unique fixed value. It varies over time depending on industry conditions, the strategy employed and operating efficiency of the management-owner team in charge. Best owners can obtain the highest value by employing new strategies and better execution to maximize risk adjusted cash flows. Simply put - best owners can extract the most synergies from an acquisition by bringing more than money to the table. Recent examples of this concept are being played out in the Big Pharma Industry.
Winning bidders usually pay a price close to the next highest bidder in a competitive bid situation. Whether the deal adds value depends on the value of the synergy improvement exceeding the premium paid. It is not enough to create synergies. You must create more synergies than the other bidders to avoid the Winner's Curse.

Synergies come in two flavors. The first are common synergies available to multiple bidders. An example is unused debt capacity. Common synergies typically are captured by the seller in the premium paid. Unique synergies are those that can be achieved bidders who are the best owner. Unique synergies are retained by the buyer.

The above can be reflected as follows:

1)     Deal Price = Target Pre Bid Price + Common Synergies +/- Market Cycle Premium/Discount
2)     Deal Value = Target Standalone Cash Flows + Synergies
3)     Value Added to Acquiring Firm =  Synergies - Premium
a)     Premium = Common Synergies +/- Market Cycle Premium/Discount
b)     Market Cycle Premium/Discount factors: financing liquidity + market momentum
c)     Synergies = Common + Unique
4)     Net Value Added to Acquiring Firm = (Unique Synergies + Common Synergies) -  (Market Cycle Premium/Discount + Common Synergies)  = Unique Synergies - Market   Cycle Premium/Discount

Thus, over priced late market cycle deals by bidders lacking unique synergies tend to be losers. Buyers need to know where they are in the M&A and Industry market cycles and whether they are the best owner of a target before bidding. So be prepared.


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