M&A involves complex interrelated strategic, financial
and risk issues. It should be approached in an integrated multidisciplinary
manner. Nonetheless, M&A is usually handled in a disjointed manner by the
CEO, CFO and CRO-each with separate agendas. Thus, they fail to appreciate the
crossover involved. When all you have is a hammer, then everything looks like a
nail.
CEOs drive the investment process focusing on growth to
capitalize on perceived product market opportunities. They are focused more at
the strategic versus project - capital budgeting level. M&A serves as a
means of implementing that strategy. The key principle is whether the acquirer
is the best owner of the target’s assets - meaning it can execute the highest
value added strategy and use that execution to achieve increased shareholder
value.
The CFO focus is more on funding and transactional
execution. Additional considerations include the ratings and dividend implications
of the acquisition. CROs concentrate on how to manage the transactions
incremental risks. The objective is to ensure the acquirer’s capital market
access and ability to fund its on-going strategic plan is not interrupted. A
key risk management component is having sufficient capital to absorb unexpected
“bumps in the road “to avoid post close OMG moments. Other components include
risk mitigation (e.g. sprinklers), stress tests and scenario analysis.
Potentially conflicting external stakeholder considerations
also must be balanced thru effective Board level governance. Shareholders are
concerned with risk adjusted long term returns defined as ROE > Ke. Failure
to achieve such results will depress stock prices and attract activists or
raiders-especially when the share price drops below 75% of the firm’s comparable
firm transaction multiples. The actions of rating agencies impact the
acquirer’s capital market access and liquidity as was illustrated in the
disastrous RBS-ABNAMRO transaction. Finally, regulatory issues relating to
social issues such as jobs, EPA and antitrust must be considered as the
GE-Alstom transaction highlighted.
The following illustrates the relationships among the above
factors:
Let’s look it now from a financial viewpoint. For me the
best valuation equation is the one used by M&M in their classic 1961
dividend irrelevancy Article.
A firm’s operating value has two components:
1)
Assets in place: EBIT (1-t) capitalized by WACC.
Usually the focus of the COO with an emphasis on efficiency.
2)
Growth Opportunities: I (ROA-WACC) T also
capitalized by a WACC factor. The growth can come from internal means or
M&A. Usually, the focus of the CEO. Some firms have growth potential-e.g.
Facebook, while others have only limited growth opportunities and are valued
primarily as dividend machines. The keys are:
a)
I - how much you can invest-scale that impacts
NPV v IRR
b)
ROA-WACC-the spread without which growth has no
value. In an M&A context it is the difference between the premium and
synergies based on the best owner principle.
c)
T - the competitive advantage period which
determines how long the growth opportunity exists based on the sustainability
of entry barriers. T has dropped dramatically for the big pharma firms whose
drugs are going off-patent.
d)
WACC - risk estimate reflecting both business
and financial risk. A firm’s risk appetite is cyclical and is tied to it equity
value.
So get more tools in your tool belt to insure you use the
right tool. Everything is not a nail.
J
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