Session 7&8 Synergies and Acquisition Premium

Question 1

What is the general formula for the value of an acquisition?

Answer 1

Question 2

What is the breakdown of the acquisition price in an M&A transaction?

Answer 2

Question 3

What is the synergy perimeter?

Answer 3

Question 4

What are the three steps to valuing synergies?

Answer 4

1. Identification
   * Synergies are first identified based on levers to be activated:
   * Operating synergies: Revenue upside and cost savings
   * Capital synergies: Asset efficiency, increased debt capacity and tax benefits
2. Quantification
   * Identified synergies can then be quantified based on their:
   * Size and lieklihood of realization
   * Cost of implementation
   * Timing of capture
3. Valuation
   * Quantified synergies are finally translated into Net Present Value
   * DCF model should always be used
   * Multiples can be used when a quick estimate is needed and as a checkfor DCF valuation

Question 5

What is the difference between operating synergies and capital synergies, and what are their subtypes?

Answer 5

Question 6

What are the three characteristics that are involved in the quantification of synergies?

Answer 6

1. Dimension (poential size)
2. Cost of implementation
3. Timing

Question 7

What are the three types of synergies that need to be studied when considering the potential size of the deal?

Answer 7

Question 8

What are 3 of the major implementation costs for synergies in an M&A deal?

Answer 8

1. Employee related costs (e.g. relocation, early retirement)
2. Facility-related costs (e.g. moving or shutdown costs, breaking leases)
3. Other costs (e.g. financial costs from new capital structure, transaction costs for divestitures)

Question 9

What are the two major questions that have to be answered in regards to synergies timing for M&A deals?

Answer 9

1. How long will it take to capture synergies?
   * Some synergies can be fully implemented from the start (tax benefits can be 100% realized from the start)
   * Other synergies take years to be fully implemented (labor reduction may only be 50% realized in year 1)
2. For how long will synergies be captured?
   * One-off (asset divestiture)
   * Recurring for a limited time (purchasing power)
   * Recurring in perpetuity (higher yields)

Question 10

What is the way to calculate the value of synergies and the general form of the synergy waterfall?

Answer 10

Question 11

What are the common errors when dealing with synergies?

Answer 11

Question 12

What are premiums and discounts for?

Answer 12

In valuation, premiums and discounts are used to adjust certain base value, for two purposes:
1. reconciling differences in the characteristics of:
* the target; and
* the selected sample of comparables selected;
2. reconciling differences between different notions of value

Question 13

What 2 factors are the observable differences with respect to the base value due to in premiums and discounts calculations?

Answer 13

1. Risk profile
2. Size of profile of the cash flow

Question 14

What is another way to look at a premium or discount?

Answer 14

The calculation of a premium or a discount can be considered equivalent to an:
1. Adjustment to the discount rate;
2. Adjustment to the cash flow;
3. Adjustment to both of them (mind double-counting).

Question 15

What are the 2 subdivisions
of permiums and how are they related?

Answer 15

• Acquisition premium measures the difference between standalone values and acquisition values.
• The control premium is associated with the presence of only private benefits.

Question 16

What are the benefits of control of a company (private benefits)?

Answer 16

Question 17

What are the two different methodologies to estimate control premiums?

Answer 17

Question 18

What is the most popular technique for estimating takeover premiums?

Answer 18

Takeover premium = Takeover price – Market price (before the takeover announcement)

Question 19

What are the 2 reasons for a discount when acquiring minority shareholding?

Answer 19

1. impossibility of deciding strategic directives and participating in the selection of management → discounts for lack of control:
   * rationale: poor protection granted to the holders of smaller blocks of shares;
2. difficulty in trading the shares’ blocks of lower relevance to control → discounts for lack of liquidity or marketability;
   * rationale: difficulty in trading in the minority shares at an equitable price, and reasonable time period, and/or lower grade reserved to minority holdings when needing to give guarantees for obtaining financing.

Question 20

What are the 2 reasons for a discount when acquiring majority shareholding in a company?

Answer 20

It is also possible to apply a discount with respect to the base value of the entire equity, because of two factors:
1. the presence of specific risk elements such as:
* the dependence of the business on a strategic supplier;
* high levels of clients portfolio concentration; or
* deficiencies in the organizational structure;
2. the lower liquidity typical of the market for control in comparison with that of the stock market.

The holding discount is sometimes included in the class of company-level discounts. It deals with the under-valuation of:
* listed holding companies in comparison with the sum of the market values of the shareholding held in other listed companies.
The discount may be motivated by the fact that:
* a holding could be seen as a non-optimal shareholding portfolio; or
* tax inefficiencies might arise (e.g., the generation of taxable capital gains in the case of the alienation of the securities).