Value creation through M&A

When promoter wants to create value through exit, the crucial question is "what is stand-alone valuation for entity?" In many cases it is easy to calculate and understand. Typical ratios like book value, leverage ratio, size of earnings, profit margin and return on equity generally reflects stand-alone valuations. Sellers know that they deserve premium on that stand-alone valuation. Seller expects premium from acquirer’s forecasted synergies. In M&A world, this premium is known as "controlling premium". In reality controlling premium is proxy of synergies that could be achieved post merger.



Sellers exit plans vary from social, financial, personal or strategic reasons. A cash starved company could infuse fresh equity capital and could demand premium for his established business. A promoter who can’t figure out their future business trend can think of an exit from existing business. If promoter’s majority of wealth is associated in his single venture, he could diversify his wealth with partial exit decision. A promoter, who sees his inability to develop new products or services for future development, can think of exit. In consolidation trend of industry, a merged entity can create economics of scale and thus create dominance among other smaller players. In all cases premium is paid to seller. A buyer who wants to expand geographically could pay premium for seller’s established distribution channel. A buyer could pay premium for synergic products or for forward or backward integration.



For successful deal making competitive factors, consolidation trends, economics of scale, and buyer-seller motivation should be understood by all participants. In any deal it is emphasized to thoroughly understand the value of synergy before negotiations begins. Seller’s benefit comes from negotiating the best possible price. The seller should attempt to determine what its maximum investment value is, which potential buyer may have the capacity to pay the most in an actuations and what alternative each buyer has, and then negotiate accordingly. A buyer’s benefits realize from not paying high price. A value oriented buyers should recognize that acquisitions price should be lower than the forecasted potential synergies.



In order to create value, however seller and acquirer must be able to measure and manage it. This process begins with the ability to identify and quantify these factors that create value for both. Is this ability not rare to seller and acquirer, who mostly do single deal in their life span!



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