Transactional Valuation - M&A / Private Equity August 2011

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1 Transactional Valuation - M&A / Private Equity

2 Agenda Valuation for Mergers and Acquisition Valuation for PE Valuation for Demergers Slide 2

3 Valuation for Mergers and Acquisitions Understanding difference between Merger and Acquisition Motives and Determinants of Merger / Acquisition Due Diligence findings that could impact valuation Key Considerations - Control Premium Possible Regulatory Checks Related Party Transactions Slide 3

4 Understanding difference between merger and acquisition Under a merger a new company / entity is formed and the existence of the merged entities is lost In an acquisition the acquired company loses its existence, while the acquiring company continues Payment Consideration In a merger the shareholders of both the merging companies continue to remain stake holders in the merged entities In an acquisition the shareholders of the acquired company may (in case consideration is in shares) or may not (in case consideration is in cash) continue in the acquiring company Motive Mergers are primarily for synergies and acquisitions could be of unrelated business or purely a financial investment (e.g PE) Valuation under mergers are relative and not absolute Slide 4

5 Motives and Determinants of Merger / Acquisition Synergies Operational Synergy (quick capacity enhancement, market reach) Financial Synergy (better leveraging) Diversification Integration Horizontal integrations (getting into similar products) Vertical Integration (Backward / forward) Tax Motives Enhancement of stake (Related Party Transactions) Financial Investment (PE) Slide 5

6 Determining the Motive behind a merger / acquisition Simplest rationale is undervaluation, i.e., that firms that are undervalued by financial markets, relative to true value, will be targeted for acquisition by those who recognize this anomaly. A more controversial reason is diversification, with the intent of stabilizing earnings and reducing risk or entry into new markets. Synergy refers to the potential additional value from combining two firms, either from operational or financial sources. Operating Synergy can come from higher growth or lower costs Financial Synergy can come from tax savings, increased debt capacity / lower financial cost, or cash slack. Poorly managed firms are taken over and restructured by the new owners, who lay claim to the additional value. Managerial self-interest and hubris are the primary, though unstated, reasons for many takeovers. Slide 6

7 Valuing Target based on underlying motive If motive is Undervaluation Diversification Operating Synergy Financial Synergy Control Manager s Interest Target firm Value target firm as stand-alone entity: No extra premium Value target firm as stand-alone entity: No extra premium Value the firms independently. Value the combined firm with the operating synergy Synergy is the difference between the latter and former Target Firm Value = Independent Value + Part of Synergy Tax Benefits: Value of Target Firm + PV of Tax Benefits Debt Capacity: Value of Target Firm + Increase in Value from Debt Cash Slack: Value of Target Firm + Surplus Cash Control Value of Target Firm run optimally Value of Target Firm: No additional premium Slide 7

8 Due Diligence Findings that may impact valuation Some Examples: Past vs projected performance may not be comparable Quality of reported earnings Non-compliance with environmental regulations Aggressive tax positions Inadequate access to information specifically business unit wise information Reported v Actual profitability determination could be a challenge Unfunded post-retirement benefits Large number of contractual employees resulting in restating profitability Informal arrangements and related party transactions Concentrated vendor / supplier base Title to assets may not be clear - Status of land use rights needs review in real estate industry Idle / under-utilized assets Unauthorized use of Intellectual Property Rights Slide 8

9 Key Consideration Control Premium Ideally, deduct the value of target as is from the value as if optimally managed. This would mean taking into account any change in investment and financing decision Practically, looking at industry average and the extent of control The value of control should be inversely proportional to the perceived quality of that management and its capacity to maximize firm value. Value of control will be much greater for a poorly managed firm that operates at below optimum capacity than it is for a well managed firm. Value of Control = Value of firm, with restructuring - Value of firm, without restructuring Negligible for firms which are operating at or close to their optimal value Control Premium / Discount should also be dependent on the resulting stake in the target. Whether to be considered In an acquisition if motive is control In a merger consider for the both companies Slide 9

10 Possible Regulatory Checks for Mergers SEBI Requirement - Fairness opinion required in case of a listed company merger by a merchant banker Approvals required Board Role of Non Executive Directors Shareholders Lenders / Creditors Court Stock Exchange (s) Registrar of Companies Valuer answerable to Stock Exchange, Court as well as Registrar of Companies Slide 10

11 Related Party Transactions Key Points for Consideration by the Board Whether the Valuer and due diligence advisor is independent, reputable and experienced? Consideration to Findings of due diligence report Valuer to consider and Share with Board Sharing of due diligence report / outcomes with Valuer Approaches considered by the Valuer If values significantly different under different approaches, how is it resolved? Quality of Projections Terminal Value share in business value WACC / Discount Rate Selection of Comparable Companies Treatment of surplus assets, contingent liabilities, etc. Other issues ESOP, Outstanding Warrants / Options Slide 11

12 Valuation for PE A PE acquisition is different from a business motive backed acquisition Limited Horizon period Expected returns as a financial investor (WACC could be higher based on expected return) Importance of Exit Value and Exit Mechanism to assess risk associated with exit Typically not included in managing the business Includes various safeguards (captured in shareholder agreement) Slide 12

13 Valuation for Demergers Ideally not required May be required for tax purposes Computation of demerger ratio may be done To determine the share capital base of the company a larger capital base may impact certain ratios like asset turnover, etc Slide 13

14 Thank You! This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers Private Ltd, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers Private Ltd. All rights reserved., a registered trademark, refers to PricewaterhouseCoopers Private Limited (a limited company in India) or, as the context requires, other member firms of International Limited, each of which is a separate and independent legal entity.

Introduction to Mergers & Amalgamations

Introduction to Mergers & Amalgamations Amrish Shah ICAI WIRC Seminar February 2013 Content Modes of M&A in India Amalgamation and Merger Basic concept Type of mergers Key driver for mergers Domestic mergers