Value creation analysis - An alternative way of Merger model

hopinggtsgy's picture
Rank: Gorilla | 520

I read something about valuation creation analysis basically valuing the combined company after a merger and compare it to the original acquirer's implied value, I am a bit confused as to how this works and the mechanics, can someone tell me what is this analysis and maybe give an example and ways to calculate it?

I tried to search online but did not find anything too informative, help needed, thanks!

Comments (12)

Mar 7, 2017

Up!

Mar 7, 2017

bump!! anyone??

Best Response
Mar 7, 2017

Few ways to do this, but is essentially a way for a banker to make 1+1=3. In all of these it is important to remember that share price today is the present value of share price tomorrow, so only need to discount by cost of equity in the future. You are essentially comparing what the future share price would be assuming the same expected return on future earnings (with the value created).

  1. Capitalize synergies at estimated combined company EBITDA multiple and add to combined company enterprise value, solve for equity value.
  2. Forecast EPS and if Accretive deal and combined P/E multiple (usually weighted by ownership or market cap) to get equity value of combined company. Compare.
  3. Repeat step 2 and add in dividends compared to company A dividends after synergies and financing (or look at combined company dividend yield and divide by company yield pre deal to get new value).

The real magic here is using synergies and low cost of capital to replace more burdensome capital and assuming the market will give you credit for the difference. Don't look behind the curtain though.

Mar 7, 2017

Sorry, forgot to add one crucial piece. Multiply the implied stock prices by exchange ratio for comparison.

Mar 7, 2017

Haven't heard of this but it sounds like you're saying that you could subtract the pre-merger value of the acquirer from the post-merger and get the value of the target.

If there were no synergies and you were literally just slapping two companies together then ya, that difference would be the value of the target but as soon as you start to add synergies then it gets messy. And there's always synergies.

Learn More

7,548 questions across 469 investment banks. The WSO Investment Banking Interview Prep Course has everything you'll ever need to start your career on Wall Street. Technical, Behavioral and Networking Courses + 2 Bonus Modules. Learn more.

Mar 7, 2017

If you combined the companies for no reason, then you have a lot of work to convince your shareholders that it was a good idea. This analysis is used to show shareholders that the deal makes the value of their investment worth more than not doing the deal. When you use the numbers, it seems like less of a wave of the hand.

Mar 7, 2017

Thank you!! @George_Banker Thanks for taking the time and giving this detailed explanation, very helpful! I do have a follow up question:

I was able to extract some info on this subject from a friend of mine who is a M&A associate, he told me this formula: buyer's market cap + seller's market cap + synergies - changes in net debt. He spoke very fast on the phone and needed to get off the phone fast so I wasn't able to ask more.

I have a question: what does this change in net debt represent? And how to calculate it specifically?

Say, if buyer A's market cap is 800 m, has debt 200 m, cash 80 m, purchased the target B for 450 m (raised debt 200 m and used 50 m cash to do the deal), target B has 20 m cash, 40 m debt.

Can someone pls illustrate how to calculate the change in net debt in this scenario?? Pls excuse my numbers - I made them up just now so it's easier for everyone to illustrate with an example.

Thanks!!

Mar 7, 2017

Up!!

Mar 7, 2017

bump - anybody??

Mar 7, 2017

bump!!

Mar 8, 2017

We do this all the time in telecom especially when working with legacy LECs that want to expand their fiber network. Fiber companies typically trade at 11-12x while LECs trade at 6-8x so pretty much any transaction will be dilutive if you look at it on an EPS basis.

The value creation analysis can be done with a DCF but usually with just a multiple. For illustrative purposes, you project out what TEV would be in the standalone case by applying the current multiple to each year's EBITDA then go down to implied share price. Then you do the same thing with the pro forma company and for that you would use a blended multiple that's the pro forma TEV / combined EBITDAs plus run rate cost synergies. Apply the multiple every year and get down to implied share price. Compare the pro forma case vs the standalone and boom, illustrative value creation.

Pretty easy and straightforward, most annoying part is building out the actual operating models... if you're lucky you'll get there okay from your team to just use the company's projected financials

Mar 7, 2017
Comment