7. Some Final Thoughts
Market View
In February 2012, United Parcel Service (UPS), the world’s largest logistics company, submitted an unsolicited offer for TNT Express, the Dutch delivery company. After months of trying to negotiate a friendly agreement with TNT’s management, UPS’s management decided to take its offer directly to TNT’s shareholders. UPS proposed to pay €9 a share to acquire TNT, a 42 percent premium to TNT’s share price the day before the announcement of the proposed transaction. In March 2012, UPS increased its offer to €9.50 and won TNT’s management approval.
Many investors were confident that the deal would go ahead, even after the European Union (E.U.) Competition Commission launched an in-depth investigation into the proposed transaction, citing concern about “a very high combined market share.” TNT’s share price barely moved after the commission announced the investigation in July 2012. It is standard for large M&As to require the approval of antitrust regulators, and although the financial community was prepared for the commission to demand that UPS and TNT divest some of their assets before approving the transaction, most analysts and investors were optimistic that the commission’s demands would not derail the acquisition.
In January 2013, however, the commission announced that it had prohibited the acquisition of TNT by UPS. Joaquín Almunia, the E.U.’s competition commissioner, said:
Many businesses active in the E.U. ... require access to affordable, reliable services that truly fit their needs. These businesses would have been directly harmed by the takeover of TNT by UPS because it would have drastically reduced choice between providers and probably led to price increases. We worked hard with UPS on possible remedies until very late in the procedure, but what they offered was simply not enough to address the serious competition problems we identified.”1
UPS had offered to sell some of TNT’s assets to DPD, a delivery company, but it was not sufficient to address the commission’s concern.
Following the commission’s decision to block the acquisition, UPS dropped its offer. As the financial community realized that there was no hope for the transaction and that no other bidder was in sight, many investors sold their shares in TNT. The company’s share price lost 49 percent in one day. Although the stock recovered in the following days, TNT’s share price after the failed acquisition remained lower than before the announcement of the proposed transaction in February 2012.
In the previous six chapters, we explored a variety of topics regarding the process of valuing a company. The journey involved a thorough analysis of a company’s historical and forecast performance, a number of accounting dilemmas analysts face when valuing companies, financial reporting and tax considerations, and the variety of valuation methods commonly used in today’s financial markets. In this chapter, we bring closure to the journey.
1 Valuation: A Debriefing
When reviewing a potential merger or acquisition, it is crucial for an acquirer to undertake a sound valuation of the target; to do otherwise is a certain invitation for the winner’s curse. After the acquirer has identified and screened a potential target candidate to ensure that the proposed merger or acquisition is appropriate from a strategic standpoint, the process of conducting the due diligence investigation begins. The first step is for the analyst to collect data—financial and nonfinancial—about the target and its environment. Then the analyst must analyze that data to fully understand the target’s business model, operations, and capital structure, and to be able to assess its financial well-being. This financial review is primarily based on accounting data; however, before the analyst can undertake this step of the due diligence investigation, he or she must verify the relevance and reliability of the accounting data. Indeed, issues such as the target’s revenue recognition, inventory, depreciation, asset capitalization, and asset revaluation policy can considerably affect the financial review. When the financial review is completed, the analyst can develop forecasts by means of pro forma analysis. The analyst is then ready to value the target using one or several valuation methods. The final step is for the analyst to perform sensitivity, scenario, and/or Monte Carlo simulation analyses to assess the sensitivity of the target’s value to the key assumptions made during the pro forma and valuation analyses.
As illustrated in Chapters 3 and 4, analysts have a wide range of valuation methods to choose from. Some are direct valuation methods, which provide a direct estimate of a company’s value. Others are relative valuation methods, which give an indication of a company’s value relative to a benchmark or peer group. Depending on the target’s industry, its characteristics, and the analyst’s preference and expertise, some valuation methods are more appropriate than others. Exhibit 7.1 provides a framework to guide an analyst’s choice regarding the most appropriate valuation methods(s).
2 Some Caveats to Consider
When valuing a target, the analyst must bear certain caveats in mind. First, whichever valuation method is used, a target’s value is highly sensitive to the assumptions the analyst makes to model the target’s future. As revealed by the valuation of Mattel in Chapter 3, the assumption regarding the growth rate to perpetuity was found to be crucial: With a growth rate of 5 percent, Mattel’s equity value per share was approximately three times greater than with a growth rate of 0 percent. Consequently, the analyst should always choose assumptions carefully and perform sensitivity, scenario, and/or Monte Carlo simulation analyses to assess the effect of each key assumption on the target’s value.
Second, each valuation method has its strengths and weaknesses. Thus, whenever possible, it is always best for an analyst to use several valuation methods. If the different methods yield relatively similar results, the analyst can have some degree of confidence that the financial modeling and valuation results are reasonable. In contrast, if the different methods yield significantly different results, the analyst should be skeptical about the valuation results and investigate the source(s) of the difference. These caveats make us mindful of one of this book’s key themes: Valuation is an art to be learned, not a science to be practiced.
3 Closure
Valuing a target can be a lengthy process. After an acquirer has determined a range of values for the target’s equity, it must negotiate a final price with the target’s management and/or shareholders. If the target rejects the acquirer’s offer, a hostile conflict could begin. Even if a friendly agreement can be reached between an acquirer and a target, the merger or acquisition is rarely free of impediments. For example, a competing bidder might enter the scene with a higher offer price and premium. In addition, the proposed transaction might not receive the necessary governmental and/or antitrust regulatory approvals, as illustrated by the vignette at the beginning of this chapter. Even if the merger or acquisition is completed, potential pitfalls remain, such as integrating the acquirer and the target. In short, many factors can cause a merger or acquisition to fail.
For managers who try to cross these waters, we end this journey by reiterating the five principal reasons M&As fail to create shareholder value:
1. Overestimation of the target’s value, primarily caused by an overestimation of the growth and/or market potential
2. Overestimation of the expected operating, financial and/or managerial synergies
3. Overbidding and overpayment
4. Failure to undertake a thorough due diligence of the target
5. Failure to successfully integrate the target after the merger or the acquisition
Analysts and corporate executives should always keep these five points in mind and work to avoid becoming the victim of a failed acquisition.
Endnote
1. This quote is available at http://europa.eu/rapid/press-release_IP-13-68_en.htm (accessed 8 March 2013).