In his latest interview with TMF, Michael Mauboussin offers a framework for investors to analyze any M&A deal. Here’s an excerpt from the interview:
M&A deals generally have a strategic and a financial rationale. A target company may be a great business but the acquirer still risks overpaying if its prospects are fully priced into the offer price. Further, earnings accretion is a demonstrably poor way to assess a deal’s financial merit. A much better approach is to compare the present value of the synergies the deal is expected to generate to the control premium the buyer offers. When the synergy value is greater than the premium, the deal adds value for the buyer. When the premium is greater than the synergy value, the deal destroys value for the buyer.
Taking a step back, we suggest addressing four issues when a deal is announced. The first is how material the deal is for the buyer. We answer this through the calculation of “shareholder value at risk,” or SVAR. SVAR determines what percentage of the acquiring company’s value is at risk if the deal creates no synergy at all. For a cash deal, SVAR is the premium pledged divided by the market capitalization of the acquirer. If no synergy materializes, the premium is a wealth transfer from the shareholders of the company buying to the shareholders of company selling. So SVAR measures the downside in the case the deal is a dud.
We also note what type of deal it is. Intuitively, opportunistic deals that are close to the buyer’s core business tend to succeed at a high rate, while transformation deals that launch a company into a new industry, rarely succeed.
How the company chooses to pay for the deal is also important. Historically, deals funded with cash do better than those financed with stock. The SVAR is higher for a cash deal than a stock deal, so confident buyers should always prefer to pay with cash if they can because there is more upside. Further, deal financed with stock may signal less confidence in the deal and may also suggest that management views its own stock as overvalued. While the signal from the form of financing is not always straightforward, expectations investors are attuned to the potential implications of the chosen form of remuneration.
Finally, comparing the present value of the synergy to the premium can help anticipate how the stocks of the buyer and seller are likely to react. Our website provides a tutorial, along with a downloadable spreadsheet, to guide this analysis: https://www.expectationsinvesting.com/online-tutorial-9.
You can read the entire interview here:
Michael Mauboussin – TMF Interview
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