Blog de ÀLEX PLANA PALUZIE
[Between laws & precedents] The purpose of this blog is to analize the legal system of Catalonia, Spain and Europe. It focuses mainly on business law and, in particular, corporate and mergers and acquisitions (M&A). It also addresses issues about economics, marketing, politics, current affairs and other legal systems different to the aforementioned.
Valuation and pricing of companies in M&A transactions
Butterflies - Odilon Redon
Regarding business acquisitions (M&A) we
need to separate the economic valuation of the company to be acquired (target)
and the price that the buyer (bidder) is committed to pay.
While it is true that the valuation of the
company can vary widely depending on the calculation method used and the
performance of the due diligence, the amount resulting from such valuation is
theoretically equal whatever the bidder.
As opposed to the economic valuation, the price
paid can vary widely according to each bidder. This means that the valuation
focuses on the object (the target) while the price focuses both on the object
and the acquirer subject (bidder). In this regard, it is important to note that
the price paid depend more on the economic advantage that the bidder can obtain
due to the acquisition, especially because the so-called synergies, than the
economic capacity of such bidder. Therefore, the maximum price that the bidder
can pay will be higher than the value of the target, probably with a control
premium and, this increased value (price) will be higher or lower depending on
the synergies resulting from the integration between the bidder (buyer) and the
target (seller), among other variables.
Another important fact to take into account is
that sometimes the benefit of the transaction is not to make a profit but to
avoid a loss. In this sense, a company may acquire another that does not imply
a direct profit but a way to avoid future losses.
The difference between value and price is due
to the following formula:
PP = V + P + Co + Cf
PP is the purchase price
V is the value of the company prior to the
acquisition (pre-money value)
P is the premium or control premium
Co (initial costs) is the transaction costs,
including financial and legal advisors, Notary public fees, taxes, borrowing
Cf (final costs) is the cost of the integration
As it can be seen with the formula, the value
of the company (target) is only one variable among others to obtain the total
price of the transaction. The valuation method is not 100% objective but need
to follow this path. However, the premium will depend on each sector (the more
competition exists between bidders in M&A transactions of one sector, the
higher is the premium) and the economic benefit that the acquirer can obtain
because the integration of the target (synergies). According to this, some
companies will be able to obtain more synergies than others, so then the
premium is higher or lower depending, in especial, on the bidder and its
economic benefits, more than due to its economic capacity.
During these competitive processes risk-benefit
relation also plays an important role. Therefore, the bidder willing to assume
higher risks may come up with a better price than another company with more
resources. All these circumstances explains the reasons why M&A
transactions study is a social science.
As the formula shows, in addition to the
valuation and premium, to determine the total price it is also required to
determine transaction costs. These costs can be separated between those
resulting from the execution of the transaction and those resulting after the