valuation for m a Building Value in private companies phần 1 pot

A great guide to computing market and strategic value for buyers and sellers, it also provides a wealth-building road map for private companies.. Ourtechniques incorporate value enhancem

“The authors bring a common sense approach to the complex subject of corporate valuations Their approach is rational and insightful and includes what value drivers or risk drivers most influence corporate value.

I particularly like the provocative questions throughout the book such as

‘how can the valuation reflect these various risk drivers and value drivers?’ ”

Russell RobbPresident, Association for Corporate GrowthManaging Director, Atlantic ManagementCompany, Inc

Editor, M&A Today

“No library on valuation for merger and acquisition is complete without this book A great guide to computing market and strategic value for buyers and sellers, it also provides a wealth-building road map for private companies Incisively written by two of America’s leading experts in the valuation of companies A must read!”

Steven F Schroeder, JD, ASA, FIBA, MCBAEconomic and Valuation Services

Richard M Wise, FCA, FCBV, ASA, MCBAWise, Blackman, CA

Jay Fishman, ASAPrincipal

Kroll Lindquist Avey

“A practical reference for business owners and M&A professionals The authors combine sound valuation theory with real-world insight One of the most valuable reference works which has crossed my desk.”

Michele G Miles, EsquireExecutive DirectorInstitute of Business Appraisers

VALUATION FOR M&A

Wiley M&A Library

Buying and Selling Businesses: Including Forms, Formulas, and Industry Secrets by William W Bumstead

Cost of Capital: Estimation and Applications by Shannon Pratt Joint Ventures: Business Strategies for Accountants, Second Edition by

PartnerShift, Second Edition by Ed Rigsbee

Winning at Mergers and Acquisitions: The Guide to Market-Focused Planning and Integration by Mark N Clemente and David S.

Greenspan

VALUATION FOR M&A

Building Value in Private Companies

Frank C Evans David M Bishop

John Wiley & Sons, Inc.

New York • Chichester • Weinheim • Brisbane • Singapore • Toronto

This book is printed on acid-free paper.

Copyright © 2001 by John Wiley and Sons, Inc All rights reserved.

Published simultaneously in Canada.

No part of this publication may be reproduced, stored in a retrieval system or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, except as permitted under Sections 107 or 108

of the 1976 United States Copyright Act, without either the prior written mission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, 222 Rosewood Drive, Danvers,

MA 01923, (978) 750-8400, fax (978) 750-4744 Requests to the Publisher for mission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 605 Third Avenue, New York, NY 10158-0012, (212) 850-6011, fax (212) 850-

per-6008, E-Mail: PERMREQ@WILEY.COM.

This publication is designed to provide accurate and authoritative information in regard to the subject matter covered It is sold with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional services If legal advice or other expert assistance is required, the services of a competent professional person should be sought.

Library of Congress Cataloging-in-Publication Data:

ISBN 0-471-41101-9 (cloth : alk paper)

1 Corporations Valuation 2 Consolidation and merger of corporations I Title: Valuation for M&A II Title: Valuation for M and A III Bishop, David M., 1940- IV Title V Series.

HG4028 V3 E93 2001

658.15 dc21 2001035231 Printed in the United States of America.

10 9 8 7 6 5 4 3 2 1

The mystery surrounding a company’s value often causes tives to make bad investment and operational decisions But thesepoor choices can be avoided Accurate valuations are possible andM&A deals can succeed for both buyers and sellers The keys tosuccess are in the pages that follow

execu-Through providing valuation advisory services to hundreds ofcompanies and thousands of corporate executives, we have devel-oped the tools to accurately measure and successfully build value

in companies By employing these techniques, owners and agers can determine their company’s value, what drives it, and how

man-to enhance that value both in M&A and through daily operations

In M&A, sellers, buyers, and even their advisors struggle overthe value of a business Often, they are frustrated by what they see

as the other side’s unrealistic expectations The following tainties abound:

uncer-• Do profits, usually computed as EBIT or EBITDA, representthe company’s true return to shareholders?

• Is the forecasted performance realistic?

• What is an appropriate rate of return or multiple,

considering the investment’s risk?

• Should the transaction be structured as an asset or stock deal?

• Has the seller properly prepared and packaged the

company to get the best price?

• What personal issues are of critical importance to the seller?

• Has the buyer found the best target and accurately

quantified potential synergies?

• Does the deal make sense at the quoted price?

vii

viii Preface

Greater fundamental mystery exists in private companies—those not traded on a public stock market, including thinly tradedpublic companies or divisions of large corporations Most ownersand managers operate these companies year after year withoutever knowing the answers to these basic questions:

• What is the company worth?

• How much more would a strategic buyer pay to acquire it?

• What factors most affect the company’s stock value?

• What is the owners’ real return on investment and rate ofreturn?

• Does that return justify the risk?

• Are owners better off selling, and if so, how and when? This book provides the tools to answer these and relatedquestions It is written for investors and managers of companieswho lack the guidance of a stock price set by a free and active mar-ket Our solutions to valuation and return on investment ques-tions create accountability and discipline in the M&A process Ourtechniques incorporate value enhancement into a private com-pany’s annual strategic planning to provide direction to share-holders in their investment decisions In short, our book is aroadmap to building value in both operating a company and sell-ing or buying one

Many investors have heard about building value in a publiccompany where the stock price provides the market’s reaction tothe company’s performance It is much more difficult to develop

a successful strategy and measure performance accurately when

no stock price exists Difficult, but not impossible

We invite our readers to employ these techniques to achieveaccurate M&A valuations and to build value in daily operations.Trade the mystery for this roadmap to wealth

Frank C EvansDavid M BishopJune 2001

Contents

CHAPTER 1 Winning through Merger and Acquisition 1

Critical Values Shareholders Overlook 2Stand-Alone Fair Market Value 4Investment Value to Strategic Buyers 6

“Win-Win” Benefits of Merger and

CHAPTER 3 Competitive Analysis 31

Linking Strategic Planning to Building Value 33Assessing Specific Company Risk 35Competitive Factors Frequently

Encountered in Nonpublic Entities 41

CHAPTER 4 Merger and Acquisition Market and

Common Seller and Buyer Motivations 47Why Mergers and Acquisitions Fail 48Sales Strategy and Process 50

Acquisition Strategy and Process 62

Key Variables in Assessing Synergies 80

CHAPTER 6 Valuation Approaches and Fundamentals 85

Using the Invested Capital Model to Define the Investment Being Appraised 87Why Net Cash Flow Measures Value Most

Frequent Need to Negotiate from Earnings

Managing Investment Risk in Merger and

CHAPTER 7 Income Approach: Using Rates and

Why Values for Merger and Acquisition Should Be Driven by the Income Approach 105Two Methods within the Income Approach 107Establishing Defendable Long-Term

Growth Rates and Terminal Values 113

CHAPTER 8 Cost of Capital Essentials for Accurate

x Contents

Contents xi

Fundamentals and Limitations of the Capital Asset Pricing Model 122Modified Capital Asset Pricing Model 125

Summary of Ibbotson Rate of Return Data 132International Cost of Capital 136How to Develop an Equity Cost for a Target

CHAPTER 9 Weighted Average Cost of Capital 143

Iterative Weighted Average Cost of Capital

CHAPTER 10 Market Approach: Using Guideline

Companies and Strategic Transactions 155

Merger and Acquisition Transactional Data

Guideline Public Company Method 160Selection of Valuation Multiples 164Market Multiples Commonly Used 165

CHAPTER 11 Asset Approach 171

Book Value versus Market Value 173

Use of the Asset Approach to Value Lack-of-Control Interests 174Asset Approach Methodology 174Treatment of Nonoperating Assets or Asset

Specific Steps in Computing Adjusted

Control versus Lack of Control in

Fair Market Value versus Investment Value 196

CHAPTER 13 Reconciling Initial Value Estimates and

Essential Need for Broad Perspective 200

Value Reconciliation and Conclusion 212Candidly Assess Valuation Capabilities 213

Deal Structure: Stock versus Assets 219Terms of Sale: Cash versus Stock 226

See the Deal from the Other Side 233

CHAPTER 15 Measuring and Managing Value in

Key Differences in High-Tech Start-Ups 236

xii Contents

Computation of the Stand-Alone

Computation of Investment Value 280Suggested Considerations to Case

The authors wish to thank those who provided valuable assistance to the writing of this book In addition to Maggie Horne, Cori Surano, Chuck Laverty, and Nancy Bernard at Smith Evans Strimbu Valuation Advisory Services, the talented professionals at John Wiley & Sons, and those individuals acknowledged at the end of certain chapters, our sincere appreciation and thanks go to:

Harry Evans, who offered faith and encouragement, as well as wickedly sharp red pen editorial review.

Frank Evans

Jeanne Bishop, whose talents and support have enriched both this book and my life.

David Bishop

ac-This book focuses on business value—what creates it, how tomeasure it, how to build it, and how to maximize it in merger andacquisition These concepts are equally important to buyers andsellers because both can and should benefit from a deal But dif-ferent results frequently occur Sellers may sell under adverse con-ditions or accept too low a price due to lack of preparation orknowledge And every buyer runs the risk of purchasing the wrongbusiness or paying too much That is why understanding value—and what drives it—is critical in merger and acquisition.

Wise shareholders and managers do not, however, confinetheir focus on value to only M&A Value creation drives theirstrategic planning and, in the process, creates focus and directionfor their company Their M&A strategy supports and complementstheir broader goal of building shareholder value and they buy andsell only when the deal creates value for them

1

Chapter 5 presents a very necessary second view of the potential results of M&A.

2 Winning through Merger and Acquisition

This brings us back to the purpose of this book It explainshow to create, measure, and maximize value in merger and acqui-sition in the context of the broader business goal of building value.Senior managers in most public companies focus on value everyday because it is reflected in the movement of their stock price—the daily scorecard of their performance relative to other invest-ment choices Private companies, however, lack this market feed-back and direction Their shareholders and executives seldomunderstand what their company is worth or clearly see what drivesits value For this reason, many private companies—and businesssegments of public companies as well—lack direction and under-perform

Managing the value of a private company, or a division of apublic corporation, is particularly difficult because that value isharder to compute and justify Yet most business activity—andvalue creation or destruction—occurs at this operational level.Being able to accurately measure and manage the value ofsmaller businesses or business segments is critical in the value cre-ation process And this skill will pay off in M&A as well becausemost transactions involve smaller entities Although we read andhear about the big deals that involve large corporations withknown stock prices, the median M&A transaction size in theUnited States in recent years has been about $25 to $40 million.Smaller deals involving closely held companies or segments ofpublic companies are the scene for most M&A activity

Therefore, every value-minded shareholder and executivemust strive to maximize value at this smaller-entity level wheredaily stock prices do not exist The concepts and techniques thatfollow explain how to measure and manage value on a daily basisand particularly in M&A The discussion begins with an under-standing of what value is

CRITICAL VALUES SHAREHOLDERS OVERLOOK

When buyers see a potential target, their analysis frequently begins

by identifying and quantifying the synergies they could achievethrough the acquisition They prepare a model that forecasts thetarget’s potential revenues if they owned it, the adjusted expense

Critical Values Shareholders Overlook 3

levels under their management, and the resulting income or cashflow that they anticipate They then discount these future returns

by their company’s cost of capital to determine the target’s value

to them Armed with this estimate of value, they begin tions aimed at a deal that is intended to create value

negotia-If the target is not a public company with a known stock price,frequently no one even asks what the target is worth to its presentowners However, the value the business creates for the presentowners is all that they really have to sell Most, and sometimes all,

of the potential synergies in the deal are created by the buyer,rather than the seller, so the buyer should not have to pay theseller for the value the buyer creates But in the scenario just de-scribed, the buyer is likely to do so because his or her companydoes not know what the target is worth as a stand-alone business.Consequently, the buyer also does not know what the synergiescreated by his or her company through the acquisition are worth,

or what the company’s initial offer should be

Sellers are frequently as uninformed or misinformed as ers Many times the owners of the target do not know if they shouldsell, how to find potential buyers, which buyers can afford to paythe most to acquire them, what they could do to maximize theirsale value, or how to go about the sale process After all, many sell-ers are involved in only one such transaction in their career Theyseldom know what their company is currently worth as a stand-alone business, what value drivers or risk drivers most influence itsvalue, or how much more, if any, it would be worth to a strategicbuyer Typically none of their team of traditional advisors—theircontroller, outside accountant, banker, or attorney—is an expert

buy-in busbuy-iness valuation Few of these professionals understand whatdrives business value or the subtle distinction between the value of

a company as a stand-alone business versus what it could be worth

in the hands of a strategic buyer

The seller could seek advice from an intermediary, most monly an investment banker or business broker But these advisorstypically are paid a commission—if and only if they achieve a sale.Perhaps current owners could achieve a higher return by improv-ing the business to position it to achieve a greater value before sell-ing This advice is seldom popular with intermediaries because itpostpones or eliminates their commission