Merging with and acquiring other entities is often a smart strategy to access new markets, expand product lines, and capitalize on cumulative resources. But, a deal that looks good on paper does not always translate well in reality. A lot of M&A deals have floundered post-closing because of misplaced focus or unrealistic expectations. Granted, no one can ever be sure whether the merger will succeed after things are all said and done, but there are some important items to consider before moving forward. In many cases, it is the seller who comes out on top, as they usually reap the financial rewards without having to deal with much of the aftermath. Here is a down and dirty framework for assessing a prospective merger or acquisition:
An important goal for any strategic business decision is to increase shareholder value. Obviously, the goal of any merger or acquisition will be to increase revenue streams and maximize profit potential. When this happens and there is an overall increase in earnings for the company, then the earnings per share obviously increases, driving up shareholder value. The impact of a deal on shareholder value is something that has to be assessed for any potential merger or acquisition, but it can be hard to quantify as it often assumes best case scenarios. Many companies utilize the shareholder value at risk, which looks at the company’s value that is at risk in the event that the deal does not materialize as anticipated. There are different ways to calculate this depending on whether the deal is a cash sale, stock sale, or a combination of both.
Realization of Synergies
One of the key factors that will affect the expected increase in value has to do with the realization of synergies. Companies usually look at operational and financial synergies to see how and to what extent the joining of the two entities will enhance output and ultimately revenue. Companies often overestimate the likelihood and scope of prospective synergies, and there tends to be more focus on increased revenues via higher sales. However, higher revenues will be irrelevant if costs are not contained. Thus, it is important for companies to pay a bit more attention to the ways in which the companies can capitalize on cutting costs due to their newly combined efforts.
Cash versus Stock
The notion that cash is king continues to reign across all sectors and with virtually any kind of deal, M&A included. However, in a cash M&A deal, the buyer is assuming all the risk, while the seller is essentially guaranteed instant enrichment. On the other hand, stock deals allow the buyer to share the risk associated with the deal with the stockholders. This can actually be a good thing if the seller intends to retain some portion of those outstanding stocks, but it can also be quite problematic as stock deals often cause investor dilution. Thus, companies must carefully consider the consequences of an all cash, all stock, or mixed financing purchase.
The value of a deal can only be achieved when it is clear what it is that the parties are seeking. There are different reasons for companies to engage in M&A, and a deal is only successful if the reason for pursuing it is accomplished. For example, the purpose of an M&A deal may be operational, opportunistic, or transformational, but the end result does not always match the primary intention. As a result, companies have to determine whether they are willing to accept an alternative outcome given the risk of uncertainty.