the seven sins in acquisitions… - valuewalk...p&g gillette piglet: no synergypiglet: synergy...
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Thesevensinsinacquisitions…
Aswath Damodaran
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1. RiskTransference:Attributingacquiringcompanyriskcharacteristicstothetargetfirm.
2. Debtsubsidies:Subsidingtargetfirmstockholdersforthestrengthsoftheacquiringfirm.
3. Auto-pilotControl:The“20%controlpremium” andothermyth…
4. ElusiveSynergy:Misidentifyingandmis-valuingsynergy.5. Itsallrelative:Transactionmultiples,exitmultiples…6. Verdictfirst,trialafterwards:Pricefirst,valuationtofollow7. It’snotmyfault:Holdingnooneresponsiblefordelivering
results.
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Testingsheet
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Test Passed/Failed Rationalization
Risk transference
Debt subsidies
Control premium
The value of synergy
Comparables and Exit MultiplesBias
A successful acquisition strategy
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Letsstartwithatargetfirm
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¨ Thetargetfirmhasthefollowingincomestatement:Revenues 100OperatingExpenses 80= OperatingIncome 20Taxes 8=After-taxOI 12
¨ Assumethatthisfirmwillgeneratethisoperatingincomeforever(withnogrowth)andthatthecostofequityforthisfirmis20%.Thefirmhasnodebtoutstanding.Whatisthevalueofthisfirm?
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Test1:RiskTransference…
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¨ Assumethatasanacquiringfirm,youareinamuchsaferbusinessandhaveacostofequityof10%.Whatisthevalueofthetargetfirmtoyou?
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Lesson1:Don’ttransferyourriskcharacteristicstothetargetfirm
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¨ Thecostofequityusedforaninvestmentshouldreflecttheriskoftheinvestmentandnottheriskcharacteristicsoftheinvestorwhoraisedthefunds.
¨ Riskybusinessescannotbecomesafejustbecausethebuyerofthesebusinessesisinasafebusiness.
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Test2:Cheapdebt?
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¨ Assumeasanacquirerthatyouhaveaccesstocheapdebt(at4%)andthatyouplantofundhalftheacquisitionwithdebt.Howmuchwouldyoubewillingtopayforthetargetfirm?
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Lesson2:Renderuntothetargetfirmthatwhichisthetargetfirm’sbutnotapennymore..
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¨ Asanacquiringfirm,itisentirelypossiblethatyoucanborrowmuchmorethanthetargetfirmcanonitsownandatamuchlowerrate.Ifyoubuildthesecharacteristicsintothevaluationofthetargetfirm,youareessentiallytransferringwealthfromyourfirm’sstockholdertothetargetfirm’sstockholders.
¨ Whenvaluingatargetfirm,useacostofcapitalthatreflectsthedebtcapacityandthecostofdebtthatwouldapplytothefirm.
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Test3:ControlPremiums
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¨ Assumethatyouarenowtoldthatitisconventionaltopaya20%premiumforcontrolinacquisitions(backedupbyMergerstat).Howmuchwouldyoubewillingtopayforthetargetfirm?
¨ WouldyouranswerchangeifItoldyouthatyoucanrunthetargetfirmbetterandthatifyoudo,youwillbeabletogeneratea30%pre-taxoperatingmargin(ratherthanthe20%marginthatiscurrentlybeingearned).
¨ Whatifthetargetfirmwereperfectlyrun?
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Lesson3:Bewareofrulesofthumb…
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¨ Valuationisclutteredwithrulesofthumb.Afterpainstakinglyvaluingatargetfirm,usingyourbestestimates,youwillbeoftenbetoldthat¤ Itiscommonpracticetoaddarbitrarypremiumsforbrandname,qualityofmanagement,controletc…
¤ Thesepremiumswillbeoftenbebackedupbydata,studiesandservices.Whattheywillnotrevealistheenormoussamplingbiasinthestudiesandthestandarderrorsintheestimates.
¤ Ifyouhavedoneyourvaluationright,thosepremiumsshouldalreadybeincorporatedinyourestimatedvalue.Payingapremiumwillbedoublecounting.
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Test4:Synergy….
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¨ Assumethatyouaretoldthatthecombinedfirmwillbelessriskythanthetwoindividualfirmsandthatitshouldhavealowercostofcapital(andahighervalue).Isthislikely?
¨ Assumenowthatyouaretoldthattherearepotentialgrowthandcostsavingssynergiesintheacquisition.Wouldthatincreasethevalueofthetargetfirm?
¨ Shouldyoupaythisasapremium?
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TheValueofSynergy
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Synergy is created when two firms are combined and can be either financial or operating
Operating Synergy accrues to the combined firm as Financial Synergy
Higher returns on new investments
More newInvestments
Cost Savings in current operations
Tax BenefitsAdded Debt Capacity Diversification?
Higher ROC
Higher Growth Rate
Higher Reinvestment
Higher Growth RateHigher Margin
Higher Base-year EBIT
Strategic Advantages Economies of Scale
Longer GrowthPeriod
More sustainableexcess returns
Lower taxes on earnings due to - higher depreciaiton- operating loss carryforwards
Higher debt raito and lower cost of capital
May reducecost of equity for private or closely heldfirm
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ValuingSynergy
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(1)thefirmsinvolvedinthemergerarevaluedindependently,bydiscountingexpectedcashflowstoeachfirmattheweightedaveragecostofcapitalforthatfirm.(2)thevalueofthecombinedfirm,withnosynergy,isobtainedbyaddingthevaluesobtainedforeachfirminthefirststep.(3)Theeffectsofsynergyarebuiltintoexpectedgrowthratesandcashflows,andthecombinedfirmisre-valuedwithsynergy.
ValueofSynergy=Valueofthecombinedfirm,withsynergy-Valueofthecombinedfirm,withoutsynergy
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Synergy- Example1Highergrowthandcostsavings
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P&G Gillette Piglet: No Synergy Piglet: SynergyFree Cashflow to Equity $5,864.74 $1,547.50 $7,412.24 $7,569.73 Annual operating expenses reduced by $250 millionGrowth rate for first 5 years 12% 10% 11.58% 12.50% Slighly higher growth rateGrowth rate after five years 4% 4% 4.00% 4.00%Beta 0.90 0.80 0.88 0.88Cost of Equity 7.90% 7.50% 7.81% 7.81% Value of synergyValue of Equity $221,292 $59,878 $281,170 $298,355 $17,185
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Synergy:Example3TaxBenefits?
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¨ AssumethatyouareBestBuy,theelectronicsretailer,andthatyouwouldliketoenterthehardwarecomponentofthemarket.YouhavebeenapproachedbyinvestmentbankersforZenith,whichwhilestillarecognizedbrandname,isonitslastlegsfinancially.Thefirmhasnetoperatinglossesof$2billion.Ifyourtaxrateis36%,estimatethetaxbenefitsfromthisacquisition.
¨ IfBestBuyhadonly$500millionintaxableincome,howwouldyoucomputethetaxbenefits?
¨ IfthemarketvalueofZenithis$800million,wouldyoupaythistaxbenefitasapremiumonthemarketvalue?
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Lesson4:Don’tpayforbuzzwords
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¨ Throughtime,acquirershavealwaysfoundwaysofjustifyingpayingforpremiumsoverestimatedvaluebyusingbuzzwords- synergyinthe1980s,strategicconsiderationsinthe1990sandrealoptionsinthisdecade.
¨ Whileallofthesecanhavevalue,theonusshouldbeonthosepushingfortheacquisitionstoshowthattheydoandnotonthosepushingagainstthemtoshowthattheydonot.
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Test5:ComparablesandExitMultiples
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¨ Nowassumethatyouaretoldthatananalysisofotheracquisitionsrevealsthatacquirershavebeenwillingtopay5timesEBIT..GiventhatyourtargetfirmhasEBITof$20million,wouldyoubewillingtopay$100millionfortheacquisition?
¨ WhatifIestimatetheterminalvalueusinganexitmultipleof5timesEBIT?
¨ Asanadditionalinput,yourinvestmentbankertellsyouthattheacquisitionisaccretive.(YourPEratiois20whereasthePEratioofthetargetisonly10…Therefore,youwillgetajumpinearningspershareaftertheacquisition…)
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Biasedsamples=Poorresults
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¨ Biasedsamplesyieldbiasedresults.Basingwhatyoupayonwhatotheracquirershavepaidisarecipefordisaster.Afterall,weknowthatacquirer,onaverage,paytoomuchforacquisitions.Bymatchingtheirprices,weriskreplicatingtheirmistakes.
¨ Evenwhenweusethepricingmetricsofotherfirmsinthesector,wemaybebasingthepriceswepayonfirmsthatarenottrulycomparable.
¨ Whenweuseexitmultiples,weareassumingthatwhatthemarketispayingforcomparablecompaniestodayiswhatitwillcontinuetopayinthefuture.
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Lesson5:Don’tbealemming…
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¨ Alltoooften,acquisitionsarejustifiedbyusingoneofthefollowingtwoarguments:¤ Everyoneelseinyoursectorisdoingacquisitions.Youhavetodothesametosurvive.
¤ Thevalueofatargetfirmisbaseduponwhatothershavepaidonacquisitions,whichmaybemuchhigherthanwhatyourestimateofvalueforthefirmis.
¨ Withtherightsetofcomparablefirms,youcanjustifyalmostanyprice.
¨ EPSaccretionisameaninglessmeasure.Afterall,buyingancompanywithaPElowerthanyourswillleadmathematicallytoEPSaccretion.
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Test6:TheCEOreallywantstodothis…ortherearecompetitivepressures…
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¨ NowassumethatyouknowthattheCEOoftheacquiringfirmreally,reallywantstodothisacquisitionandthattheinvestmentbankersonbothsideshaveproducedfairnessopinionsthatindicatethatthefirmisworth$100million.Wouldyoubewillingtogoalong?
¨ Nowassumethatyouaretoldthatyourcompetitorsarealldoingacquisitionsandthatifyoudon’tdothem,youwillbeatadisadvantage?Wouldyoubewillingtogoalong?
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Lesson6:Don’tletegosorinvestmentbankersgetthebetterofcommonsense…
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¨ Ifyoudefineyourobjectiveinabiddingwaraswinningtheauctionatanycost,youwillwin.Butbewarethewinner’scurse!
¨ Thepremiumspaidonacquisitionsoftenhavenothingtodowithsynergy,controlorstrategicconsiderations(thoughtheymaybeprovidedasthereasons).TheymayjustreflecttheegosoftheCEOsoftheacquiringfirms.Thereisevidencethat“overconfident”CEOsaremorelikelytomakeacquisitionsandthattheyleaveatrailacrossthefirmsthattheyrun.
¨ Pre-emptiveordefensiveacquisitions,whereyouoverpay,eitherbecauseeveryoneelseisoverpayingorbecauseyouareafraidthatyouwillbeleftbehindifyoudon’tacquirearedangerous.Iftheonlywayyoucanstaycompetitiveinabusinessisbymakingbadinvestments,itmaybebesttothinkaboutgettingoutofthebusiness.
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Toillustrate:Abaddealismade,andjustifiedbyaccountants&bankers
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TheCEOstepsin…anddigsahole…
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¨ LeoApothekerwastheCEOofHPatthetimeofthedeal,broughtintoreplaceMarkHurd,thepreviousCEOwhowasforcedtoresignbecauseofa“sex”scandal.
¨ InthefaceofalmostuniversalfeelingthatHPhadpaidtoomuchforAutonomy,Mr. Apotheker addressing a conference at the time of the deal: “We have a pretty rigorous process inside H.P. that we follow for all our acquisitions, which is a D.C.F.-based model,”he said, in a reference to discounted cash flow, a standard valuation methodology. “And we try to take a very conservative view.”
¨ Apotheker added, “Just to make sure everybody understands, Autonomy will be, on Day 1, accretive to H.P….. “Just take it from us. We did that analysis at great length, in great detail, and we feel that we paid a very fair price for Autonomy. And it will give a great return to our shareholders.
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Ayearlater…HPadmitsamistake…andexplainsit…
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Test7:Isithopeless?
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¨ Theoddsseemtobeclearlyweightedagainstsuccessinacquisitions.Ifyouweretocreateastrategytogrow,baseduponacquisitions,whichofthefollowingoffersyourbestchanceofsuccess?
This OrthisSoleBidder BiddingWarPublictarget PrivatetargetPaywithcash PaywithstockSmalltarget LargetargetCostsynergies Growthsynergies
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Bettertoloseabiddingwarthantowinone…
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Returns in the 40 months before & after bidding warSource: Malmendier, Moretti & Peters (2011)
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Youarebetteroffbuyingsmallratherthanlargetargets…withcashratherthanstock
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Andfocusingonprivatefirmsandsubsidiaries,ratherthanpublicfirms…
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GrowthvsCostSynergies
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Synergy:Oddsofsuccess
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¨ Studiesthathavefocusedonsynergieshaveconcludedthatyouarefarmorelikelytodelivercostsynergiesthangrowthsynergies.
¨ Synergiesthatareconcreteandplannedforatthetimeofthemergeraremorelikelytobedeliveredthanfuzzysynergies.
¨ Synergyismuchmorelikelytoshowupwhensomeoneisheldresponsiblefordeliveringthesynergy.
¨ Youaremorelikelytogetashareofthesynergygainsinanacquisitionwhenyouareasinglebidderthanifyouareoneofmultiplebidders.
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Lesson7:Foracquisitionstocreatevalue,youhavetostaydisciplined..
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1. Ifyouhaveasuccessfulacquisitionstrategy,stayfocusedonthatstrategy.Don’tletsizeorhubrisdriveyouto“expand” thestrategy.
2. Realisticplansfordeliveringsynergyandcontrolhavetobeputinplacebeforethemergeriscompleted.Byrealistic,wehavetomeanthatthemagnitudeofthebenefitshavetobereachableandnotpipedreamsandthatthetimeframeshouldreflecttherealitythatittakesawhilefortwoorganizationstoworkasone.
3. Thebestthingtodoinabiddingwaristodropout.4. Someone(preferablythepersonpushinghardestforthemerger)
shouldbeheldtoaccountfordeliveringthebenefits.5. Thecompensationforinvestmentbankersandothersinvolvedin
thedealshouldbetiedtohowwellthedealworksratherthanforgettingthedealdone.
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AReallyBigDeal!
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TheAcquirer(ABInBev)
LatinAmerica42%
Africa0%
AsiaPacific11%
Europe11%
NorthAmerica36%
RevenueBreakdown(2014)
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TheTarget(SABMiller)
CapitalMix Operating MetricsInterest-bearingDebt $12,550 Revenues $22,130.00LeaseDebt $368 OperatingIncome(EBIT) $4,420.00MarketCapitalization $75,116 OperatingMargin 19.97%DebttoEquityratio 17.20% Effectivetaxrate 26.40%DebttoCapitalratio 14.67% After-taxreturnoncapital 10.32%BondRating A3 ReinvestmentRate= 16.02%
LatinAmerica35%
Africa31%
AsiaPacific14%
Europe19%
NorthAmerica
1%
RevenueBreakdown(2015)
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Settingupthechallenge
¨ SABMiller’smarketcapitalizationwas$75billiononSeptember15,2015,thedayABInBev announceditsintenttoacquireSABMiller.
¨ Thedealwascompleted(pendingregulatoryapproval)amonthlater,withABInBev agreeingtopay$104billionforSABMiller.
¨ CanABInBev create$29billioninadditionalvaluefromthisacquisitionandifsowherewillitfindthevalue?¤ Themarketseemstothinkso,adding$33billioninmarketvaluetothecombinedcompany.
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TheThree(Value)ReasonsforAcquisitions
¨ Undervaluation:Youbuyatargetcompanybecauseyoubelievethatthemarketismispricingthecompanyandthatyoucanbuyitforlessthanits"fair"value.
¨ Control:Youbuyacompanythatyoubelieveisbadlymanaged,withtheintentofchangingthewayitisrun.Ifyouarerightonthefirstcountandcanmakethenecessarychanges,thevalueofthefirmshouldincreaseunderyourmanagement
¨ Synergy:Youbuyacompanythatyoubelieve,whencombinedwithabusiness(orresource)thatyoualreadyown,willbeabletodothingsthatyoucouldnothavedoneasseparateentities.Thissynergycanbe¤ Offensivesynergy:Highergrowthandincreasedpricingpower¤ Defensivesynergy:Costcutting,consolidation&preemptingcompetitors.¤ Taxsynergy:Directlyfromtaxclausesorindirectlythroughdent
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Fournumberstowatch
1. AcquisitionPrice:Thisisthepriceatwhichyoucanacquirethetargetcompany.Ifitisaprivatebusiness,itwillbenegotiatedandprobablybasedonwhatothersarepayingforsimilarbusinesses.Ifitisapubliccompany,itwillbeatapremiumoverthemarketprice.
2. StatusQuoValue:Valueofthetargetcompany,runbyexistingmanagement.
3. RestructuredValue:Valueofthetargetcompany,withchangestoinvesting,financinganddividendpolicies.
4. Synergyvalue:Valueofthecombinedcompany(withthesynergybenefitsbuiltin)– (Valueoftheacquiringcompany,asastandaloneentity,andtherestructuredvalueofthetargetcompany)
¨ TheAcidTest¤ Undervaluation:Pricefortargetcompany<StatusQuoValue¤ Control:Pricefortargetcompany<RestructuredValue¤ Synergy:Pricefortargetcompany<RestructuredValue+ValueofSynergy
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SABMillerStatusQuoValue
SABMiller +CoorsJV +ShareofAssociates SABMillerConsolidatedRevenues $22,130.00 $5,201.00 $6,099.00OperatingMargin 19.97% 15.38% 10.72%OperatingIncome(EBIT) $4,420.00 $800.00 $654.00InvestedCapital $31,526.00 $5,428.00 $4,459.00Beta 0.7977 0.6872 0.6872ERP 8.90% 6.00% 7.90%CostofEquity= 9.10% 6.12% 7.43%After-taxcostofdebt= 2.24% 2.08% 2.24%DebttoCapitalRatio 14.67% 0.00% 0.00%Costofcapital= 8.09% 6.12% 7.43%
After-taxreturnoncapital= 10.33% 11.05% 11.00%ReinvestmentRate= 16.02% 40.00% 40.00%Expectedgrowthrate= 1.65% 4.42% 4.40%Numberofyearsofgrowth 5 5 5ValueoffirmPVofFCFFinhighgrowth= $11,411.72 $1,715.25 $1,351.68Terminalvalue= $47,711.04 $15,094.36 $9,354.28Valueofoperatingassetstoday= $43,747.24 $12,929.46 $7,889.56 $64,566.26+Cash $1,027.00- Debt $12,918.00- MinorityInterests $1,183.00Valueofequity $51,492.26
Price on September 15, 2015: $75 billion > $51.5 billion
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SABMiller:PotentialforControl
SABMiller ABInBevGlobal Alcoholic Beverage Sector
Pre-taxOperatingMargin 19.97% 32.28% 19.23%
EffectiveTaxRate 26.36% 18.00% 22.00%
Pre-taxROIC 14.02% 14.76% 17.16%
ROIC 10.33% 12.10% 13.38%
ReinvestmentRate 16.02% 50.99% 33.29%
DebttoCapital 14.67% 23.38% 18.82%
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SABMiller:ValueofControl
Status Quo Value Optimal valueCost of Equity = 9.10% 9.37%After-tax cost of debt = 2.24% 2.24%Cost of capital = 8.09% 8.03%
After-tax return on capital = 10.33% 12.64%Reinvestment Rate = 16.02% 33.29%Expected growth rate= 1.65% 4.21%
Value of firmPV of FCFF in high growth = $11,411.72 $9,757.08Terminal value = $47,711.04 $56,935.06Value of operating assets today = $43,747.24 $48,449.42+ Cash $1,027.00 $1,027.00+ Minority Holdings $20,819.02 $20,819.02- Debt $12,918.00 $12,918.00- Minority Interests $1,183.00 $1,183.00 Value of Control
Value of equity $51,492.26 $56,194.44 $4,702.17Price on September 15, 2015: $75 billion > $51.5 + $4.7 billion
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TheSynergies?
Inbev SABMiller
Combined firm (status
quo)Combined firm
(synergy)LeveredBeta 0.85 0.8289 0.84641 0.84641Pre-taxcostofdebt 3.0000% 3.2000% 3.00% 3.00%Effectivetaxrate 18.00% 26.36% 19.92% 19.92%DebttoEquityRatio 30.51% 23.18% 29.71% 29.71%
Revenues $45,762.00 $22,130.00 $67,892.00 $67,892.00
OperatingMargin 32.28% 19.97% 28.27% 30.00%OperatingIncome(EBIT) $14,771.97 $4,419.36 $19,191.33 $20.368
After-taxreturnoncapital 12.10% 12.64% 11.68% 12.00%ReinvestmentRate= 50.99% 33.29% 43.58% 50.00%ExpectedGrowthRate 6.17% 4.21% 5.09% 6.00%
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Thevalueofsynergy
Inbev SABMiller
Combined firm (status
quo)Combined firm
(synergy)CostofEquity= 8.93% 9.37% 9.12% 9.12%After-taxcostofdebt= 2.10% 2.24% 2.10% 2.10%Costofcapital= 7.33% 8.03% 7.51% 7.51%
After-taxreturnoncapital= 12.10% 12.64% 11.68% 12.00%
ReinvestmentRate= 50.99% 33.29% 43.58% 50.00%
Expectedgrowthrate= 6.17% 4.21% 5.09% 6.00%
Value of firmPVofFCFFinhighgrowth= $28,733 $9,806 $38,539 $39,151Terminalvalue= $260,982 $58,736 $319,717 $340,175Valueofoperatingassets= $211,953 $50,065 $262,018 $276,610
Value of synergy = 276,610 – 262,018 = 14,592 million
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PassingJudgment
¨ Ifyouadduptherestructuredfirmvalueof$56.2billiontothesynergyvalueof$14.6billion,yougetavalueofabout$70.8billion.
¨ Thatiswellbelowthe$104billionthatABInBev isplanningtopayforSABMiller.
¨ Oneofthefollowinghastobetrue:¤ Ihavemassivelyunderestimatedthepotentialforsynergyinthismerger(eitherintermsofhighermarginsorhighergrowth).
¤ ABInBev hasoverpaidsignificantlyonthisdeal.Thatwouldgoagainsttheirhistoryasagoodacquirerandagainstthehistoryof3GCapitalasagoodstewardofcapital.