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Valuation in Mergers & Acquisitions

Introduction

Towards the end of 2010, pundits predicted that Global Merger and Acquisition (‘Global M&A) activity would be robust in 2011 due to the fact that large corporations would have the means, motive and opportunity to make acquisitions:

  1. Means – large global corporations have sizeable cash reserves and access, however limited, to debt financing at historically low rates and on potentially favourable terms.
  2. Motive – after almost three or so years of difficult economic times, companies are seeking growth.
  3. Opportunity – given the length and severity of the economic downturn, many companies have not performed as well and are therefore for sale, shedding assets, or are vulnerable to an unsolicited bid.

According to the latest Allen & Overy M&A Index, the increased volume and value of ‘take-privates’ (i.e. where a listed company is taken private) and ‘recommended public acquisitions’ (i.e. where the acquiring company makes a public offer to purchase shares from the target) have played a significant role in boosting global M&A in Q1 2011 (compared to Q1 2010). Their findings reveal:

  • A 60% year-on-year increase in the value of global ‘public recommended’ M&A in Q1 2011;
  • A three-fold year-on-year increase in the number of mergers in Q1 2011;
  • A 150% year-on-year increase in the value of ‘take privates’ in Q1 2011.

Insights

Transport sector

According to Deloitte Research, there were major deals in the transport industry in 2010 as United bought Continental for $3.7 billion and Berkshire Hathaway bought Northern Santa Fe for $22 billion. Deloitte believes that more large transactions could be ahead. A big driving factor is the need for economies of scale as fuel prices rise in response to Mideast turmoil. If economic conditions improve, some transport companies will be interested in deals to support new strategic aspirations. Governments are putting transport services up for sale as seen in the case of the UK air traffic control service, the Spanish airports operator and debate in the US regarding the privatisation of Amtrak and air traffic control. There are also opportunities in emerging markets, where governments might agree to deals that offer the hope of expediting modernisation and expansion. For example, China will require 45 new airports in the next four years [Source: Deloitte M&A Market Trends and Outlook March 2011].

Retailers

French luxury goods conglomerate LVMH is paying over $6 billion to buy Italy’s Bulgari SpA. The transaction highlights an ongoing consolidation war in the lively, luxury-goods industry. The deal enhances LVMH’s first-place position and shores up its jewellery division, which had been an exception to the company’s pattern of leading in each of its segments.

Information Technology

In South Africa, Deloitte Corporate Finance was required to provide a Fairness Opinion on a deal that would see UCS Group Limited disposing of the majority of its business to the much larger Business Connexion Group Limited (BCX). The deal is worth approximately R706m and is motivated by the fact that both parties believe that the target companies would benefit from operating under the BCX banner (market reach etc). In essence, this is another effort to boost profitability within a target company through economies of scale. This is in line with global trends.

Thought leadership

The uptick in Global M&A will lead to an increase in the demand for Corporate Finance Services; valuation services in particular. Negotiating parties in the deal environment will have to be aware of the values that are on the table as these serve as the base from which acquisition premiums or discounts are derived.  Accurate representations of intrinsic value are therefore required in order to ensure that negotiating parties are not under or over-paying. This is more important than ever given that global stock markets seem decidedly out of kilter with the economies underlying them.

For example, the Dow Jones Industrial Average Index grew some 14% between September 2010 and March 2011 while the underlying economy grew by between 2% and 3% over the same period. Some may argue that the market is an indication of things to come rather than a reflection of the present. In this instance, the point is moot given that US GDP growth is expected to be 3% in 2011 according to the IMF. According to research by Plexus Asset Management, the current average p:e ratio of 17 times on the Johannesburg Stock Exchange is 30% higher than the historical average of 13.2 times since 1982 and 15,4% higher than the average since end-2004. This is despite the fact that economic growth in South Africa has slowed and prospects for the next few years are quite bleak. The disconnect between economic and stock market growth is a direct result of historically low global interest rates and the resultant increase in available investment capital.

Conclusion

Our view is that the market approach (i.e. applying multiples etc), often favoured by market participants is no longer suitable as a primary valuation method as it, more than ever, may not provide a realistic indication of intrinsic value. The income method (i.e. Discounted Cash Flow) is preferred since this looks through economic cycles and ignores market exuberance. However, the discounted cash flow method relies heavily on key inputs or assumptions and valuation results can be manipulated. Valuations are not for the faint hearted and valuation expertise, provided by the likes of Deloitte Corporate Finance, should form an integral part of any M&A transaction.

By Mmatu Mzaidume and David McDuff

Mmatu is a Manager at Deloitte Corporate Finance

David is a Partner at Deloitte Corporate Finance

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