VALUATION OF FIRMS IN MERGERS AND ACQUISITIONS. OKAN BAYRAK. Definitions. A merger is a combination of two or more corporations in which only one corporation survives and the merged corporations go out of business.
- between competing companies
- Between buyer-seller relation-ship companies
- Neither competitors nor buyer-seller relationship
. Value of Operations:The value of operations equals the discounted value of expected future free cash flow.
. Value of Debt
. Value of Equity
- Fundamentally to increase its value a company must do one or more of the following:
. Increase the level of profits it earns on its existing capital in place (earn a higher return on invested capital).
. Increase the return on new capital investment.
. Increase its growth rate but only as long as the return on new capital exceeds WACC.
. Reduce its cost of capital.
. Determining the Risk-free Rate (10-year bond rate)
. Determining The Market Risk premium5 to 6 percent rate is used for the US companies
. Estimating The Beta
. Long explicit forecast approach
. Growing free cash flow perpetuity formula
. Economic profit technique
. HP-COMPAQ will become the leader in most of the sub-sectors
. Ability to offer better solutions to customer’s demands
. New strategic position will make it possible to increase R&D efforts and customer research
. Decrease in costs and increase in profitability
. Financial strength to provide chances to invest in new profitable areas
. Acquiring market share will not mean the leadership
. No new significant technology capabilities added to HP
. Large stocks will increase the riskiness of the company (Credit rating of the HP is lowered after the merger announcement)
. Diminishing economies of scale sector which both companies have already a great scale.
- (8)% to 46% over exchange ratios implied by average prices for the 10 trading days prior to announcement, with a median premium of 23%.
- (7)% to 58% over exchange ratios implied by average prices for the 20 trading days prior to announcement, with a median premium of 23%.
- (12)% to (29) over exchange ratios implied by average prices for the 1 trading days prior to announcement with a median premium of 15%.
Based on its analysis, Salomon Smith Barney determined a range of implied exchange ratios of 0.585x to 0.680x by applying the range of premiums for other transactions to the closing prices of Compaq and HP on August 31, 2001 and the average historical exchange ratio for Compaq and HP for the 10-day period ending on August 31, 2001, as appropriate.