I struggle coming up with a crisp approach how to evaluate an M&A situation (i.e., whether acquiring another company creates sufficient value). How to do this in a case interview??
Evaluating a potential acquisition
here is a rough high-level description of how I coach my coachees on M&A cases:
1. Clarify the underlying reasons objectives of the potential acquisition.
Reasons could be:
- General strategic reasons? (like consolidation pressure, access to new markets, diversification, preventing competitor moves,...)
- Tax advantages?
- Synergies (Revenue / Cost / Financial)
The objective will most likely be economic value creation.
2. If economic value creation is indeed the objective, you can build your framework on the following structure.
Condition for the acquisition to make economic sense:
[ (A) Initial value of the target] - [ (B) Excpected price for the acquisition] + [ (C) Value increase after acquisition] >> 0
- (A) is essentially an analysis of current profits projected over the target investment horizon (to be clarified with interviewer)
- (B) is, well, the price
- (C) encompasses expected profit increase due to better management, Synergies, but also the negative effects of integration costs and financing costs (if appliccable)
So you can build a framework consisting of these 3 blocks, and further enrich it with a 4th lens, i.e., risks and barriers (cultural, legal).
So there is an array of different analyses that need to be conducted for an exhaustive assessment. Within the frame of a case interview, informed hypothesizing and/or interviewer guidance will determine the focus areas.
At the consulting interviews you may have two types of PE cases:
- Due-diligence of the target company
- Synergies calculation of two merging companies
You can check which type of case you have by asking whether the PE fund already has another company in the portfolio for the synergies.
1. For DD you can use the following structure:
- Growth rates
- Distribution channels
- Market shares of competitors and their segments (see the next point)
- Concentration / fragmentation (Fragmented market with lots of small players is less mature and easier to enter from a scratch. Concentrated market is hard to enter but has potential acquisition targets)
- Unit economics of the players (Margins, relative cost position)
- Key capabilities of the players (e.g. suppliers, assets, IP, etc)
- Unit economics (Margins, costs) in current or target markets
- Product mix
- Key capabilities
Feasibility of exit:
- Exit multiples
- Exit time
- Existence of buyers
2. For Synergies Calculation you can use the following structure:
- Revenue synergies - here you calculate the synergies in price and quantity (depending on the case it may be new geographies, new products, new distribution channels, bigger share on shelves crosselling opportunities, etc.)
- Cost synergies - typically you use a value chain structure tailored to the industry (e.g. supply-production-distribution-marketing-after sales support)
- Risks - major risks that can decrease the synergies (tip: don't underestimate the merging companies culture factor)
- Total synergies potential in $, adjusted by risk (probability of failure)
In private equity interviews, the cases will be much more detailed in financial part. Depending on the company you'll need to:
- Find the relevant information in P&L and Balance sheet
- Do the simplified valuation using NPV: calculate cash flows and make assumptions about growth rate and discount rate
- Do the valuation using comps - you'll have to explain which comps you will use and why
You can find very interesting insights for your question in this previous thread (that is already addressing the same topic)
quoting a previous post that I wrote, I would consider the following steps:
1) GOAL CLARIFICATION. It is always good to start with the end in mind – thus what is the specific reason why they want to buy the company? Just make profits reselling in 3 years for a higher price? Benefit from synergies with a portfolio company? Test the market for a bigger acquisition?
2) INDUSTRY ANALYSIS. Industry evolution can have a strong impact on the future results of the target (think about newspapers vs cryptocurrency growth and size) thus should always be part of your analysis There are two macrovariables here.
- Key industry numbers/facts. This includes for the market and potential subsegments the following
- Barriers to entry (BTE)
- Key industry players. This includes:
- Customers segmentation
- Occasionally for some cases: suppliers and substitutes.
You should present this area connecting with the goal, and not purely listing the elements to analyse as if it was a laundry list. The best way to do so is explain how a certain variable will help you to achieve you goal. Eg, if your goal is to increase revenues with the acquisition, don’t simply say “I want to look at growth, size and BTE”, rather “I want to look at growth and size – this will tell me if the market segment of the target has the potential to provide enough revenues for our client. I would also like to check BTE, to understand which are the obstacles in entering such a market/segment via an acquisition and thus increase revenues”.
3) COMPANY - TARGET OBJECTIVE FEASIBILITY. Here you want to check the fit between the client and the target.
- What is the result in terms of the key objective we have (eg profits, revenues, increase in value, etc) if we buy this company?
- Are there positive or negative synergies with the acquisition?
In the first point, you will probably have to go through a profitability/revenue/cost framework, to calculate the effective result.
4) PRICE AND CAPABILITIES. Once you know the industry/segment is attractive and you can reach you goal buying the company, you should consider if the price is fair and you have enough capabilities
- Is the price fair? To understand so, you should do a comparison between the acquisition price and the company value, using multiples in the industry or a DCF analysis.
- Do we have enough money and other required resources (eg more proper management) to implement our strategy?
You can find more information on the DCF analysis at the link below: https://www.preplounge.com/en/consulting-forum/case-net-present-value-calculations-325
5) RISKS AND NEXT STEPS. What are the major elements that we should further analyse based on the previous points (eg regulator decision, potential other targets to consider, implementation risks, exit strategies)?
Hope this helps,
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