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Valuation and M&A cases

Giuseppe

HI,

I'm having a lot of trouble trying to understand what is the best mathematical approach to estimate the price of company target of a M&A strategy?

Does an interviewer ask to make calculation on discounting?

Thanks

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Sidi replied on 06/12/2018
McKinsey Engagement Manager & BCG Consultant | Interviewer at McK & BCG for 7 years | Coached 50+ candidates secure MBB offers

Hi Giuseppe,

short answer: the fair price of a company (assuming that you keep running the company) is its stand alone value (profits) PLUS synergies that can be expected over a certain investment horizon. Discounting is almost always disregarded in case interviews.

The interesting thing is that this principle thinking frame is not only true for M&A cases, but for 90% of all cases that you will ever encounter (market entry, new product, capacity expansion, licence purchase, etc. etc.). It is always about value creation! If you learn to rigorously think according to the principles of value creation, the typical case frameworks from Case in Point etc. become practically obsolete.

Cheers, Sidi

(edited)

Vlad replied on 06/12/2018
McKinsey / Accenture / Got all BIG3 offers / More than 300 real MBB cases / Harvard Business School

Hi,

Several important things here:

  1. In the case interviews, they don't ask you to do a discounting. Usually, you have to calculate the NPV of the project or the Value of the company in perpetuity in a very simplified way, i.e. = profit / discount rate (usually it's 10%). In rare cases, you will use a perpetuity formula with a growth rate - profit*(1+g.r.)/(disc rate-g.r.)
  2. Still, you should know what are the different valuation methods and how to apply them (NPV, valuation using the comps multiples, valuation using comparable transactions)
  3. In the cases about selling the company / assets, have in mind that sometimes it is more beneficial to sell different assets at the fair value
  4. In the M&A cases, they may ask you to calculate the value of the company, but usually M&A cases are much more about due diligence then thinking purely about valuation
  5. In the synergies cases, they never ask to calculate the NPV. Just calculate the total synergies (sometimes adjusted by probability)

Here is how to approach M&A and synergies cases:

1. For commercial DD in M&A you can use the following structure:

Market

  • Size
  • Growth rates
  • Profitability
  • Segments
  • Distribution channels

Competition

  • 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)

Company

  • Unit economics (Margins, costs) in current or target markets
  • Brand
  • Product mix
  • Key capabilities

Feasibility of exit:

  • Exit multiples
  • Exit time
  • Existence of buyers

2. For Synergies Calculation you can use the following structure:

  1. 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.)
  2. Cost synergies - typically you use a value chain structure tailored to the industry (e.g. supply-production-distribution-marketing-after sales support)
  3. Risks - major risks that can decrease the synergies (tip: don't underestimate the merging companies culture factor)
  4. 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

Good luck!

Francesco replied on 06/13/2018
#1 Expert for coaching sessions (1600+) | Ex BCG | 800+ reviews with 100% recommendation rate

Hi Giuseppe,

there are three general methods to estimate the price of a company

  1. Discounted cash flow (DCF). To calculate it you can follow the steps below:
    1. Find the average free cash flow generated in one year (which is different from the profit)
    2. Add/subtract the synergies and cannibalization effects affecting free cash flow
    3. Use the perpetuity method based on the free cash flow. You normally don’t have to discount, but should know the general formula
    4. Subtract net debt
  2. Multiples. The most common one is P/E (price/earnings) ratio. To use it
    1. Find the net earnings of the company
    2. Add/subtract the synergies and cannibalization effects affecting earnings
    3. Apply the multiple to the earnings of the client
    4. Correct for higher net debt of the company compared to the industry average from which you derived the P/E ratio
  3. Fair value of assets.
    1. Find the book value of the assets
    2. Adapt the value for increases/decreases in value
    3. Add/subtract the synergies and cannibalization effects affecting assets
    4. Subtract net debt

The ones you will actually find in an interview are methods 1 and 2 – DCF with perpetuity by far is the most common.

For more information on the DCF you can look at the following link:

https://www.preplounge.com/en/consulting-forum/case-net-present-value-calculations-325

Best,

Francesco

Anonymous A replied on 06/13/2018

I agree 100% with both Sidi and Vlad.

Here are some extra points to think about - I have never seen them in a case however great to chat about with the interviewer

Generally, in a public takeover, we use current share price +30% = Offer price. If you know there are for example 1 million shares outstanding, you can calculate the overall valuation price.

Also always ask for a multiple figures - a past sale etc to help benchmark the valuation also.

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