A primal simplification of the merger and acquisition process can be found in the universal predator/prey model.
After an assessment of the environment the predator (the acquirer) embarks on the hunt. It carefully considers the available prey (the targets) before making its move. By the time the dust settles one of two scenarios will have played out.
Either the predator emerges with the spoils or the prey escapes unharmed — nimbler and wiser — leaving the predator to try its luck elsewhere. But there are occasions when both predator and prey emerge from the affray better or worse for wear.
South Africa has witnessed its share of unsuccessful hunts in recent months. The freshest example is Tiger Brands’ failed attempt to acquire rival food producer AVI. The target’s executive dismissed an attractive offer out of hand, leaving Tiger’s shareholders carrying the can to the tune of R32.6-million.
BHP Billiton, which has a secondary listing on the JSE, also recently withdrew its ambitious offer for resources giant Rio Tinto, settling for a complex joint venture instead. Deals often fail because ‘the business environment evolves fundamentally during the time of the transaction”, says James Formby, head of corporate finance at RMB.
What has to be in place for a successful merger or acquisition? The deal must make commercial sense. The executive of both target and prey — hostile takeovers excepted — must be in basic agreement on the terms of the deal and the price (valuation) must be spot-on. Once these pillars are in place the dealmakers concern themselves with shareholder approval and regulatory issues.
Valuation becomes the cornerstone of any successful transaction. Edward Bell, an expert valuer at tax, audit and advisory firm Mazars Moores Rowland, says ‘companies are typically valued in terms of net asset value [NAV], price-earnings ratio [PE], or free cash flow [FCF]”.
The appropriate method varies from transaction to transaction.
NAV is favoured when determining the minimum value for a business, the price one would pay for the nuts and bolts of the operation. ‘The NAV valuation excludes goodwill, focusing on tangible assets such as buildings, plant, equipment and stock,” says Bell.
The PE valuation is determined by ‘applying an appropriate multiple to the annual earnings of the business”. It is common practice to base this multiple on companies plying their trade in a similar sector.
According to Bell, the ‘FCF method sets out to predict future cash flows on the basis of forecasts grounded in the company’s past performance”. An assessment is made of future turnover, working capital and capital requirements before analysts determine the present value of these future cash flows.
Traditional valuation techniques don’t cover all eventualities. Many service-oriented or technology companies derive value from intangibles. ‘A property-owning company which is a target company can easily have its assets appraised to form an objective valuation,” says Chris Bull, partner at Spoor & Fisher. But ‘intangible assets, and in particular intellectual property assets, are much harder to evaluate and value”.
During the dotcom boom in the late 1990s many valuations were based on ‘the apparent attraction of intangible assets”. Deal negotiators set massive premiums which later proved wholly inflated and contributed to the subsequent information technology collapse.
Bull is concerned with the number of local transactions that simply ignore intangible assets. He believes the target company should value intangible assets — including rights, relationships, undefined intangibles and intellectual property — before signing on the dotted line. These intangibles are valuable and measurable, with intellectual property protected by law.
Patents, proprietary technology, copyright, trademarks, registered designs and plant breeders’ rights must be considered during the valuation process. The only gray area in the business of valuation is objectivity, says Bell, adding that this remains the ‘Holy Grail” of business valuation.