Merger and Acquisition - Deal Making
M&A meaning, objective, process & examples.
Last month I signed up for M&A elective course as part of my HKU MBA program. As someone not from the finance industry, I was one of the students who decided to challenge herself to learn more about M&A.
Why not? M&A strategy is core for all businesses — either sales or buy side. Here are some of my key learnings from the course and a snapshot of the group project I worked on with my teammates: Ann Yang, Hiroe Li, and Anzhi Cheng
What is M&A: We all would have heard about X company buying Y company. Still, people don’t understand the level of complexity or the strategy behind the acquisition and why companies make M&A a part of their growth strategy.
The merger means X and Y form a new company called Z
Acquisitions mean Y becomes part of the X integral business.
The decision of which company to buy and the bidding process are very important, and valuing the target company is not just about finance but seeing the story behind the brand, and understanding & exploring the synergies behind an acquisition. M&A can fail when the intentions are good but have bad results or when you have bad intentions and bad results, or when you have agency issues like the CEO’s or board of directors’ hidden moto to sell the company.
You can do two kinds of acquisitions; a stock sale and an asset sale. A stock sale is where the buyer purchases the entire business entity and everything that comes with it, including assets and liabilities. Asset sale is where the buyer purchases a particular asset of the target business, such as a piece of equipment or intellectual property. Meanwhile, mergers are where two companies of the same size consensually join together to form one entity.
Why M&A is a core strategy: For companies, M&A is a part of their growth strategy, a powerful tool that can transform your business overnight. The primary intention of M&A could be for the following reasons:
- Cut down costs & build a new capability
- Enter a new market and gain market share (e.g., Disney x Fox)
- Be more potent in the industry (e.g., Microsoft x Activision)
- Kill the future competition (e.g., Facebook x Instagram)
- Product diversification (e.g., Apple x Beat)
- Defensive mechanism
- Leverage target companies’ patents, technology, and talent (Eg: Google X Motorola)
However, not all acquisitions are success stories; a bad acquisition could also devastate your business.
What is Leverage Buyout: LBOs are done by a financial sponsor, and they always have an exit strategy of 5 years. They buy the company and later sell it for profit. Financial Sponsor (they use 60 to 70% Leverage and look for companies with good cash flow) vs Strategic buyer (Invest in startups, less debt, and more equity) vs LBO (use a lot of leverage, 60% debt, high cash flow, and would like to exit with a 20% profit later. IPO could be part of their exit strategy. The goal will be to increase EBITDA and reduce debt. Most LBOs take bank debt, and covenants are part of the contract, which means they cant engage in risky tasks or crazy business.
AI impact on M&A: AI won’t take over the M&A roles as it majorly needs human skills; AI will make the process efficient and faster but won’t replace Investment Bankers. GPT can replace analysts’ jobs as it can tell you tomorrow’s stock price. Resilience, ability to communicate, and leadership are core to working in this field hence AI can only make them more efficient.
M&A Process: Going to explain the M&A process from an IBanker side with the help of my team project example. We picked up Giant Biogene, a Chinese home-grown functional skincare company that was founded in 2000 and listed in HKex in 2022
1. Identify a target company:
Pick a company performing well, and study its products, market cap, market growth, and financial status.
2. Forecast growth possibility:
Understand the market it functions in and project 5 years growth plans with some assumptions based on past track records.
3. Start the valuation process:
It’s essential to put a price tag or range for the target company by doing a details analysis of its Equity and enterprise value. A detailed study of the company’s competitive advantages, strategies, and financials, together with the industry perspectives, is conducted to understand key facts to be used as guardrails for the valuation. We used the Discounterd Cash Flow (DCF) model as the principal valuation method, with other comparable methods and precedent analysis, as a sanity check.
4. Look for comparable companies:
Comparable companies will usually share similar industry, business, and financial characteristics with the target. You will be able to make the most meaningful comparisons among valuation multiples of companies in the comparable universe when peers have similar prospects for growth and return on invested capital. Use Bloomberg terminal / CapitalIQ to look at company financial data.
5. Comparable and Precedent Transactions:
Comparable transaction analysis is used to determine a company’s value. This approach looks for similar or comparable past transactions in which the company targeted for acquisition has either a similar business model or is of similar size.
Precedent transaction analysis is a valuation method in which the price paid for similar companies in the past is considered an indicator of a company’s value. Precedent transaction analysis creates an estimate of what a share of stock would be worth in the case of an acquisition.
6. Valuation range:
With Discounted Cash Flow model as the principal valuation method and others as a sanity check, we derived an enterprise value for Giant Biogene ranging from RMB 90 billion to RMB 120 billion is suggested to be adopted for further negotiation with the potential buyers.
7. Look for potential buyers & look for synergies:
To fully maximize Giant Biogene’s potential and capture the market growth opportunities both domestically and in the international markets, it is imperative to select buyers with a successful track record of mergers & acquisitions, with strong synergy to be found with their existing business or portfolios.
Final thoughts: M& A is more than just the buying and selling of a company. There is a lot of strategy and complexity involved in every transaction. Each of the above-mentioned transactions is executed to transform a company into a better one.
