What is meant by the term synergies
What are some examples of synergies
Synergies are when benefits are created because the combined entity is worth more than the sum of the parts of the business.
Cost synergies are when expenses are reduced through economies of scale
Revenue synergies are when sales are increased through economies of scope.
Negative synergies - diverse holdings can create costs of inefficiencies due to diseconomies of scale.
What are some top down drivers of corporate transactions
High security prices.
High security prices lead to a higher value of your own stock, this means that you can use it basically as an overvalued currency in order to go out and make acquisitions.
High security prices lead to higher ceo confidence, this means they are more likely to go out and make speculative transactions.
Low cost of capital
If you have higher stock prices it means that the same deal costs less in terms of shareholder dilution than it might otherwise have.
Industry shocks
Often restructuring occurs in waves. One company in the industry will make an acquisition and then other companies will respond.
What are the three main types of transactions
Investment actions - focused on expansion - equity investments and jvs
Divestment actions - selling off a subsidary becaise you need liquidity or becuase you need to focus on a more core competency.
Restructuring - this can be split into two parts
- opportunistic restructuring used to improve returns
- forced restructuring necessary due to external pressures
What is the definition of materiality
Materiality is defined if it represents more than 10% of the acquiring companies enterprise value. Or if the savings that they are expecting is more than 10% of sales.
What are the three main types of investment action
Equity investments
Joint ventures
Controlling investments (acquisitions)
Explain equity ingestments
A company purchases a material but LESS THAN 50% stake in another company
Both companies maintain their independance, however the investor might be represented on the board.
You might want to exert strategic influence, or make a move towards an acquisition.
Explain joint ventures
What accounting method do you usually use here
Two or more companies contribute to a jointly controlled separate entity.
Often used to enter foreign markets by pairing with a company which has the domain knowledge.
You usually account for them through the equity method
Explain controlling investments
Controlling investment are when the company purchases a majority stake. They are then a subsidary of the other business.
They then report consolidated financial statements where they record all assets and liabilities. You need to look at the profitability and the leverage ratios in order to work out if the acquisition has been sucessful or not.
Explain divestment, and the two main types
Sales and spin offs
Divestment is when you sell of a subsidary business to meet liquidity needs, satisfy a regulator, or to refocus on core competency.
You can also use it to get rid of business units that are valued irrationally highly.
Explain sales in terms of divestment
Sales are when you sell the division to another company.
This si the opposite of an acquisition and oyu reciev cash proceeds that can either be retuned to shareholders, or reinvested. There is no longer any exposure unto the divested business.
Explain spin offs in terms of divesting
Spin offs are when the company creates a new separate legal entity, and distributes its equity to the parent company’s existing shareholders. This does not guarentee that the company which is engaging in the spin off will generate any cash proceeds.
What is the main method that people use to evaluate a divestment.
The main way is through a sum of the parts valuation. You use multiples like EV/EBITDA or EV/SALES to determine if the market is accturately valuing the segments compared to the whole. They also prepare pro foam statement to see how when you remove the division it impacts key ratios like the DEBT/EBITDA.
What is restructuring what are the two types
What is the difference between them
Restructuring is when you change the capital structure or operating by selling of splitting off operating assets. Opportunistic restructuring and forced restructuring
Opportunistic is when the company voluntarily changes things to improve return on capital
Forced is when external factors like less demand overcapacity and poor management mean that the business has to change
What are the types of restructuring actions
What are the two types of both of these
Cost restructuring
Cost restructuring is aimed at improving the operational efficiency of the business. This is usually after a period of poor performance.
Either outsourcing or offshoring
Outsourcing is when you move standardised processes to third party vendors
Offshoring is when you relocate a business process to a wholly owned subsidiary.
And balance sheet restructuring
Sale and leaseback. Selling an asset to a lessor and then leasing it back for the rest of it’s life
Dividend recapitalisation when you use debt to finance dividend or share repurchase, this can reduce the wacc if the debt is cheap however it is often suited to companies with stable cashflows.
What are LBOs
What are the 4 stages
Leveraged buyout is when you symletaniously have investment divestment and restructuring
1 investment
When a private firm uses a lot of debt to buy another company
2 divestment
When the firm sells unrelated parts of hte business to generate the cash for the debt
3 restructuring
The remaining operations are reorganised. These improve performance
4 exit
Once you’ve added value the pe firm exits through a sale to another company or a public listing.
How else can you use an LBO not for investment purposes
You can use it as a defence mechanism in a hostile takeover scenario
It’s a post offer defence mechanism becuase management can buy back all of the outstanding shares, and turn it into a privvate company, this protects it from the bidder as long as the value to shareholders by the management team are offering is better than the acquirers offer.
What is the initial valuation of a corporate action and what are the steps that you should take to establish it
Initial valuation
Preliminary valuation
Modeling and valuation
Update investment thesis
What are the key things you’re looking at during the initial evaluation
The investor is trying to work out:
What the action is
Why they’re doing it
When are they doing it
And is it a material transaction. Will it significantly impact the company’s value.
What are the two dimensions that you should evaluate materiality
Size and fit should be used to evaluate materiality
Size means is it 10% of the relevant metric
For acquisitions or divestments it’s 10% of enterprise value whereas for restructuring it’s relative to the total sales
What is meant by fit for materiality
Fit relates to how well the action aligns with the company’s existing business. Or their prior actions.
For example, divesting a business that was acquired for diversification means that this might have failed or that the strategy has changed.
What is a good indicator for wether the restructuring is appropriate or not
Usually hte stock price is a good indicator of whether the market thinks that the investment will be value accretive or destructive.
What are the three main ways that you can value the target of an acquisition
DCF analysis, comparable company analysis and comparable transaction analysis
Explain the dcf alaysis method for valuation of a target
What are the advantages or the disadvantages of using this method
DCF is an intrinsic method that estimates the targets value, by calculating the pv of the future cashflows to the business.
You create financial statement to estimate the future free cashflow.
You use a wacc that is relevant to the specific business’s risk profile.
Advantages are that it lets you model the target’s specific cost structure. And the operating synergies. It doesn’t rely on current market sentiment
Disadvantages are that it is highly sensitive to its inputs. Minor changes in the growth or discount rate will alter the value.
A large portion of the value si often tied to the terminal value which is often very uncertain.
Explain the comparable company analysis
Compatible company analysis takes the relative valuation metrics of a group of businesses that are similar, and then adds a takeover premium to determine a fair price for the acquirer to pay.
