A Phase-by-Phase Analysis of an M&A Deal
Mergers and Acquisitions (M&A) is a general term used to describe the process of combining two companies into one. News in the financial world is often littered with rumours of one firm’s hostile attempts to acquire another, or huge conglomerates looking to expand their market share through merging with other firms. In this way, M&A is fundamental to the financial world and the workings of the economy. But why would a company want to merge with or acquire another? And how does it take place? This article explores the timeline of an M&A deal whilst contextualising case studies along the way, pointing out reasons for potential success and failure.
Phase 1: Acquisition Strategy and Criteria
An investment bank is usually brought in by a company who wishes to investigate the possibility of merging with or acquiring another firm. M&A deals start with a set goal or target in mind. This can vary but ultimately it comes down to what the acquirer desires from the deal. There is a huge array of reasons as to why a firm may want a transaction to take place, and these can be generalised into two categories: financial or strategic. Financial reasons encompass reasons related to the return that can be achieved as a result of the deal (i.e. the money that can be made or the financial health improvements that can be made), while strategic reasons place more of an emphasis on benefits from dual-company synergies.
Once a strategy is established, it is then time to detail the criteria that the acquirer is looking for. The criteria are a description of what the acquirer wants from the deal. The list could be endless, but common examples include companies looking to access a certain consumer base, reach a certain profit level, achieve market penetration or acquire a certain product line to name but a few.
In 2019, the proposed merger of UK supermarkets Sainsbury’s and Asda was founded on the basis that the deal would lower costs for both firms. This is an example of a financial reason as through achieving lower costs, the firms are able to reach higher profit levels and more economic success. This benefit was estimated to amount to around £500m worth of capital improvements, brought about through synergies from the deal .
Phase 2: Planning
Once a strategy and criteria are found, the acquirer will screen for targets that could roughly meet the standards desired. It is integral here that the acquirer thoroughly assesses potential strengths and weaknesses in prospective targets.
It is also important here to consider any regulatory consequences of the transaction and how this could impact the deal in terms of length and cost. Arguably this was not sufficiently considered in the case of Sainsbury’s and Asda, whereby the Competition and Markets Authority (CMA) blocked the deal on the proposed grounds that it would form a monopoly in the UK supermarkets market and thus could potentially put customers at risk of higher prices and reductions in quality .
At this point, if the targets found are deemed a potential acquisition, contact will be made with these firms to see their openness to a deal as well as to obtain more information about them (e.g. financial data). If one target is then chosen for the acquisition, a letter of intent (LOI) will be sent to the target, notifying them of the proposed merger/acquisition.
Phase 3: Valuation
With the information gathered from the ‘Planning’ phase, various financial models and valuation techniques are used to estimate a figure for the deal.
One such valuation technique is Comparable Analysis, which involves comparing the current value and financial data of the proposed acquisition company to other similar firms. This can be done using various metrics. For example, analysts may look at data points such as enterprise value (a calculated statistic encompassing a range of financial data including debt, interest, share price and cash) or earnings per share (a calculation of profit divided by the number of outstanding shares) to compare the target acquisition to.
Precedent Transaction Analysis (PTA) is another technique that may also be used. This involves looking at similar deals that have occurred previously to create an estimate of what this acquisition could cost.
Another popular valuation technique is use of the Discounted Cash Flow (DCF) model. Analysts use financial modelling techniques to discount future estimated cash flows and values, which is then used to calculate a present enterprise value, thus giving an estimate of the company’s worth. This technique is often favoured as it is more open to scenario analysis (taking into account economic conditions) and is more accurate than valuing M&A cases using adaptive expectations (which is determining current and future values based on historical data).
The outcome of all this analysis, which can take between six months and a year, will be a figure with which the acquirer can approach the target with. The accuracy of this outcome is greatly important; fine margins can be the difference between a good deal, a bad deal and failed negotiations.
Phase 4: Negotiations and Due Diligence
Now that the valuation analysis is complete and an estimate has been made, the acquirer approaches the target company and begins negotiations following the LOI sent in Phase 2. This is where the finer details of the deal are considered, and the months of analysis and model-building are utilised to their full extent to agree on a final valuation figure.
Once this figure is agreed on, due diligence takes place. Due diligence is the process of authentication and investigation of the potential deal in order to confirm financial information and verify the accuracy of everything found in the valuation stage. This includes getting sales figures, an entire financial background of the company as well as the target company’s intellectual property level within the firm (copyrights, patents, etc.). Deals that undergo a high level of due diligence often have a higher level of success as decisions of higher quality can be made. Additionally, there are instances where the due diligence process enables the acquirer to re-open negotiations with the target company as they may have a more precise valuation figure.
Phase 5: Execution of the Deal
Finally, when negotiations are sorted and issues from the due diligence report have been corrected, the deal itself can begin to take place. The two companies discuss how the company is going to be acquired. The acquirer has the option of either a stock purchase (buying the target’s shares) or an asset purchase (purchasing the target’s assets – this is usually favoured and includes physical capital, intellectual property, etc.). Upon this decision being made, the two parties discuss the financing of the deal and begin communicating about the integration plan. As can be imagined, integration issues such as a lack of technological consistency between the two firms’ systems or differences in working culture may arise from the merging of two companies, so these must be considered and dealt with by the acquirer. Once the negotiations are closed and final meetings are held, the deal is done.
M&A enables businesses to grow quickly and achieve great economic success, but it is imperative that firms to focus upon thoroughness and accuracy throughout a deal, as ultimately, this is at the heart of determining overall success.