23 Aug Able to buy, or ready to own? Valuation and the true cost of M&A
In our work over the years, businesses typically do a great job of estimating and tracking the added costs of acquiring a business (eg broker commissions, legal fees, etc). Most also go to great lengths to model desired synergies (both top and bottom-line), and build these into their valuation. Yet what surprises me is how often the costs and risks of ownership are either not considered at all, or at best given much less attention than other financial aspects of a deal. Why not? In simple terms, it’s largely human nature to focus on these items – Cost to buy: easy. Benefits of ownership: positive, exciting and necessary to build the Business Case. Cost of ownership: uncertain, difficult to reliably estimate, and out in the distance.
A simple calculation however will confirm that these costs are the ones that should get at least as much attention as the other categories when conducting valuation. Of course every deal is different, but in a simplified ‘typical’ 3-year acquisition Business Case, the following numbers might surprise you:
- Deal fees (cost of purchase) commonly represents at least 11% of acquisition benefit
- A 10% reduction in net deal benefits achieved in the first 3 years represents 93% of deal fees
- Each month of delay in delivering deal benefits reduces net deal benefit by just over 4%; 6 months’ delay reduces it by 25%
- A ‘typical’ integration profile (ie one that includes commonly-seen reductions and delays in benefits delivery, and slight overruns in anticipated integration costs) can represent approximately 40% of net deal benefits. An interesting figure when compared to the regularly-confirmed view that 40% of acquisitions fail to add long-term value.
“Yes”, I can hear you say, “but even if it takes a little longer or costs a little more, we get there in the end so the short-term impact is more than compensated by the long-term benefits!” Nice idea in principle, but unfortunately largely untrue: Discounting, even at current WACC rates will still erode the present value of any future benefit. More importantly, benefits not achieved within the first three years typically are never achieved at all, especially those related to cost-reductions. Little short-term impacts post-close have long-term impacts to your deal benefits, and therefore to your deal valuation.
So what to do about it? Simple: Make sure your synergy modelling and deal valuation activities include a rigorous estimation of post-close costs and risks; put the right (operational and integration) people on the job, and don’t be put off by a culture or environment that sees these items as not material to the deal price or something that can be dealt with later. OK, sometimes not so simple, but critical nonetheless.