Choosing the Acquiring Firm
Assume now that you are an analyst for an M&A group that advises acquiring firms. (The simplest assumption, which you do not have to use, is that you work for an advisor to the acquirer whose deal you worked on in project 1 and that the deal you studied in project 1 was successful enough that the acquirer is looking for another similar target). Your boss has asked you to propose the next target.
Points to cover in your report:
1.Choose your acquiring firm and study its Management Discussion and the risk section of the 10-K. Use that information to list three or four characteristics you think your acquirer should look for in a target firm.
2.Choose your target: (If you are sticking with the same acquirer you might go back to the set of firms from Project 1 that had attractive growth and operating margins.) Clearly explain the reason or reasons for your selection.
3.Briefly describe your target firm and your acquiring firm, including main lines of business and recent positive or negative news.
4.Select at least ten firms that are possible comps for your target, collect the most recent data for expected revenue growth[ There is a new comps spreadsheet posted that computes Expected Revenue Growth. ] and the same operating margins you used in Project 1. After you sort the data on revenue growth and the operating metrics, choose your set of firms that are comparable to the target. Then, collect the current multiples for EV/Rev, EV/EBITDA and EV/EBIT for the comps and decide which multiple you are going to use for the Continuing Value calculation in your DCF valuation of the target. Explain your choice.
5.Get the acquirer’s and the target’s WACC and Income Statement, Balance Sheet and Cash Flow Statement from Bloomberg. Use the information on the target to fill out the historical percentages section in the DCF. Use this information to decide on assumptions for Revenue Growth, EBITDA Margin, the tax rate, Depreciation+Amortization /Revenue, Net Capex/Revenue and Net Non-Cash Working Capital/Revenue for the target as a stand-alone enterprise. Explain your logic behind EACH of these assumptions.
6.Use these assumptions to fill in an initial DCF for the target. Use the target’s WACC for the discount rate and your valuation multiple from (2) to compute Continuing Value. You will have to program the DCF to use the multiple you want. Use the target’s balance sheet to fill in the lower portion of the DCF to derive an intrinsic value per share of the target. Include any assets and stronger claims you think are relevant. Compare this value to the current price of the target.
For extra credit, also add a Constant Growth or H-Model Terminal Value calculation in a separate DCF and compare the two values. Explain which terminal value model seems to make the most sense for this target. [ I will post blank spreadsheets with the formulations for the Constant Growth and H Model calculations.
3 If your acquirer is private you will have to estimate its WACC from comparable companies. Come see me about that issue.
7.Compare the Growth Rate and Operating Margins of the target to those of the acquirer. Adjust the DCF(s) if there are areas where the acquirer is superior to this target. Also, now use the acquirer’s WACC as the discount rate. Explain your adjustments and compare this value to the current price of the target.
For more extra credit, create a sensitivity table and/or a best and worst case scenario analysis or some sensitivity analysis using Goal Seek to enhance your prospective valuations of the new target firm.
8.Find the 52-Week High of the target. Use this and your answers to (4), (6) and (7) to set a range for the intrinsic value per share of your proposed acquisition.
9.Create an Executive Summary page that summarizes your analysis and conclusions. Give your reasons for selecting the target and explain whether you think the DCF value(s) of the new target is/are believable. Your cover page should also show a graph of the target’s price over at least the last three years. The graph should also show your range of intrinsic values for the new target.