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Business Valuation is the process of determining how much a business (as a whole) is worth. A business valuation looks at all aspects of a company from the equipment and buildings to their employees and intangible assets, and comes up with a total “value” for the company as a whole.
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Lecture BM&A, June 13 1
Pankaj Khanna, Siemens AG Stuttgart, June 2013
Business Management & Administration Business Valuation / Mergers & Acquisition / Post Merger Integration
Lecture BM&A, June 13 2
Business Valuation
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Content
Lecture BM&A, June 13 3
Starting with some basics
What is Business valuation? Business Valuation is the process of determining how much a business (as a whole) is worth. A business valuation looks at all aspects of a company from the equipment and buildings to their employees and intangible assets, and comes up with a total value for the company as a whole. Why do we need to determine the value of a business? Transaction related reasons e.g.: - Acquiring or selling a business - Pay-out of a shareholder Non-transaction related reasons e.g.: - To check the credibility of a business - Tax reasons
Lecture BM&A, June 13 4
Starting with some basics
Definition Mergers & Acquisition
-> An acquisition normally involves the purchase of another firms assets and liabilities, with the acquired firm continuing to exist as a legally owned subsidiary of the acquirer. -> Takeover is often used for hostile acquisitions. -> A merger of equals on the other hand is a combination of two firms where a new corporate entity is created by exchanging the shares of both companies for shares in the new company. -> Most M&As, however, are simple acquisitions since only around three percent of all deals can be classified as real mergers between equals
Lecture BM&A, June 13 5
There are several types of mergers/acquisitions
Types of Mergers
9 Horizontal mergers: two companies in the same industry Vertical mergers: along the value chain of a good/service Product-extension: access to complementary products Market-extension: access to complementary markets Conglomerate mergers: different industries
Lecture BM&A, June 13 6
What are reasons for mergers and aquisitions?
- M&A as a Tool to Achieve Synergy (2+2=5 effect )
- M&A as a Tool to Achieve Strategic Objectives - Increased market power - increase vertical integration - Increase speed for certain technologies
- M&A as a Diversification Tool
- Other real reasons: - Investments of free cash flows (instead of paying dividends) - To keep on track with competitors - Angency Issue (increase management power) - overestimation of one's own capabilities
Lecture BM&A, June 13 7
The M&A process includes the integration of the acquired business Overview of usage for different valuation methods
Page 8 Lecture BM&A, Julne 13 8
The M&A process is divided into three phases
M&A phases Strategy Transaction
Imple- mentation
P-Proposal Signing
Core tasks Identify strategic gaps / technology evaluation Explore opportunities for external growth Market and competitive research Define acquisition goals Candidate screening / deal book Selection of target companies Manage interfaces
Support on screening and selection (e.g. financial reports)
Create indicative evaluations and initial business plan
Define financial dealbreakers / IRR considerations Support on P-Proposal
Continuous review of strategic fit of target (incl. Participation in DD
Support integration plan Manage interface to CD, Sector Strategy
Coordinate due diligence (incl. Financial, HR, Compliance, Legal, etc.)
Develop business plans and scenario analysis Perform valuation Deal structure Develop integration plan and retention concepts Follow-up negotiation process Manage interfaces to Business Owner Legal, tax
experts, treasury, functional experts (e.g. HR, Compliance),
Lecture BM&A, June 13 9
Business Valuation
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Content
Lecture BM&A, June 13 10
Business Valuation: What is the issue?
The basic problem of business valuation is how to set a value on all the assets of a business, including the intangibles.
Lecture BM&A, June 13 11
We will focus on market valuation and discounted cash flow method
Overview valuation methods
1) EPS: Earnings per share Source: Prof. Dr. Volker H. Peemller
Valuation methods
Earning value method Asset value method Market valuation Mixed valuation methods
DCF-method Earning value method
mit Netto-Cash-Flows
beim Eigner
mit Netto- Ausschttungen
des Unternehmens
mit Einzahlungs- berschssen
des Unternehmens
mit Netto-Einnahmen
des Unternehmens
mit Periodenerfolgen
des Unternehmens
Bruttoverfahren (Enterprise -Approach)
Nettoverfahren (Equity-
Approach)
APV-Verfahren (Adjusted Present
Value)
Similar Public Company Method
Recent Acquisitions
Method
Initial Public Offerings
Comparative Company Approach
Multiples
With full production values
(going concern)
With liquidation values
bergewinn- verfahren
Mittelwert- verfahren
Fair value calculation
Other valuation methods: - Leverage buy out analysis - Break-up analysis - EPS1) accretion / (dilution) - 52 week trading high-low
Lecture BM&A, June 13 12
The DCF*-method is the most exact but time consuming method
Classification of methods concerning time consumption and meaningfulness
high low
low
high Discounted Cash-Flow
Earning value- methode
Asset value method
Liquidation values
Market valuation
Effort for valuation
Meaningfulness of valuation
Lecture BM&A, June 13 13
There are substantial differences in usage of evaluation methods regarding seller or buyer perspective of the transaction
Usage of evaluation methods by seller and buyer side
1) DCF: Discounted Cash Flow 2) Based on transaction price Source: P. Beck 1995
Multiple-method shows biggest difference regarding user group
DCF 1)
85%
Comparable Analysis 2)
72%
Multiples
67%
Earning value
61%
Seller Buyer
DCF 1)
63%
Earning value
77%
Comparable Analysis 2)
46%
Market capitali- zation
34%
Multiples
31%
Lecture BM&A, June 13 14
Overview market valuation methods
The most appropriate valuation method strongly depends on the valuation task
Key business data Multiples and ratio's Stock figures and analysis Transaction prices Share deal information Volume based
comparison (e.g. floor space, ...)
Sales based comparison
Business plan ratification Top management Number of internet
site visit Spending per internet
page visit Visibility in market Predictability Reputation / credibility Quality of products Strategy, organization
1) P/E: Price / earning ratio 2) P/G: Price / growth ratio 3) P/B: Price / book ratio
Market valuation
Comparative company approach
New valuation for start-up companies Multiples
Based on earnings Based on sales
P/E ratio 1) P/EBITDA 7) P/G 2) P/B 3) P/cash flows EPS 4) forecast ROI 5)
Sales multiple EV 6) / sales
4) EPS: Earning per share 5) ROI: Return on invest 6) EV: Enterprise value
7) EBITDA: Earnings before interest, tax, depreciation and amortization
For public companies
For private / public companies
For public companies
For private / public companies
Lecture BM&A, June 13 15
Market valuation enables to come up quickly with an order of magnitude value
Pros and cons of market valuation approach
Pros Cons
Clearly focused on market conditions High acceptance by non-valuation specialists Focused on key issues / results to be achieved Valuation can be achieved in a short period of time Focusing on future expectations rather than history Can be based on real performed transactions, much more
hands-on (Somebody really paid that much money) Prognoses problem not relevant and reduction of com-
plexity easily to be adapted While comparing only with one company in traditional
DCF valuations now several companies are compared External facts and relations are dominant Focus of analysis on market data rather than funda-
mental analysis of valuated company Use of market perspective already includes several
additional variables such as power, market share, etc. ...
Highly depending on quality of gathered data Key data, crucial information is difficult to find (e.g.,
different definitions, mixed publication of EBIT, EBITA, EBITDA figures, etc...)
Comparability of defined peer group to be ensured (e.g., technology, size/volume, service portion, etc..)
Market data is past oriented; data from different periods of time
High volatility of stock markets in some industries Country differences to be taken care off Deal prize conditions are difficult to figure out (e.g.,
special agreements with strong influence, golden parachutes,..)
Acceptance by client (e.g., tendency to create own artificial multiples,..)
A further detailed analysis should be conducted for relevant targets
Lecture BM&A, June 13 16
The comparative company approach is mainly used to evaluate private companies
Overview comparative company approach
Methodology: Valuation based on real
transactions values for comparable companies
Transaction values are published in:
Financial journals / magazines (e.g. M&A review, FT, FAZ, manager magazine)
Internet sides like: Northern light Hoovers online Thedeal.com more-IPO.com
Databases like: Investext Dun & Bradstreet Reuters Moodys
Pros: Quick, easy and market
oriented Value based on real prize
not theoretical estimations First approach for an order
of magnitude value
Cons: Identification of truly
comparable transactions very difficult
Transaction contracts and prizes may have not publicly known clauses like golden parachutes golden handshake or side deals included that deteriorate the transaction price
Submethods: A) Comparable company analysis (CC) B) Similar public company method
(SPCM) C) Recent acquisition method (RAM) D) Comparability method
Fields of usage: Mostly used for private companies For assets and real estate For small, medium sized companies
whereas earning or cash flow approach seems overwhelming
Used for tender valuation Acquisition prize estimation
Lecture BM&A, June 13 17
Enterprise and equity value have to be distinguished
The enterprise value concept
Enterprise value ("EV")
The value of the business as presented by the sum of the market value of the various claims on business profits and cash flows
Essentially the market capitalisation plus all other sources of capital utilised by the business
Used in ratios that measure the return to all sources of capital
Equity value ("EqV")
Essentially the same as market capitalisation (number of shares times share price)
EqV is the capital source that belongs to the shareholders only
Used in ratios that measure the return to shareholders
Lecture BM&A, June 13 18
Different multiples are used for either enterprise or equity value determination
The enterprise value concept (continued)
Source: Warburg Dillon Read
Enterprise value ("EV")
Selected flows or values available to satisfy all the claims of capital providers
Equity value ("EqV")
Selected flows or values available (left) to shareholders or equity providers
Sales Operating cash
flow ("EBITDA") Operating profit ("EBIT") Operating free
cash flow ("OpFCF") Invested capital ("IC")
Earning before tax ("EBT") Cash earnings ("CE") Net earnings ("E") Net assets ("NA") Shareholders'
equity books ("Eq")
Consistent application of the matching principle is key to arrive at meaningful results
Lecture BM&A, June 13 19
Calculation schemes for selected multiples
Calculation of selected multiples
Enterprise value ("EV") Equity value ("EqV")
Based on measures relevant to the equity shareholders' interest in the company
Price / earnings ratio (P/E)
Equity market value Net earnings
Price / cash earnings ratio (P/CE)
Equity market value Cash earnings
Price / book ratio (P/B)
Equity market value Net asset book value
Source: Warburg Dillon Read
Based upon measures which relate to the whole business - the enterprise
EV / operating cash flow (EBITDA)
Enterprise value EBITDA
EV / operating profit (EBIT)
Enterprise value EBIT
EV / operating free cash flow (OpFCF)
Enterprise value OpFCF
Lecture BM&A, June 13 21
The sales multiple can be used to determine the company value and for comparison to competitors
Sales multiple
Sales multiple = Definition
Relevance / rationale
Origin in business valuation for rapid growth companies that are not profitable in the beginning due to up-front investments and start up cost
Goal: Industry branch-specific multiples deliver a rough estimation / explanation of the potential market price for acquisitions
Original purpose
Application for value benchmarking
Much relevance for acquisition negotiations in the Anglo-American area (approximate estimation of business value)
Determination of exact business value usually by using different method Relevance based on purely empirical foundation
Comparison between businesses of different sizes Business value is scaled via sales
Enterprise value* Sales
* Enterprise value = market capitalization + long-term debt - cash; business value allows assessment of the value independent of capital structure
Lecture BM&A, June 13 28
Discounted Value Method
Lecture BM&A, June 13 29
What is a discounted cash flow (DCF) analysis?
Philosophy of discounted cash flow method
Source: Warburg Dillon Read
In essence, DCF is the net present value of future (projected) cash flows of a business or project future cash-flows are discounted to the present, reflecting the time value of cash
(opportunity cost of capital) and the risk of these cash-flows
In a DCF analysis, there are three main components the projected future cash-flows the terminal value the discount or hurdle rate DCF allows a more sophisticated approach to valuation than is possible through the use of multiples many value drivers can be separately included in a DCF-model DCF is a multi-period approach But ... DCF is subjective, difficult to use and can easily incorporate mistakes
Lecture BM&A, June 13 30
Preparing an enterprise DCF valuation
Elements of DCF valuation
Forecast
Free cash flows
Other elements
Produce integrated forecast cash-flows, profit & loss account and balance sheet
Calculate ratios for the forecast-period and check against historic ratios Check that the forecasts are properly funded and are realistic
Project the cash-flows over a reasonable time period, generally 5 to 10 years, depending on the situation
Last year in the projection period should reflect steady growth and profitability (normalization)
Taxation only deduct taxation which relates to EBIT
Working capital all elements, excluding those which relate to financing activities
Provisions only include here changes which relate to operating items in free cash-flow
Lecture BM&A, June 13 31
Analyzing the future free cash flow is the main task within a DCF analysis
Definition of enterprise free-cash flow
Enterprise free cash flow ("FCF") is the cash available to all the providers of capital, it may be used to pay interest or repay debt used to build cash balances or other investments used to pay dividends or buy-back shares Free cash flow must be post tax and post all investments expenditure needed to support the future
forecast FCF
Free cash flow = debt cash flow + equity cash flow
Lecture BM&A, June 13 32
How to calculate the free cash flow?
Free cash flow - Standard calculation
EBIT (normal operating profit) X Taxes on EBIT (X) NOPAT (normal operating profit less adjusted taxes) X
Depreciation and amortisation X Gross cash flow X
Capital expenditure (X) Change in working capital (X) / X Non-cash changes in operating provisions (X) / X Enterprise free cash flow X
Lecture BM&A, June 13 33
The net present value of a corporation is the sum of its future Free Cash Flows discounted with the wacc-rate to the achieve the present value
Net present value of FCFs
DCF-valuation depends on: Business plan and assumptions for the
Free Cash Flows within the explicit forecast period (typically 5-10 years)
Assumption for cost of capital - wacc Formula used for the determination of the
terminal value
Net present value of future FCF
Present value of FCFs
for explicit forecast period
= FCF (n)
(1+wacc) n
N
n=1
Present value of Continuing value
or Terminal Value
= Terminal value
(1+wacc) N
Lecture BM&A, June 13 34
For Discounted cash flow valuation the present value of the future free cash flows have to be calculated
Elements of DCF valuation
FCF
Time n 1 2 3 4 5 6 7 8 9 10 N N+1 oo
... ...
Discount rate
Time n 1 2 3 4 5 6 7 8 9 10 N N+1 oo
... ...
Present value FCF / Discounted
FCF
Time n 1 2 3 4 5 6 7 8 9 10 N N+1 oo ... ...
1 (1+wacc)n
FCF n (1+wacc)n
Explicit forecast period 1..N Continuing period for terminal value
Lecture BM&A, June 13 35
Terminal value is extremely critical for the valuation of companies
Definition of terminal value
A terminal value is a simplified valuation assumption - the hypothetical value of a business beyond the forecast period
It is used to replace a much longer period of explicit projections
Typically, it would require an explicit forecast period of 25 years to capture 66% of the total business value 50 years to capture 90% of the total business value 100 years to capture 99% of the total business value
There are two primary methodologies to calculate terminal value terminal multiple approach (sector or trading multiple driven) constant growth in perpetuity (cash flow driven)
Lecture BM&A, June 13 36
Depending on the valuation assumptions three formulas* for the calculation of the Terminal Value are used
Terminal Value Calculation
* Where formula 1 and 2 can be derived form the value driver formula
FCF(N) = the expected free cash flow in year N wacc = weighted average cost of capital g = the growth rate in perpetuity (in general the GDP growth) NOPAT = Net operating profit after tax
Name Formula Comment
Assumption: the net improvement in future FCF will not generate additional value
TV = FCF (N+1)
wacc 1 Convergence Formula
Assumption: the net improvement in future FCF underlie a constant growth rate g (only valid for g
Lecture BM&A, June 13 37
Shareholders value can be described as achieving a positive return on cost of capital
What is cost of capital?
It is the required return of investors ... the discount rate which equates the present a value of future cash flows with the
price investors are willing to pay for those cash flows
Cost of capital is a key component in valuations ... the discount rate in DCF valuations a basis for interpreting differences in valuation multiplies a mean of evaluating the effects of changes in capital structure
Cost of capital is one of the most intractable problems in finance! ... so be not surprised if there are more questions raised than answers given
The EVA or GWB methodology is based on this philosophy
Lecture BM&A, June 13 38
How to calculate the cost of capital?
Weighted average cost of capital - WACC
Source: Siemens Management Consulting, Practice M&A
Most DCF valuations are done from an enterprise perspective and therefore as WACC
WACC is simply the average of the costs of equity and debt, weighted by their relative market values
COE: Cost of equity (the required return of equity investors) COD: Cost of debt (post-tax to reflect the tax-shield a company has when borrowing)
Equity Total capital
Debt Total capital
WACC = x COE + x CODpost-tax
The following will illustrate the complexity involved in estimating the WACC
Lecture BM&A, June 13 39
The WACC can be derived from the cost of equity and cost of debit
CO
E 1
) C
OD
2)
Equity risk premium
Levered company Beta
Levered debt premium
Tax rate
Company risk premium
Levered company cost of
debt
Net cost of debt
Levered cost of equity
[x]
[+]
[+] [x]
[x]
[+]
[x (1 - tax rate)]
20.0%
80.0%
WACC Risk free rate
1) COE: Cost of equity 2) COD: Cost of dept Source: Practice M&A
Weighted average cost of capital
Lecture BM&A, June 13 40
Source: Warburg Dillon Read, Siemens Management Consulting, Practice M&A,
Based upon portfolio theory, investors required return depends upon the contribution of a stock to portfolio risk not the total risk of the investment
beta is a measure of market (non-diversifiable or systematic) risk
Under the CAPM framework, the cost of equity can be broken down into two components
a rate component (or minimum return component) an excess equity return component
CAPM fails when used as an ex-ante model, especially in a simple firm valuation context
As a result, CAPM is heavily criticised but is the most generally accepted basis for estimating the cost of equity
CAPM-framework is heavily criticised but is the most generally accepted basis for estimating
The capital asset pricing model (CAPM)
Lecture BM&A, June 13 43
1) Public companies 2) Private companies
Fully applicable Not applicable
A thorough company's evaluation has to be based on more than one method
Estimated applicability of single evaluation methods
International National ( German) Big
companies Small
companies Focus on assets
(intangible +tangible) Quick & dirty Method
applied
(Complementary) (Complementary) (Complementary)
(Indirect)
multiplier approach/ Swiss model
Earning value method
Discounted cash-flow
Asset value method
Market value approach
Liquidation value approach
Mixed approaches
Situation of evaluation
1) 1) 1) 2)
- DRAFT -
Football Field
1) Comparable Companies: Alstom, Bombardier, Invensys, Thales; plus 40% premium on equity value, assuming Thomas's net cash of 310' EUR2) Implied transaction multiples of Siemens Peers (ABB, Alstom, Emerson, GE, Honeyw ell, Schneider, Tyco) acquisitions >0.5bn $ transaction value since 2009
0,00 1,00 2,00
Current trading (share price 7.30)
12 month range ( 5.29 - 9.13)
Broker target prices ( 7.94 - 9.70)
DCF Valuation (Standal. + Synergies)
EV / 2012E Sales
EV / 2012E EBITDA
EV / 2013E EBITDA
EV / 2012E EBIT
EV / 2013E EBIT
Sales multiple paid
EBITDA multiple paid
EBIT multiple paid
Siemens Peers EV / EBIT - all sectors(high - low range) 2)
Thomas Valuation
Precedent transactions
0"97
0''71
0''43
1''050''80
0''53
1''02 @30% Premium1''12 @40% Premium
9.36 16.50
Trading comps1) (low /high + 40% prem.)
Implied Thomas share price in
Enterprise Value (m)
Median: 0''67
Median: 2''01
0''54
0''77
0''72 1''61
0''66 1''45
max 2''61
0''79
1''941''06
1''21
0''83
1''88
1''02 1''58
Median: 0''72
Median: 0''87
Median: 0''76
Median: 1''19
Median: 1''08
Median: 1''20
0''60 1''29
0''55 1''20Median: 0''65
1''06
0''95
1''27
1''31
Median: 0''95
0''77
Lecture BM&A, June 13 49
Value and price are not linked together
Relationship between Value and transaction price
Total value expected by buyer
Step 1 Step 2
Total price paid by buyer (Effect on value)
Loss to seller (Market cap minus price)
Net value added to buyer
(Total value minus price) and
Premium to seller (Price minus market cap)
Buyer wins Seller wins
Buyer wins Seller loses
Hig
h Lo
w
Pric
e of
ac
quis
ition
Net value lost by buyer (Price minus
Total Value to Buyer)
Buyer loses Seller wins
Stand alone value to be acquired from seller
(Current market capitalization)
Value that buyer hopes to create
(Synergies) Valuation methods (e.g. DCF*) are based on forecast figures which
are depending on planning data
Goal of acquisition: Additional value creation based on business
Lecture BM&A, June 13 50
Business Valuation
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Content
Lecture BM&A, June 13 51
Definition of Due Diligence
Source: Deutsche Steuer-Zeitung Nr. 3 1999,
Due Diligence is the systematic analysis of a business
The Due Diligence study is
the systematical legal and business analysis (including Technology)
for the evaluation of the advantage of a contract
for an intended company transaction.
Lecture BM&A, June 13 52
Goals of Due Diligence
Source: Deutsche Steuer-Zeitung Nr. 3 1999,
Due Diligence serves to identify risks of an acquisition
Due Diligence serves
to identify and evaluate risks of an intended acquisition as well as
to provide the buyer with arguments for transaction price reductions or improvement of the contract conditions
to find arguments for the funding of the demanded selling price from the vendor's point of view
to enable the buyer to get a fair view of the company for the closing phase
Lecture BM&A, June 13 53
Due Diligence is focused more on qualitative than on quantitative values
Differences between Due Diligence and Company Valuation
Due Diligence Company Valuation
Detailed illustration of transaction-relevant data for the principal, e.g. factors that influence the transaction price
Evaluation of company value (as stand-alone or integrated business with synergies)
Goal
Focus on Market position of company, internal situation, chances and risks within the scope of the transaction
Deduction of future earnings and withdrawals flows, future capital cost, selection of method important
Basis Rather qualitative description and rating
Quantitative and monetary values
More qualitative oriented
More quantitative
oriented
Relates to Present situation Future situation
Results Qualitative statements Figures and numbers
Lecture BM&A, June 13 54
Only a combination of Due Diligence and Company Valuation leads to a fair deal
Focus of Due Diligence and Company Valuation
Buyer wins - Vendor wins
The paid price is dependent from the market
situation (demand) and from negotiation
Price paid
Evaluation of company value
Deduction of future earnings and with drawals flows, future capital cost, selection of method important
Future situation
Quantitative and monetary values
More quantitative oriented
Company Valuation
* Calculated with company assessment methods like Discounted cash flow (DCF)
Detailed illustration of transaction-relevant data for the principal, e.g. factors that influence the transaction price
Market position of company, internal situation, chances and risks within the scope of the transaction
Rather qualitative description and rating
Present situation
Due Diligence
More qualitative oriented
Expected synergies
Current company
value*
Buyers expectation
There must be a rational relationship between
synergies, value and price
Lecture BM&A, June 13 55
A systematic Due Diligence will avoid tricks of vendors and buyers
Tricks of vendors and buyers, examples
"Cooking the books," e.g. restatements, consolidations, Goodwill
Conversion to so-called transparent accounting
Patent entries in private names, but no agreements
Artificially lower costs for group-internal agreements
Limitation of Due Diligence via guarantees
Drafting rights for sales contract
Inadvertent indiscretions
Concealment of serious illnesses of key personnel
Skillfully worded competition clause
Rumors about purchase prices
...
Behavior of the vendor Behavior of the buyer
Coalition with management
Exclude parts from the deal / reintegrate them later
Negotiate parts of the deal separately
Disguise the real object of interest
Let the vendor calculate "worst case" for every risk
Request negative arguments for the transaction
Claim to have own formulas / rules of thumb
Make the decision-making procedures seem more complicated than they are
Drafting rights for sales contract
Exclusive rights
Gradually worsen deal
Coalition with bank / other investors
...
Lecture BM&A, June 13 56
The Due diligence will be realized within three main steps
Phases of a Due Diligence
Definition of investigations scope
Priorization of selected areas
Definition audit systematic
Time frame
Project organization
Ressources
Internal experts
External experts
Deal team
Data room
Interviews
Company and site visits
Expert reports
Segmentation and evaluation of information
Planning Phase
Team and Organization
Due Diligence execution
Information gathering and evaluation Reports
Lecture BM&A, June 13 57
The deal team synthesizes the internal and external information and delivers the DD report
Due diligence, Team and Organization
Inside / out statement Company information Financial data Company structure
Outside / in statement Third part financial
statement Company performance Market Competitive landscape
External market studies
External specialized
lawyers
Certified Public
Accounters
Tax Accounters
Management Consultants
Investment- bankers
Insurance specialists
Real estate reports
External technical reports
Environment Consultants
Marketing / Sales
Controlling/ strategic Planing
Law, taxes, finance
Accounting
HR / corporate citizenship
IT
Technologies
Environment
Production
R&D
Operation / Laws /Taxes /
Finance
Externer experts circle
Deal team
Redaction and delivery of the Due Diligence
report
Management decision head Negotiation Team
Internal experts circle
Lecture BM&A, June 13 58
1 2 3
3 main sources for the information gathering have to be considered to acquire an objective opinion about the company
Information gathering of a Due Diligence
Planning Phase
Team and Organization
Due Diligence execution
Information gathering and Evaluation Reports
Data room
Get the hard facts about the company...
Concentration of company information documents in one room for a limited timeframe (P&L, balance sheets, taxes declaration, production plans, salary, supplier and customer contracts, patens)
Site visits and interviews
...complete with soft facts...
Direct contract with the management and the employees brings subjective opinion and increase the "soft fact" knowledge about the company
External information sources
...get fairness opinions from third party
Interview with supplier, customer, competitors
Interview with banker, lawyer, broker, industry experts
Information from press articles, publication, broker report
Confidentiality level of the documents which will be used during the due diligence have to be discussed and cleared within the letter of intend (e.g. copy of documents from the data room have to be destroyed,...)
Lecture BM&A, June 13 59
The main problem with Due Diligence in small and mid-sized companies is the gathering of information
Exceptional case: Due Diligence in acquisition / merger involving mid-sized companies
In general, there are no differences between smaller and bigger companies concerning the course of Due Diligence,
but some particularities in a small company's structure complicate Due Diligence
Structural Aspects Impact on Due Diligence
Middle-sized company as central knowledge basis
*Aufgabenbe...tung:
Consolidation of tasks: Mid-sized entrepreneur as central knowledge base
Mittelstndische Unternehme... als zentraler
Wissenstrger *Aufgabenbe...tung:
Insufficient accounting
(reporting system)
Mittelstndische Unternehme... als zentraler
Wissenstrger *Aufgabenbe...tung:
Underdeveloped / missing
controlling
The company itself is extremely heavily involved in Due Diligence process
There are no year-end financial statements examined by an auditor
Obtaining information becomes a central problem
Backup
Lecture BM&A, June 13 61
People, Organization, Culture
Management Human resources & Recruiting Pensions and Salary Organization Information Technology Communication Culture
Each aspect has to be analyzed in detail
Financial
Income Balance Sheet Cashflow Legal & taxes
Production and Technology
Plants & Sits Capacity Quality R&D Factor Costs
Marketing and Sales
Sales & Revenue recognition Market & Customer Product & Services Marketing & Pricing strategy
Environment
Environmental exposure Locations sensitivity Management system &
compliance Legal aspect
Supply Chain
Purchasing & Supplier Inventory Logistics Sales and Distribution
channels
Clusters of Due Diligence
Lecture BM&A, June 13 62
The Financial Due Diligence is the overarching roof of a Due Diligence
Financial Due Diligence
Income
Profit and Loss accounts, long term and segment information Sales and quantities analysis Revenue and expenses analysis ...
Balance Sheet
Value and existence of all fixed assets listed, e.g. plants, equipment, and financial assets
Evaluation of inner reserves, e.g. real estate Working capital structure: Receivables assessment, stock
evaluation, securities, liabilities, accrued liabilities Financial structure: long term bank loans, borrowings, etc. ...
Cash flow
Cash flow analysis, history and future plans Existence and Quality of cash management,
interest management and currency management Financial status, liquidity ...
Legal & taxes
Company law aspects: Legal form (external and internal structure of companies), list of partners, relations, ...
Pending lawsuits Tax liabilities, tax risks, tax aspect during/after acquisition Special arrangements with third parties, e.g. private persons or
trade unions ...
Information
Annual or Monthly Reports or from databases
Head of Accounting / controlling, CPA's, tax departments etc.
Lecture BM&A, June 13 63
Interface with the customer and sales strategy are the main scope of the Marketing and Sales due diligence
Marketing and Sales Due Diligence
Advertising / Promotional plan Budget breakdown Forecast systematic Trade & Company image Pricing policies (fluctuation, sensitivity, ev. leadership...) Pricing scheme by product line ...
Volume and growth rate by region and product line Identification and analysis of significant changes Identification of non-operating & non-recurring revenues Type of contract completion method (percentage or completed) Impact on the revenue recognition ...
Sales & Revenue recognition
Product & Service
Marketing & pricing strategy
Markets & Customer
Description of the market (volume, growth rates, segmentation...) Estimated market shares and markets penetration Key success factors / Factor affecting the demand (e.g., price, technology, political issues...) Overview of the main market trend Analyse and ranking by region and product (ABC analysis...) Identify key account customers, check contratcs ...
Breakdown of major product / service category by sales and profit contribution Basic buying considerations (e.g., price, quality, service, engineering, reputation...) Description of the past and prospective pattern changes in the industry Analysis of the product mix Consideration of the life cycle stage of each major product (maturity) Impact on the further R&D requirements ...
All adoptions have to be proven, especially for
market and competitors
Lecture BM&A, June 13 64
Due Diligence reports can have different addresses
Reports of a Due Diligence
Planning Phase
Team and Organization
Due Diligence execution
Information gathering and Evaluation Reports
Detailed or comprehensive report
Referee function, lawyer and vendor authorize you to make a proposal
Fairness opinion
Detailed or comprehensive report
Specialist or expert, i.e., if you have knowledge in special sectors or businesses
...
Expert opinion
Detailed or comprehensive report is exclusively mandated by one of the parties
Due Diligence report
Lecture BM&A, June 13 65
Business Valuation
Introduction to Business Valuation
Valuation Methods
Due Diligence
Post Merger Integration
Content
Lecture BM&A, June 13 66
Siemens AG / 2012. All rights reserved May 2012
Creating value is the key challenge of any M&A project
Deal Announced
Deal Closed
90 Days 1 Year
Source: KPMG
Break Even
Destroy Value
What Companies Typically Get
Create Value
What Companies Want
Premium Paid
Combined Value
Pre-and Post-Acquisition Cost
KPMG Study results:
30% Add value 31% Destroy value 39% No discernable
difference
Siemens AG / 2012. All rights reserved May 2012
The implementation phase bears still the greatest failure risk
% of respondents
Which phase bears the greatest failure risk?
28% 28%
44%
Source: Corporate Strategy Board Survey 2006
Transaction Implementation Strategy
Siemens AG / 2012. All rights reserved
Typical Reasons for Integration Failures are missing perspectives, inefficient communications
Mergers often fail because of inefficient integration
26% slow integration speed
21% IT-issues brought on table too late
missing integration dynamics 37%
missing commitment of top management
37% missing masterplan
finance- /synergy - expectations unrealistic or unclear 47%
compromises on new organisation
unclear strategic concept
47%
32%
26%
58% ineffective communication
Integration mistakes and success factors
Source: AT Kearney, McKinsey, Mercer, KPMG Press Releases, SMC
Success factors for integration
Clear target setting and tracking ensure speed establish professional communication use the best people put together a strong (joint) management
team ensure excellent integration management be pragmatic concentrate on value creation
and poor integration management
Siemens AG / 2012. All rights reserved May 2012
We have improved our proceedings by capturing learnings from past projects
Have a clear strategy Select the right projects Buy / Sell at the right point of time
Have a clear process in place and follow through Analyze the risks and opportunities diligently Pay / get the right price and a fair contract Integrate / Carve Out professionally
Ensure that you have experts included Take advantage of the corporate experience Enable systematic learning and know-how transfer
Do the Right Projects
Do the Projects Right
With the Right People
Siemens AG / 2012. All rights reserved May 2012
Ongoing Business
Our integrated process framework builds the basis for sucessful M&A projects
Know-How Transfer, Improvement
Integration
Carve out / Stand alone
Acquisition Joint Venture Divestment
Post Closing Management
Transaction Implementation Strategy
Strategic Planning M&A Projects
Clear processes are a pre-requisite of successful M&A Projects
Siemens AG / 2012. All rights reserved May 2012
Q-Gates and predefined formats ensure consistency over the entire process
Performance Controlling Strategy
A two step decision approach and consistent deal tracking ensures high success rates of M&A Projects
Pre Signing Decision
Pre Negotiations Decision
Transaction Implementation Strategy
Siemens AG / 2012. All rights reserved May 2012
Combined Siemens Unit
Acquired Unit
Acquiring Siemens Unit
Deal Execution
We consider Integration from the very beginning and focus our management attention on it
Integration
Signing Closing 1
Year 2
Years
New Structure, Value Creation Program
Business Plan, Purchase Price, Contract
Acquisition Goals
Business Results
Shareholder
Make people from different environments working together and shape the new, combined organization to manage growth
Leverage synergies, improve value and market position
Keep old and win new customers to realize projected revenues
Give direction and keep momentum to achieve strategic goals
Siemens AG / 2012. All rights reserved
Fundamental questions drive integration
A successful integration depends on the early definition of the integration cornerstones
Source: BoozAllen; M&A Practice
How will we create value?
How will this merger be led?
How will we approach this merger?
Do we absorb, integrate, create or attach? Will we apply the best of both philosophy, or is there a preference for either companys model? Will this philosophy apply to the leadership team selection?
What role should the CEO play? How will we run the business while simultaneously maintaining focus on the integration and the
realization of the synergies? How aggressive to we want to be? How should the teams be formed? How much line involvement?
What must we preserve to realize the potential of this deal? What are we prepared to give up?
Where do we redesign, create, adopt or eliminate (by segment, portfolio, organization, process, geography) ?
What must be integrated immediately? Where do we have to set priorities? What can wait?
What people strategy is required?
What is the decision-making model? Top-down or bottom-up? What degree of cultural change is required to make the integration work? How do we identify, select and retain a superior team? How can we ensure that we treat all people fairly and with respect?
Siemens AG / 2012. All rights reserved
Learnings from past PMI projects clearly indicate the keys to a successful integration
Key success factors for PMI projects
Integration team Early staffing of qualified Integration
Manager & Workstream Leaders Involvement in Due Diligence with
early verification of integration concepts Empower Integration Manager with
decision authority and resources
Integration planning & controlling Involvement of integration experts Definition of non-negotiables /
cornerstones (strategic objectives) based on explicit choices & trade-offs
Setup of PMI controlling
Key pillars of an integration Organizational clarity Immediate divestiture of parts not
needed Branding decisions Governance & legal
country setup
Communication & Change management Cultural assessment Open and effective communication based on a clear & shared value creation vision Trust building is paramount Pulse checks
Setup of new management team Ramp-up of new
leadership group Management commitment
Value creation of an acquisition Early definition of business model and value drivers Preserve value of legacy business Effective and consistent execution Tracking of synergies / growth targets Long term review of deal
Interface management Corporate departments Siemens Regional Companies Leverage on existing integration know-how
Key success factors for PMI
projects
Fast adoption of non negotiables Accounting & Controlling requirements Compliance Program IT Infrastructure & Security HR policies Chain of Command / LOA Implementation
Siemens AG / 2012. All rights reserved
In post mergers, collaboration and building trust are paramount
Boy, Im glad it isnt leaking on our side!
Lecture BM&A, June 13 77
Synergy trap: Frogs and Princesses
END
Synergy trap: Frogs and Princesses Many managers were apparently over-exposed in impressionable childhood years to the story in which the imprisoned, handsome prince is released from the toads body
by a kiss from the beautiful princess. Consequently, they are certain that the managerial kiss will do wonders for the profitability of the target company. Such
optimism is essential. Absent that rosy view, why else should the shareholders of company A want to own an interest in B at a takeover cost that is two times the
market price theyd pay if they made direct purchases on their own? In other words investors can always buy toads at the going price for toads. If investors instead
bankroll princesses who wish to pay double for the right to kiss the toad, those kisses better pack some real dynamite. Weve observed many kisses, but very few miracles.
Nevertheless, many managerial princesses remain serenely confident about the future potency of their kisses, even after their corporate backyards are knee-deep in
unresponsive toads.
Warren Buffet, 1981 Berkshire Hathaway Annual Report
Foliennummer 1Foliennummer 2Starting with some basicsStarting with some basicsThere are several types of mergers/acquisitionsWhat are reasons for mergers and aquisitions?The M&A process includes the integration of the acquired businessThe M&A process is divided into three phasesFoliennummer 9Business Valuation: What is the issue?We will focus on market valuation and discounted cash flow methodThe DCF*-method is the most exact but time consuming methodThere are substantial differences in usage of evaluation methods regarding seller or buyer perspective of the transactionFoliennummer 14Market valuation enables to come up quickly with an order of magnitude value The comparative company approach is mainly used to evaluate private companiesEnterprise and equity value have to be distinguishedDifferent multiples are used for either enterprise or equity value determinationCalculation schemes for selected multiplesThe sales multiple can be used to determine the company value and for comparison to competitorsDiscounted Value MethodWhat is a discounted cash flow (DCF) analysis?Preparing an enterprise DCF valuationAnalyzing the future free cash flow is the main task within a DCF analysisHow to calculate the free cash flow?The net present value of a corporation is the sum of its future Free Cash Flowsdiscounted with the wacc-rate to the achieve the present value For Discounted cash flow valuation the present value of the future free cash flows have to be calculated Terminal value is extremely critical for the valuation of companiesDepending on the valuation assumptions three formulas* for the calculation of the Terminal Value are usedShareholders value can be described as achieving a positive return on cost of capitalHow to calculate the cost of capital?The WACC can be derived from the cost of equity and cost of debitCAPM-framework is heavily criticised but is the most generally accepted basis for estimatingA thorough company's evaluation has to be based on more than one methodFoliennummer 46Value and price are not linked togetherFoliennummer 50Foliennummer 51Foliennummer 52Due Diligence is focused more on qualitative than on quantitative valuesOnly a combination of Due Diligence and Company Valuation leads to a fair dealA systematic Due Diligence will avoid tricks of vendors and buyersThe Due diligence will be realized within three main stepsThe deal team synthesizes the internal and external information anddelivers the DD report3 main sources for the information gathering have to be considered to acquire an objective opinion about the companyThe main problem with Due Diligence in small and mid-sized companies is the gathering of informationEach aspect has to be analyzed in detailThe Financial Due Diligence is the overarching roof of a Due DiligenceInterface with the customer and sales strategy are the main scope of the Marketing and Sales due diligenceDue Diligence reports can have different addressesFoliennummer 65Foliennummer 66Creating value is the key challenge of any M&A projectThe implementation phase bears still the greatest failure riskTypical Reasons for Integration Failures are missing perspectives, inefficient communicationsWe have improved our proceedings by capturing learnings from past projects Our integrated process framework builds the basis for sucessful M&A projectsQ-Gates and predefined formats ensure consistency over the entire processWe consider Integration from the very beginning and focus our management attention on it Fundamental questions drive integrationLearnings from past PMI projects clearly indicate the keys to a successful integrationIn post mergers, collaboration and buildingtrust are paramountSynergy trap: Frogs and Princesses