14.5 Mergers and acquisitions

Mergers between companies or the acquisition of one company by another provide many opportunities for consulting work. Most of these opportunities come in the post-merger phase, when work begins on the rationalization of the production and marketing activities, and the reconciliation of the different budgeting systems, personnel policies and a host of other procedures. There is, however, one key financial task that must be undertaken before the merger, and for which consultants are often needed – the determination of the fair value of one or both of the companies involved. A consultant may also be called upon to advise as to the method of payment to be used. He or she will normally have either the acquiring company or the one to be acquired as a client, but in some cases of “friendly merger” may be advising both organizations.

Valuation of a company

There are essentially four approaches to the valuation of a company. Value can be based on:

●the current market price of the company’s common stock (if the stock is listed and actively traded);

●the market value of the assets;

●capitalized future earnings; and

●replacement or duplication value, which is an estimate of the cost of building up a similar organization from scratch.

The first of these, the current market price, is widely used. It does not in fact give a fair value of the company, but provides a “floor price” below which negotiations cannot go: if the common shares have recently been changing hands at, say, US$50, then any offer that values the total company at less than $50 per share is unlikely to be acceptable. The other three approaches do try to establish a fair value. A consultant may be called upon both to advise upon the method to be used and to assist in its implementation.

In recommending a basis for valuation, the consultant should obviously pay close attention to the client’s particular situation and needs. If the client is the company which is receiving the offer, then the appropriate method will be whichever yields the highest value: the consultant will not suggest a price based on current earnings if he or she estimates that the realizable value of the physical and financial assets of the company is higher. But when the client is the acquiring company (that is, the company making the offer) the situation is more complicated. The appropriate valuation method will depend on the company’s motives for making the acquisition, and these motives in turn will depend on its corporate strategy and long-term plans. If the acquisition is being made simply as part of a diversification strategy and the company that is being purchased will