Creating Value By
Acquisitions
Objectives & issues
January 2000
This presentation is confidential to the
intended recipient and may not be
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explicit written permission of Utility
Consultants.
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no liability for any action or inaction
arising from its use.
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not be reproduced in whole or in part
without explicit written authority from
Utility Consultants Ltd.
Contents
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Introduction
The right price
Valuing a business
Valuing synergies
Emotional factors
Assessing competition
Acquirer’s stock price
NZ lines industry
Conclusions
Sources
Introduction
• Businesses exist to create wealth for their
shareholders.
• Thirty years of evidence suggests that most
merger activity has actually destroyed
shareholder wealth, for a variety of reasons.
• The key reason for this destruction of wealth is
simply that the price paid was too high.
• A key factor for these high prices has been the
emotional involvement and attachment of
senior executives.
Introduction
• This slide show discusses acquisitions in a
wide context, and then poses the question
“what does all this mean in the context of the
NZ electricity lines industry ??”.
• It is noted that politics may significantly effect
the final outcomes of an acquisition however
no detailed comments are made on this.
• It is also recognised that managing
organisational culture is a key to making any
acquisition succeed (again, detailed comment
is beyond the scope of this slide show).
The right price
• So what is the right price for an acquisition ??
• Any acquisition must improve the shareholders
wealth or it shouldn’t be undertaken.
• Rule of thumb is that the acquisition must be
worth more to the acquirer than the purchase
price (stating the obvious !!).
• Competitive tendering adds an additional
complication which will also be discussed.
• Following slide identifies the various values
that can be placed on an acquisition.
The right price
Synergy
value
Purchase
value
Market
value
Intrinsic
value
Value captured
by acquirer’s
shareholders
Value captured
by target’s
shareholders
The right price
• Most obvious feature is that a higher than
necessary purchase price erodes the value
captured by the acquirer (fairly intuitive
conclusion !!).
• Value captured by the target shareholders is
known as the value gap.
• We will explore these four values further, which
will then be illustrated by a case study.
• We will also explore five key areas of synergy
in detail.
Valuing a business
• Previous chart indicates that a business can
have four values, and indeed the purchase
value and synergy value can vary between
purchasers.
• These four values are….
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Intrinsic value
Market value
Purchase value
Synergy value
Intrinsic value
• Intrinsic value of a business is based on the
NPV of future earnings.
• Assumes that status-quo performance will
continue into the future.
• Excludes any premium due to other market
participant’s interest.
Market value
• Market value of a business is the intrinsic value
plus a premium reflecting market participants
interest.
• Represented by the share price or the current
market capitalisation.
Purchase value
• Purchase value of a business is the price a
bidder anticipates having to pay to acquire the
target.
• Referred to as “anticipated takeout value” by
Wall St.
Synergy value
• Synergy value of a business is the NPV of the
cashflows arising from improvements made
when the businesses are amalgamated.
• These are improvements above and beyond
those that could be made by either business
separately, as these are priced into the intrinsic
value of each business.
• The five aspects of synergy will be discussed
in detail in subsequent slides.
Synergy value
• It will be apparent that each acquirer in a given
acquisition will be able to generate different
synergies.
• This in turn will limit the price that each
acquirer should pay, suggesting that there is
no single “right price” for an acquisition.
Case study
• Consider Vodafone’s bid for AirTouch
Communications.
• Prior to Bell Atlantic’s bid for AirTouch being
announced on 3/1/99, AirTouch’s closing stock
price had been $68 on 31/12/98.
• Bell Atlantic’s bid was $73 per share, a 7%
premium.
• Vodafone entered the scene on 7/1/99 with a
bid of $89 per share, a 31% premium.
• Vodafone’s final offer was $97 per share, a 43%
premium.
Case study
• This premium of $29 over the intrinsic value
required Vodafone to identify and implement
synergies worth at least $20 billion just to
break even.
• The valuation of AirTouch’s stock is shown in
the following slide.
Case study
Synergy
value to
Vodafone
Vodafone’s
purchase
price ($97)
Market value
after Bell
Atlantic’s bid
($73)
Intrinsic
value ($68)
Value captured
by Vodafone’s
shareholders
Value captured
by AirTouch’s
shareholders
($20 billion)
Case study
• The sources of synergy captured by Vodafone
as a result of the acquisition are.…
• Complementary geographical markets in Europe that
when combined would significantly reduce roaming
and interconnection fees.
• Savings in high-volume purchases of network
hardware.
• A single, pan-European flat-rate pricing plan based
on the Euro that will put downward pressure on
other cellular operators.
Valuing synergies
• Previously mentioned 5 sources of synergy,
which are….
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Cost savings
Revenue enhancements
Process improvements
Financial structure
Tax benefits
• Discussion indicates that most sources of
synergy are difficult to calculate accurately,
and should be excluded from the final estimate.
Cost savings
• Usually arise from eliminating facilities, jobs
and related expenses by consolidation or
improved scale.
• Usually the easiest to estimate of the five
categories of synergy.
• Cost savings are likely to be highest when the
acquirer and target are in the same industry
with geographically close markets.
• Often referred to as hard synergies, and have a
high certainty of being achieved.
Cost savings
• Three common pitfalls in identifying cost
savings.…
• Varying definitions of costs categories that may lead
to double-counting eg. is after-sales service
included in production or sales ??
• Costs may occur in different areas of the two
businesses - essential work may be being done in
other places.
• Eliminating positions doesn’t necessarily reduce the
head-count as some individuals must be re-deployed
to perform on-going tasks.
Revenue enhancements
• Possible for an amalgamated business to
achieve a higher revenue growth than either
business could have achieved independently.
• Primary means would be applying a targets
premium product to the acquirer’s distribution
channel.
• Very difficult to estimate - many external
factors such as customer response to new
products or services.
• Consider evaluating but probably exclude from
the final synergy estimate.
Process improvements
• Creates synergy by transferring best practice
and core competencies between the acquirer
and the target.
• Acquirer may be seeking the targets
processes, procedures and controls rather
than their products or markets.
• Acquirer may also identify an undervalued
business that can be enhanced by the
acquirer’s processes and procedures.
• Consider evaluating but probably exclude from
the final synergy estimate.
Financial structure
• Capital restructuring to lower the overall WACC
can be undertaken independently of any
acquisition, hence should not be used to justify
an acquisition.
• It may be possible to take advantage of a
targets more favorable cost of debt.
• May also be possible to pool working capital
and surplus cash.
• Probably should be included in the synergy
estimate if benefits can be calculated
accurately enough.
Tax benefits
• Often difficult to assess, but generally fall into
two broad categories….
• One-off tax costs such as capital and transfer duties,
or the inability to carry forward tax losses.
• On-going tax costs.
• Goal is to obtain a lower tax rate for the
amalgamated business.
• Global acquisitions may provide opportunities
to move tax liabilities to low-tax jurisdictions.
• Consider evaluating but probably exclude from
the final synergy estimate.
Emotional factors
• No doubt that acquisitions are very exciting !!
• This leads to intense emotional involvement
that may override commercial sense - common
theme is “we just have to have it”.
• Requires strong restraint and a clear focus on
the numbers that give a maximum price.
• Essential to remember that another potential
acquirer may be able to create more synergies,
and is hence able to bid more.
• Know your maximum price, and don’t pay a
penny more !!
Assessing competition
• Sale of a business by competitive tender adds
a large element of uncertainty to the whole
acquisition process.
• In general terms, a competitive process will
push the purchase price up, meaning that the
acquirers shareholders will capture less of the
synergy value (eroding the very reason for
undertaking the acquisition).
• Again, it comes back to knowing your
maximum price, and not paying a penny more.
Assessing competition
• Quite likely that some bidders will give all the
synergy and some of their own shareholders
wealth to the target shareholders, clearly
defeating the purpose of the acquisition.
• Having said all this, it may merit increasing the
bid to maximise the chances of winning but
again it requires a value judgement on just how
much additional synergy to give away.
• Part of this value judgement will be assessing
who the likely competing bidders are, and what
synergies they can derive.
Assessing competition
• In reality, unless there is detailed inside
knowledge of other competitors, these
judgements are unlikely to be more than
educated guesses.
• The next slide indicates the following….
• Acquirer B can create significantly higher synergies
than Acquirer A.
• Acquirer B can afford to offer a higher purchase
price than Acquirer A.
Assessing competition
Synergy value to
acquirer B
Acquirer A
purchase
price
Market value
of target)
Intrinsic value
of target
Synergy
value to
acquirer A
Acquirer B
purchase price
Assessing competition
• A key conclusion is that Acquirer B’s purchase
price needn’t be any greater than Acquirer A’s
total synergy value.
• In reality, B’s purchase (offer) price could
actually be less than A’s total synergy value
because A’s purchase (offer) price will be less
than their own synergy value in order to
capture at least some synergy.
• Precisely how much less than A’s total synergy
value will again be a value judgement !!
Assessing competition
• From A’s perspective, knowing B’s synergy
value may assist in knowing when to abandon
the chase and avoid additional costs (and
avoid revealing strategic intentions).
• Again, all this assumes that the other potential
bidders can be identified in the first place.
Acquirer’s stock price
• Referring back to the case study, Bell Atlantic’s
stock price declined 5% when its intended
acquisition of AirTouch was announced.
• Conversely, Vodafone’s stock price rose 14%
during its bid.
• So why did the market express its disapproval
of Bell Atlantic’s modest premium and yet
conversely applaud Vodafone’s substantial
premium ??
Acquirer’s stock price
• The answer comes down to synergy - Vodafone
were able to create significantly more
synergies than Bell Atlantic, which the market
recognised.
• Hence the acquirers stock price is a very good
reflection of the likely value to be created from
an acquisition.
NZ lines industry
• So what does all this mean for the NZ energy
industry, and more specifically for the lines
businesses ??
• The retailing scene is seeing some significant
acquisition activity by private-sector players
such as TransAlta and AGL.
• The lines sector of the industry is certainly less
active at the moment (but not totally dead) there was a flurry of mergers & acquisitions
around 1993 and again around 1999 due to
structural changes in the industry.
NZ lines industry
• This section seeks to apply the issues
discussed so far to the context of the lines
business to identify guidelines, opportunities
and warnings.
• These issues are….
•
•
•
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Valuing a business
Valuing synergies
Assessing competition
Acquirer’s stock price
Valuing a business
• Just like any other business, the four values
can be applied to a lines business.
• The intrinsic value is simply the NPV of the
cash flows over time - our experience indicates
that this is about 0.6 to 0.75 of the ODV.
• The market value can be represented by the
ODV in the absence of a listed NZSE price.
• The purchase price is simply the price offered
by an interested buyer.
• The synergy value is sum of the intrinsic value
plus the synergies available to each buyer.
Valuing a business
• Important to remember that the synergy value
will be different for each potential buyer.
• Recent lines business purchases range from
1.2 x ODV to 2.2 x ODV, reflecting the synergies
available and the degree of competition in each
transaction.
Valuing synergies
• As noted previously, the five sources of
synergy are.…
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Cost savings
Revenue enhancements
Process improvements
Financial structure
Tax benefits
Cost savings
• Forms the majority of synergies, under the
following broad categories….
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Governance
Management
Planning
Operations
Fault restoration
Maintenance
Network assets
Facilities
Governance
• Amalgamation should reduce the number of
executive directors, however a larger business
may involve higher remuneration and maybe
one or two additional directors.
• Amalgamation may also allow rationalisation of
share registries, statutory reporting etc.
• Cost savings in this area are unlikely to be
huge.
Management
• Amalgamation obviously allows for a single
management team, leading to reduced costs.
• However an enlarged business may require
senior executives to be paid more, and may
require additional executives to manage the
enlarged business.
• Redundancy costs for executives on high
salaries may wipe out any cost savings.
Planning
• Amalgamation will obviously reduce the
number of activities required eg. one asset
management plan instead of two.
• However, work content in each activity may
well increase.
• Some scale may occur if these activities can be
contracted out.
• Costs of achieving compatible information
systems
may
be
significant
don’t
underestimate these costs !!
Operations
• Combining network control rooms may lead to
significant cost savings after the initial cost of
relocation and combining systems.
• Local knowledge of the network is critical to
effective operations, hence staff reduction will
very likely cause difficulties for an introductory
period.
Fault restoration
• Fault workload won’t change for the
amalgamated business unless policy changes
regarding network engineering details are
made.
• Local knowledge is very critical to fault
restoration, hence service levels may decline if
staff are dismissed.
• Rationalisation of geographical fault areas may
enable improved response time and possibly
reduction of staff.
Maintenance
• Amalgamation of lines businesses won’t (or at
least shouldn’t) reduce the maintenance
workload unless policy changes lead to a
reduced underlying maintenance requirement.
• However amalgamation may enable better
coordination of resources, or alternatively
separation of work into an internally-resourced
baseload and a peak work load that can be
contracted out.
Network assets
• Cross-boundary synergies may exist if the
separate businesses share a close common
boundary.
• Most obvious synergy arises from taking
cross-boundary supply from lightly-loaded
neighboring feeders and substations instead of
installing additional capacity.
• May also be possible to provide additional
reliability to substations and individual feeders.
Facilities
• Amalgamation will generally allow one head
office to be vacated and sold (unless social or
political concessions require a second office to
be retained).
• Leased offices may incur on-going costs if the
lease prohibits sub-letting or early termination.
• Operational facilities can be combined if they
are physically close enough.
• Important to note ratio of fixed to variable costs
of facilities such as depots - reducing staff may
not reduce fixed facility costs by much.
Revenue enhancements
• Unlikely that an amalgamated lines business
could increase revenues beyond what the two
separate businesses could have unless some
cross-boundary connection allows a premium
to be charged for alternative supplies.
• Not to be confused with acquisition of a highgrowth target (which would increase revenues
regardless of any acquisition).
• Price regulation will very likely be a key
revenue issue (refer subsequent slide on price
regulation).
Process improvements
• Unlikely that any one lines business has
processes superior enough to merit acquiring
them solely for that reason.
• Generally high level of communication between
lines companies at operational levels has
meant that best practice is generally discussed
and shared openly.
Financial structure
• Previously stated that acquisitions should not
be used as a justification for financial
restructuring if the opportunity already exists.
• Cost of lines business equity varies minimally
throughout NZ, however use of debt financing
has created a noticeable spread in WACC.
• May be possible to create some synergy
through refinancing at the lower WACC (in
reality, it may lower a debt financing rate by a
fraction of a percent).
Tax benefits
• Obviously little opportunity for exploiting low
tax jurisdictions in the global sense.
• Unlikely that the amalgamated business would
achieve a more favorable tax position.
• One-off tax issues can be very significant,
especially
if
capital
repayments
to
shareholders are involved.
• Best seek specialist tax advice very early in the
process to identify the tax implications of each
acquisition option.
Price regulation
• Much recent talk of line price regulation - likely
to become a reality.
• Most likely form of regulation will be incentive
(CPI-X), which requires revenues to be reduced
by a certain percentage from last years
revenues.
• Although
incentive
regulation
doesn’t
deliberately allocate wealth back to the
customers (in terms of lower prices), eventually
all efficiencies will be exhausted meaning that
revenue reduction will erode profits.
Conclusions
• Amalgamation of lines businesses may not
reduce costs as much as expected.
• Savings are unlikely to occur in big licks, rather
it will take a thorough analysis of the
amalgamated business to identify small cost
savings that all add up.
• Fairly obviously, non-contiguous acquisitions
will yield lower synergies as many cost savings
cannot be applied.
• Obtain tax advice very early in the process !!
Sources
• Are you paying too much for that acquisition ?
- Harvard Business Review, July - August 1999.
• Strategy as a portfolio of real options - Harvard
Business Review, September - October 1998.
• Analysis of NZ electricity company sale prices
in relation to ODV - Utility Consultants, August
1999.
• CEO’s giant egos get in way of mergers - NZ
Herald, 20 January 2000.
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