Determining the Right Price for a Going Private Transaction
Considering the various mechanisms at play for a going private transaction can be a complex task; even more so when deciding on the right offer price. Although negotiations, initial valuation, and market conditions all come into play when deciding on an offer price, offerors must consider and be aware of the methods and sources behind the value of the take-private target in order to find the perfect price. Price is an important consideration when buying a business as the purchaser takes on the company’s liabilities and is exposed to significant downside risk if the deal does not lead to value creation. Consequently, buyers go through a detailed due diligence process to ensure that they are acquiring the right business for the right price.
Valuation for Go-Private Transactions
Although the valuation of go-private targets seems straightforward, the various shareholders, interested parties, and legal areas involved in the transaction can create significant hurdles when assessing the right price to pay. Unlike other M&A transactions, going-private transactions are performed on an uneven playing field, as there is an informational imbalance between the current public company’s shareholders and the prospective offeror. If the offeror is a current significant shareholder, further complications regarding conflicts of interest arise. To circumvent this, Canadian law requires an independent valuator to assess the value of the target company.
It is important to note that the actual price paid per share will likely vary from the fair value of shares arrived through the valuation, however, the valuation should properly assess whether the current share price of the target is discounted or overvalued. Costs of the independent valuation fall on the offeror, and although not required, offerors typically cover the cost of valuation regardless of the outcome of the going-private transaction.
Valuing Methodologies a Going Private Transaction
As valuation is more of an art than a science, each independent valuator will approach the valuation of the target company differently. At the minimum, the valuator will consider the risks, qualitative factors, and growth potential of the going-private target through some commonly used methods.
Intrinsic Valuation Methods
These valuation methods are based on the cash flow and margins of the company. A common intrinsic valuation method is a discounted cash flow analysis, also known as a DCF. This valuation method describes the value of the target based on the present value of its future cash flows. The future cash flows are discounted through the weighted average cost of capital which is a measure of the overall risk of the company’s operations.
This method does not consider the target’s broader positioning in relation to its competitors and industry. It relies heavily on the accuracy of the assumptions behind the future projected cash flows. If carefully considered, intrinsic methods of valuation can be extremely helpful in determining the viability of the go-private transaction, as the future cash flows of the company can be reasonable compared to the cost of debt and financing required to purchase the shares of the target. Furthermore, through the process of constructing the intrinsic valuation, various details about growth prospects and the financial health of the company can be brought into the spotlight.
Market Valuation Methods
These methods focus on comparing the company’s value, often measured through several metrics, to a “universe” of relevant peers. A common method of market valuation is a comparable company analysis. In this method, the metric of comparison is often a multiple of the company’s value over a characteristic, such as Enterprise Value/ EBITDA, or Price/ Earnings. Once the metrics are chosen, a comparable group of companies is found and the median and quartile values of the chosen metrics for the comparable group are calculated.
After applying the median and quartile metric to the company’s current characteristics, the valuator will not only come to an implied valuation but as well an approximation of the premium or discount the company is currently valued at. When paired with the other valuation methods, market valuation methods are particularly useful in determining the current state of the target company’s stock price. In comparing to similar companies, the analysis can provide insight into whether the company is under or over-valued. Although not concrete, when accompanied by a DCF or similar intrinsic valuation, the offeror can have an accurate idea of what range of prices they can propose.
Important Considerations When Taking a Company Private
While we have discussed different valuation methodologies, it is important to note that when acquiring a public company, the offer price will ultimately depend on the premium that shareholders expect to receive in exchange for giving up control and ownership of the company. As an example, let us consider Company A that has 1 million shares outstanding trading at $1 a share. After a buyer initially approaches the company management, it is evident that the company and its shareholders are willing to be bought out at $1.25 a share. This means that the price a buyer will have to pay to acquire 100% control of the company is $1.25 million. Now, if based on the valuation methodologies stated above, a buyer determines that the fair market value of this company is $1 million, then the asking price represents a premium of 25% to its fair market value. It is important to know the true value of the business to avoid overpaying for a company.
Having said that, often strategic buyers are willing to pay a control premium over the market value of the company, for multiple reasons. The strategic buyer might have a portfolio company in a related industry vertical or it might fall in line with a company’s long-term growth plan and corporate values. Buyers must spend time evaluating how much additional value they can extract from the acquisition in determining how much premium is justified. For this purpose, it is important to first lay out a long-term plan which involves effective post-merger integration and overhead planning. The company must identify opportunities to exploit synergies and then quantify those synergies to determine how much additional value a target can generate by being fully absorbed by the acquiring company.
Unlocking Value Through Synergies
Revenue Synergies: There are synergies achieved from the integration of two companies in a similar industry vertical which allows the merged entity to further penetrate its target market or expand market share through shared capabilities and economies of scale. This in turn translates to stronger cash flow generation which can be reinvested to pursue growth and capture a larger market share. Revenue synergies generally take a while to kick-in and it is important to focus on effective post-merger integration to unlock revenue and cash flow growth.
Cost Synergies: Costs synergies are often achieved through effective overhead planning and cost-cutting strategies which allows a company to eliminate inefficiencies and redundant overhead costs and improve margins. Often, strategic buyers with portfolio companies in similar industries can achieve significant cost-synergies by cross-company integration. This is a common strategy used by holding companies and many private equity firms. Cost synergies start kicking in sooner than revenue synergies and often these alone can unlock significant value.
In conclusion, it is important to have an accurate valuation and a strong understanding of a business’s true value before acquiring a company. A professional M&A advisor can assist in this process and provide an independent unbiased analysis of the company’s true worth. It is important that a buyer does not pay a premium that is not supported by fundamentals. In order to assess this, a buyer must evaluate a company’s revenue and cost synergies and create a roadmap to unlock value through growth initiatives and proper planning and execution.