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Screening and Valuation Process - Mergers and Acquisitions

   Posted On :  26.06.2018 09:47 pm

A Taker over company scans the environment to find out the right candidate for take over. The process involves following steps.

Screening and Valuation Process
 
 
A Taker over company scans the environment to find out the right candidate for take over. The process involves following steps.
 
        Identification of industries

        Selection of sectors
 
        Choosing companies (which are 5 to 10% of size bidding companies)

        Finding cost of acquisition and returns: compare candidates with respect to ROIs.

        Ranking of candidates
 
        Identify good candidate(s)

After going through the screening process the fooling considerations merit attention.
 
        Funds availability
 
        Likely positive synergies
 
        Negative synergies an weaknesses
 
        Appropriate timing
 
        Availability of required management style.
 
Next step is valuation. Valuation determines the worth or value of the M & A. Mergers & Acquisitions involve share of stocks of different companies and exchange. The valuation procedures are similar to the capital budgeting procedures.
 
(1) Valuation by P/E Ratio.
 
                        Market price per share
                  =        --------------------------------------------
                   Net earnings after tax per share
 
If market price of a share is Rs 40/- and EPS is Rs 2/- the PE ratio = 40/2=20.
 
This means this company would have to sustain profit at this level for 20 years to pay back its current price. The differences in P/E ratio for different companies are attributed to differences in the following.
 
        Growth rate of a company
 
        Risk associated with investment
 
        Competition & environment
 
Essential commodities have shorter business cycles and more uniform earning compared to sectors like heavy Engineering which are linked with growth of the economy.
 
(2) Earnings Per Share (EPS)
 
Compare the EPS of acquirer and acquired and two together. Refer the balance sheet and profit and loss account for sources and uses of funds.

(3) Divest loss making operations
 
The acquirers should divest loss making subsidiaries and reduce cash drain to invest in attractive ventures. Unwanted assets should be disposed off at book value.
 
(4) Use ratio analysis: Calculate key ratios
 
(a) Current ratio = Current Assets /Current liabilities
 
This should be checked with industry’s average to know if it is on the higher side. If high, the individual assets and liabilities should be checked. If current assets are high excess money will be with debtors or stocks may be high. This should be checked with industry’s average. Reduce current liability like bank over draft and working capital loans to save on interest charges.
 
(b) Level of stock (in months) = (Stocks/Cost of goods sold) x 12
 
If the firm’s level of stock is 8 months and industry’s average is 6 months then the stock level should be reduced. The funds should be deployed for better purposes.
 
( c) Average age of debtors (in days) = (Debtors / Sales) x 365
 
If the acquiring company’s average age of debtors is low follow the same policy of the acquired one.
 
(d) Revise Balance sheet and profit & loss account-
 
The new EPS after merger should be better for the new company.
 
(5) Incorporate growth and expectation rates
 
Prepare proforma statements with expected growth rates.
 
(6) Market value of assets: Find the current market value of assets. It is a good measure of strength.
 
(7) Replacement value (RV) of assets
 
Replacement cost is better than historical cost particularly in an inflationary economy.
 
Replacement value of an asset = 1- Age of Assets/ Total Economic life of Asset) x Current value of asset. 
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