Are you paying too much for that acquisition?

Abstract

Despite 30 years of evidence demonstrating that most acquisitions don't create value for the acquiring company, executives continue to make more deals, and bigger deals, every year. There are plenty of reasons why value isn't created, but many times it's simply because the acquiring company paid too much. It's not, however, that acquirers pay too high a price in an absolute sense. Rather, they pay more than the acquisition is worth to them. What is that optimum price? The authors present a systematic way to arrive at it, involving several distinct concepts of value. In today's market, the purchase price of an acquisition will nearly always be higher than the intrinsic value of the company--the price of its stock before any acquisition intentions are announced. The key is to determine how much of that difference is "synergy value"--the value that will result from improvements made when the companies are combined. This value will accrue to the acquirer's shareholders rather than to the target's shareholders. The more synergy value a particular acquisition can generate, the higher the maximum price an acquirer is justified in paying. Just as important as correctly calculating the synergy value is having the discipline to walk away from a deal when the numbers don't add up. If returns to shareholders from acquisitions are no better in the next ten years than they've been in the past 30, the authors warn, it will be because companies have failed to create systematic corporate governance processes that put their simple lessons into practice.

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