Complete Guide to Building an

Acquisition Strategy and

Valuation Methodologies

There are various aspects to consider when searching for an acquisition

target

IDENTIFYING AN ACQUISTION TARGET

Key Aspects of Value to an Acquiror

Competitive

Advantage

Important Market

Segment

Robust Financial

Performance

Access to

New Geographies

• Strong market position

through large, stable user

base or other competitive

edge

• Expertise in a particular

division or area

• Target's strengths can be

leveraged throughout

Acquiror's organization

• Operates key commercial

platform with potential for

strong cash growth

• Market is of key strategic

importance in the value

chain

• Target's products or services

can catalyze growth of

Acquiror's existing

businesses

• Healthy business with track

record of strong cash flows

and resilient earnings

• Strong top-line growth

trajectory

• Disciplined cost

management

• Target has established

positions in new or high

growth markets where the

Acquiror is not present

• These new markets are

relatively difficult to expand

into organically

Ideal Acquisition Target

A

1

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Aligning Acquisition Strategy to Seller Process

IDENTIFYING AN ACQUISTION TARGET

Competitive Auction

• Formal process with organized disclosure on business sold via information memos and management presentations

— Auctions usually have a longer timetable

— Higher chance that Acquiror’s interest may be leaked to public

• When drawn into a competitive auction, Acquiror can avoid a bidding war by positioning each bid strategically in two-tiered processes

— E.g. bid conservatively in first round to learn more about other bidders and preserve valuation flexibility

• Acquiror should also conduct an interloper analysis to

— Identify potential financial or strategic buyers

— Assess their ability to pay

— Estimate rivals’ ability to achieve synergies with Target

— Evaluate impact to market landscape if Target falls into competitor’s hands

Negotiated Transaction

• Less formal process with:

— More flexibility in requesting specific or customized information

• Greater access to Target’s management team

• In a limited negotiation, Acquiror can:

— Push for exclusivity to remove concerns over interloper intervention

— Enjoy more room to structure transaction creatively

– E.g. Acquiror can decide whether to acquire entire business or carve out specific assets

• Limited competition suggests a higher likelihood for Acquiror to capture pre-emptive value

Strategic positioning in a buyside approach can vary significantly depending on whether

Seller is running a competitive auction or engaged in exclusive negotiations with Acquiror

A

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Diligencing the Target entails reviewing the market, financials and the

business…

DILIGENCING THE TARGET

Key Areas Details

Market

Overview

• Size and scope of markets

• Key economic drivers

• Expected regulatory changes that could change competitive landscape

• Key competitors

— Historical, current and anticipated

— Strengths/weaknesses vs. peers

Financials

• Key performance indicators and expected trends

• Historical audited financials

• Projected financials and near-term

• Variance between historical budgets and actual performance

• Capital structure and expected maturities

Business

• Marketing and customer acquisition strategy vs. peers

• Customer mix

— Focus on high or low share customers

— Mix of customer demographics

• Outlook on required capex over next few years

— Could changes in technology etc derail those projections?

• Cost structure vs. peers

B

3

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CONTENTS

There are several critical aspects to a well thought-out acquisition strategy for enterprise assets

1. Formulating an Acquisition Strategy

A. Identifying the Acquisition Target and Process

B. Diligencing the Target

C. Evaluating Other Strategic Considerations

2. Overview of Valuation Methodologies

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CONTENTS

There are several critical aspects to a well thought-out acquisition strategy for enterprise assets

1. Formulating an Acquisition Strategy

A. Identifying the Acquisition Target and Process

B. Diligencing the Target

C. Evaluating Other Strategic Considerations

2. Overview of Valuation Methodologies

5

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Valuation Methodologies and Key Issues

OVERVIEW OF VALUATION METHODOLOGIES

Methodology Key Sensitivities

Public Market

Comparables

• Trading multiples of comparable companies

• To determine the relative value of companies within the

sector

• Quality of comparables

• Market environment

• Consistent accounting treatment

• Forward-looking multiples

• Public data

Merger Market

Comparables

• Market of comparable transactions

• Takes into consideration acquisition premium

• Quality of comparable transactions

• Historical multiples

• Generally limited public data

• Market conditions at time of transaction

Discounted

Cash Flow

(“DCF”)

• Present value (“PV”) of projected unlevered free cash

flows (“FCFs”)

• Discounted at weighted average cost of capital

(“WACC”)

• Quality of financial forecasts (large number of

assumptions)

• Discount rate

• Terminal value / perpetuity growth rate

Pro Forma

Analysis

• Impact of a transaction (growth, margins, credit rating,

etc.)

• Assess whether a transaction is accretive / dilutive to

EPS

• Near-term vs. long-term impact

• Affected by financing capital structure

• Affected by accounting (purchase price allocation)

• Not indicator of fundamental value

1

2

3

4

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Financial ratios should be compared across different sectors

1

2013E EV / Sales

2013E EV / EBITDA

Sector 1 Sector 2 Sector 3

1

Benchmarking of Market Multiples – Example Output

OVERVIEW OF VALUATION METHODOLOGIES – PUBLIC MARKET

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Overview of the Discounted Future Value Approach

Discounted Future Value Approach

• Consider the start-up when the business model approaches maturity, and achieves positive EBITDA and longer-target margin targets

• The start-up can be valued with a 1-year forward multiple on future financial metrics based on projected future forward multiples

• The resulting valuation is subsequently to today to find the present value of the start-up business

Overview

Illustrative Calculation Methodology

Forward 2017

“Steady” EBITDA

1 Year Forward

Multiple

Future Value

at 2016

Present Value Today at

2013 x = Discount

4 Years

1

1 OVERVIEW OF VALUATION METHODOLOGIES – PUBLIC MARKET

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Analysing precedent transactions will give a snapshot of multiples

being paid

Date _ _ _ _ _ _ _ _ _ _ _ _ _ _

Acquirer _ _ _ _ _ _ _ _ _ _ _ _ _ _

Target _ _ _ _ _ _ _ _ _ _ _ _ _ _

Transaction Value _ _ _ _ _ _ _ _ _ _ _ _ _ _

Period _ _ _ _ _ _ _ _ _ _ _ _ _ _

2

Selected Precedent Transactions – Example Output

OVERVIEW OF VALUATION METHODOLOGIES – MERGER MARKET

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There are three main components of a Discounted Cash Flow Analysis

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Calculation of

Discount Rate

Determination of

Free Cash Flows

Calculation of

Terminal Value

DCF

Analysis

• Value of business in

projection period

• Projections (5 – 10 years)

— Sales growth

— Margins

— Capex

— Change in Working

Capital

• Incorporates time value of

money

• WACC vs. Equity

discounting

• Discount Rate

— Acquiror, Target or

Sector?

— Risk Free Rate

— Beta

• Value of business /

cashflows post projection

period

• Exit multiple method

• Perpetuity growth method

(steady state)

A B

C

3 OVERVIEW OF VALUATION METHODOLOGIES - DCF

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Terminal value serves as proxy for present value of cash flow stream

that is to be generated after the projection horizon

• Terminal value serves as proxy for present value of cash flow stream that is to be generated after the projection horizon (usually 5 to 10 years)

— Ideally when business is in steady state

• Calculate PV of terminal value and add to PV of projected cash flows to arrive at a total value for the company

• The two principal terminal valuation approaches are:

Methodology Benchmarks

Perpetuity

Method

• Industry growth rate

• General economic growth rate

• Differentiate real growth vs.

inflation

• Compare results to check

assumptions

• Alternatively, calculate terminal

value through one method and

back out the “implied”

assumption for the other

method (e.g. implied perpetuity

growth of a certain exit multiple)

Exit

Multiple

TV = EBITDA x Exit Multiple

• Assumes sale/IPO of business at

multiple of final year’s sales,

EBITDA, EBIT or other metric

• Current trading multiples

• Mid-cycle trading multiples

• M&A multiples

TV =FCF5 x (1+g)

WACC – g

TV =FCF in Year after Final Year

WACC – Growth Rate

3B OVERVIEW OF VALUATION METHODOLOGIES - DCF

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Pro Forma Analysis is a method of calculating financial results in order

to emphasize either current or projected figures

OVERVIEW OF VALUATION METHODOLOGIES – PRO FORMA

Key Inputs to Consider

• Mix of financing

— Stock vs. cash

• Financing Cost (incremental debt to finance the acquisition)

— Interest expense on new debt issued

— Interest income lost on cash used

• Accounting Treatment

— Excess purchase price allocated to asset write-up

– Depreciated / amortized over how long?

• Transaction Costs

— Financing fees, advisor fees

— Merger costs

• Taxes

Considerations

• Impact of target to pro forma growth and margin profile

— Potential multiple impact

— Level of diversification vs. product concentration

• Synergy Analysis

— Cross-selling opportunity

— Cost savings potential

— Amount required to breakeven (if dilutive) vs. amount that is achievable

• Balance sheet impact

— Credit rating

— Ability to de-lever

— Pro forma ownership

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Deal Terms

Company B Share Price (US$) 10.00

Premium Over Purchase Price 20.0%

Acquisiton Share Price (US$) 12.00

Company B Shares Outstanding (mm) 500

Implied Takeover Equity Value 6,000

Financing Terms

Debt Financing (50%) 3,000

Equity Financing (50%) 3,000

Company A Share Price 20.00

Company A Pre-Deal Shares Outstanding 1,000

Company A Post-Deal Shares Outstanding 1,150

EPS Accretion / (Dilution)

(US$ mm) 2013E 2014E

Company A Net Income 2,000 2,200

Company B Net Income 500 550

Post-Tax Interest Expense @ 4.0% Pre-Tax¹ (78) (78)

Pro Forma Net Income 2,422 2,672

Company A Pro Forma EPS (US$) 2.11 2.32

Company A Status Quo EPS (US$) 2.00 2.20

EPS Accretion / (Dilution) 5.3% 5.6%

Company A Acquires Company B – An Illustrative Example

1 Assumes corporate tax rate of 35%

Illustrative EPS Accretion / (Dilution) Analysis Sensitivity Analysis

2013E EPS Accretion

Acquisition Share Price

Pre

-Tax C

ost

of

Deb

t

2014E EPS Accretion

Acquisition Share Price

Pre

-Tax C

ost

of

Deb

t

4

5.3% 10.00 11.00 12.00 13.00 14.00

3.0% 8.9% 7.5% 6.2% 4.8% 3.5%

3.5% 8.6% 7.1% 5.7% 4.3% 3.0%

4.0% 8.2% 6.7% 5.3% 3.9% 2.5%

4.5% 7.9% 6.4% 4.9% 3.4% 2.0%

5.0% 7.5% 6.0% 4.5% 3.0% 1.5%

5.6% 10.00 11.00 12.00 13.00 14.00

3.0% 9.1% 7.7% 6.4% 5.0% 3.7%

3.5% 8.8% 7.4% 6.0% 4.6% 3.3%

4.0% 8.5% 7.0% 5.6% 4.2% 2.9%

4.5% 8.2% 6.7% 5.2% 3.8% 2.4%

5.0% 7.8% 6.3% 4.8% 3.4% 2.0%

4 OVERVIEW OF VALUATION METHODOLOGIES – PRO FORMA

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