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Master plan for Merger Negotiations |
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Havard Business Review |
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Jan - Feb 1970 |
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By Gary E. MacDougal and Fred V. Malek |
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Page 1 2 3 4 5 6 7 8 9 10 11 |
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Laying the groundwork
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As the first step toward successful acquisition negotiations, the acquiring company should lay the groundwork in two areas: (a) it needs to think out carefully and express in specific terms its own corporate objectives and acquisition criteria; and (b) it needs to study and understand the basic financial relationships between itself and its potential acquisition.
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Objectives and criteria
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Developing corporate objectives and acquisition criteria is too important and complex a subject to be covered thoroughly here. At a minimum, for acquisition evaluation purposes, corporate objectives should include such financial standards as earnings per share growth rate and annual return on investment. Without these yard sticks, there is no way of knowing whether a given acquisition would act as a spur or brake on overall corporate performance. Consider:
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acquisition candidate that is showing an earnings per share growth rate of 9% a year compounded will look very good to a company that is currently growing at 5.5% a year compounded and aiming for an 8% growth rate. |
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However, that same acquisition candidate will (or should) hold little attraction for a would-be acquirer that is growing at 10% a year, and has set its sights on 14%.
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The earnings growth rate and return on investment an acquirer should set as its goals depend on many factors that will emerge only from a thoughtful evaluation of internal corporate potential combined with a sound assessment of the business environment. Some companies regularly measure themselves on two counts: first, against their own industry; then, against a cross section of all manufacturing companies, such as that provided by Fortune’s “500.”
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For example, an earnings per share growth rate of 12.5% a year compounded would equal the performance of companies at the bottom of the top quartile of Fortune’s “500” during the past decade. A 15% return on shareholders’ equity would also place a company at the bottom of the top quartile during this period. The end result should be performance goals that are challenging but attainable.
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Criteria for the evaluation of investments should include, in addition to the type and size of business and other appropriate screening factors, a return on investment (ROI) target that takes present-value considerations into account. The discounted cash flow method provides a good measurement of the return on investment. A typical company, then, might develop these yardsticks against which to measure prospective acquisitions:
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Annual compound earnings per share (EPS) growth rate. |
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Annual return on shareholders’ equity. |
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Prospective return on the investment, calculated on a discounted cash flow basis.
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The buying company can then proceed to examine the financial characteristics of the acquisition candidate, evaluate them in the light of the corporate objectives and acquisition criteria it has established, and begin to define the range of feasible purchase prices and terms.
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