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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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Simulated case history
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How does this analytical approach work in practice? We have devised an example to illustrate both the financial analysis which management of the acquiring company should undertake and the graphic guides it could use as tools.
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Synergetics Corporation, a publicly owned (NYSE) company with $125 million in sales, is preparing to commence negotiations with Historic Family Enterprise (HFE), a $12 million company closely held by the chairman of the board and his family. To provide a framework for its acquisition program, Synergetics’ board of directors has approved these corporate financial objectives and acquisition criteria:
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All new capital investments, including acquisitions, must provide a discounted cash flow ROI of 12% or better after taxes. |
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The objective for Synergetics’ earnings per share growth is 10% a year. |
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The target for Synergetics' annual return on shareholders’ investment is 14%. |
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Dilution of earnings per share should be minimized, and any dilution which does result should be eliminated by the third year after acquisition.
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The basic financial characteristics of Synergetics and of HFE look like this (HFE’s earnings per share are not known, and there is no established market value for HFE’s stock):
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Synergetics Corporation |
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Historic Family Enterprise |
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| Profits after taxes |
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$5,000,000 |
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$1,000,000 |
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| Earnings per share |
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$5 |
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- |
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| Past growth rate |
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6% |
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10% |
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| Management growth projection |
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6% |
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12% |
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| P/E ratio |
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12 |
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- |
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In preparing for negotiations, Synergetics’ management has two purposes in mind: (a) to understand the financial relationships that will exist between the two companies so that it will know what prices are reasonable under varying conditions—and why—and (b) to improve its ability to communicate purchase –price limits which the HFE negotiating team will understand and consider reasonable.
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At this point, Synergetics’ executives must clarify the basic financial issues. Because HFE is not publicly owned, there is no established market price, nor has HFE management indicated a preference for any particular exchange instrument. In addition, Synergetics is uncertain what rate of earnings growth to expect from HFE. Therefore, Synergetics is interested in analyzing these financial impacts:
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The relationship among probable HFE earnings per share growth rates, purchase-price levels, and Synergetics’ discounted cash flow return (e.g., with an HFE annual growth rate of 15%, what is the maximum feasible purchase price if the discounted cash flow ROI is to equal 12% or better).
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The year-by-year impact on Synergetics’ earnings per share of various HFE growth rates and purchase prices (e.g, at what growth rate is dilution overcome within three years if HFE is purchases for $20 million in common stock).
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At a given price, the year-by-year effect on earnings per share of alternate combinations of cash, common stock, and preferred stock (e.g., if the purchase price is $20 million, what is the effect on dilution of increasing the cash portion from 5% to 20%).
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The
relationship of purchase price and type of exchange instrument to the resulting degree of HFE control (e.g., if the price is $20 million and the terms are 25% cash and 75% common stock, what percentage of the new, combined enterprise will be represented by former HFE shareholders).
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