Wednesday, July 25, 2007

When M&A Makes Sense

Given the seeming poor performance of a lot of mergers and acquisitions, a natural question is when do these transactions create value for the acquiring firms. The answer is both simple and complex.

To create economic value for the acquiring firm, the target must be acquired at a cost lower than its value. Leaving aside any issues of bargaining skill, why would we expect that a buyer would be able to purchase a target at less than its value, especially when the target firm probably has a heck of a lot better idea of its true value than the buyer does? The simple answer is that the target firm must be more valuable to the buyer than it is to the seller (the assets of the target must be moved to a higher-valued use using the language of our book). The complex part is discovering / creating that difference in value. Words like "synergy" get tossed around pretty easily, but it's a lot easier to talk about synergy than it is to actually create it.

Even though it's nearly 20 years old, the logic from this article by Jay Barney remains solid. Whether you call it creating synergistic cash flows as Barney does or moving assets to higher-valued uses as we do, it's a necessary condition for creating economic value from mergers / acquisitions. When considering or evaluating a merger, ask the hard question - why is the target more valuable to the buyer than it is to the seller? If you can't come up with a strong case, don't expect a positive result.

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