Reading: Roadmap to Offer Price

The third step is to value the combined firm after the deal.

To this end, we estimate the additional value created by the deal, the so-called synergies (e.g., value-added from quicker market access for the target's product), as well as the value drained in a deal (for example because of integration cost or anti-trust interventions).

The additional value created by the deal net of the value drained by the deal is the so-called net synergy.

Example:

The acquirer A contemplates the acquisition of the target T. We have the following information about the two firms:

• The current market value of A is 1'000 and that of T is 300
• Optimally managed as a stand-alone company, T's value would be 400
• If A and T merge, the combined value would be 1'700

Based on this information, we can determine the control premium as well as the net synergy from the deal:

• Control premium = Value of optimally managed T – Stand-alone value T = 400 - 300 = 100
• Net synergy = Merged value – Stand-alone value A – Stand-alone value T – Control premium = 1'700 – 1000 – 300 – 100 = 300

Generally speaking, and ignoring the financing of the transaction for the moment (more on this later on), the merged value corresponds to the sum of the firms' stand-alone values plus the control premium plus the net synergy:
 

As we have discussed in the overview of the takeover process, these valuation steps are highly dynamic:

• At early stages, the valuations tend to be very rough (and possibly closer to guesses than estimates), as there is little if any reliable information available about the target company. 
• As negotiations and due diligence proceed, the quality of the information should increase significantly so that the valuations can be refined accordingly.
• While these quantitative steps of the takeover process are often outsourced to consultants or investment bankers, it is crucial for the firm's management to understand what the key value drivers are and how different setups of the transaction might affect these value drivers. 

From the Valuation to an Offer Price

In this section, we have discussed the logic behind the main valuation steps in a takeover process. When defining the offer price, it is crucial for the acquirer to know and understand these valuations, as they determine a reasonable price range within which an offer price should be. 

As we have discussed before, the current stand-alone value is often the minimum price an acquirer can reasonably bid to be considered. Once we have good estimates for the control premium and the deal's net synergy potential, we also know what a reasonable maximum offer price can be, namely the current value plus the full control premium and all the synergies. 

In our example above:

• Minimum offer price = Stand-alone value = 300
• Maximum offer price = Stand-alone value + Control Premium + Net Synergy = 300 + 100 + 300 = 700.

Any price between the minimum (300) and the maximum (700) offer price will add value for both the target and the acquiring firm. This crucial element of the negotiation phase, how to set the initial offer price, is the topic of the following section.