1 1 Winning through Merger and Acquisition Buyers and sellers can create a lot of value through merger and ac￾quisition (M&A). Both can win from a transaction. That is the beauty of dealmaking. And that is much of the allure that has driven the tremendous volume of M&A activity in the United States during the 1990s; in recent years this trend has extended worldwide.1 This book focuses on business value—what creates it, how to measure it, how to build it, and how to maximize it in merger and acquisition. These concepts are equally important to buyers and sellers because both can and should benefit from a deal. But dif￾ferent results frequently occur. Sellers may sell under adverse con￾ditions or accept too low a price due to lack of preparation or knowledge. And every buyer runs the risk of purchasing the wrong business or paying too much. That is why understanding value— and what drives it—is critical in merger and acquisition. Wise shareholders and managers do not, however, confine their focus on value to only M&A. Value creation drives their strategic planning and, in the process, creates focus and direction for their company. Their M&A strategy supports and complements their broader goal of building shareholder value and they buy and sell only when the deal creates value for them. 1 Chapter 5 presents a very necessary second view of the potential results of M&A. 01jwEVANS_37691 7/24/01 8:51 AM Page 1 2 Winning through Merger and Acquisition This brings us back to the purpose of this book. It explains how to create, measure, and maximize value in merger and acqui￾sition in the context of the broader business goal of building value. Senior managers in most public companies focus on value every day because it is reflected in the movement of their stock price— the daily scorecard of their performance relative to other invest￾ment choices. Private companies, however, lack this market feed￾back and direction. Their shareholders and executives seldom understand what their company is worth or clearly see what drives its value. For this reason, many private companies—and business segments of public companies as well—lack direction and under￾perform. Managing the value of a private company, or a division of a public corporation, is particularly difficult because that value is harder to compute and justify. Yet most business activity—and value creation or destruction—occurs at this operational level. Being able to accurately measure and manage the value of smaller businesses or business segments is critical in the value cre￾ation process. And this skill will pay off in M&A as well because most transactions involve smaller entities. Although we read and hear about the big deals that involve large corporations with known stock prices, the median M&A transaction size in the United States in recent years has been about $25 to $40 million. Smaller deals involving closely held companies or segments of public companies are the scene for most M&A activity. Therefore, every value-minded shareholder and executive must strive to maximize value at this smaller-entity level where daily stock prices do not exist. The concepts and techniques that follow explain how to measure and manage value on a daily basis and particularly in M&A. The discussion begins with an under￾standing of what value is. CRITICAL VALUES SHAREHOLDERS OVERLOOK When buyers see a potential target, their analysis frequently begins by identifying and quantifying the synergies they could achieve through the acquisition. They prepare a model that forecasts the target’s potential revenues if they owned it, the adjusted expense 01jwEVANS_37691 7/24/01 8:51 AM Page 2 Critical Values Shareholders Overlook 3 levels under their management, and the resulting income or cash flow that they anticipate. They then discount these future returns by their company’s cost of capital to determine the target’s value to them. Armed with this estimate of value, they begin negotia￾tions aimed at a deal t