Strategic Corporate Finance: Applications in Valuation and Capital Structure

M&A FACT AND FALLACY

Today’s M&A environment seems more challenging than ever. But potential buyers have generally restored their debt capacity, are building surplus cash, and face increasing pressure to renew their growth options.

Since early 2000, the market has seen a steady decline in profitability, returns on capital, valuations as well as actual and expected growth rates. The proportion of enterprise value predicated on profitable growth for the S&P500 had declined from 72 percent in December 1999 to 56 percent in March 2003, almost a 50 percent decline from $8,550 billion to $4,350 billion.

However, not all acquisition strategies are created equal. Companies that actively managed their portfolios have outperformed those that did not. Acquirers outperformed divestors but lost to companies that balanced acquisition programs with a healthy dose of divestitures.11

The current environment of low interest rates and reduced valuations offers an opportunity for many companies to renew growth options. Yet we find three recurring issues that stand in the way. We will address these pitfalls that commonly impede transactions:

1. Goodwill

2. Market timing

3. Earnings dilution

The Goods on Goodwill

Under the pooling method, goodwill had been ignored with no record on the balance sheet of the accounting premium—the excess purchase price over book value—and no associated amortization expense postdeal. The exclusion of the accounting premium allowed for a higher level of earnings, return ...