Mergers & Acquisitions - a Real Option valuation approach of investment decision under uncertainty
©2003
Masterarbeit
74 Seiten
Zusammenfassung
Inhaltsangabe:Abstract:
The objective of this dissertation is to examine the application of Real Options for the evaluation of companies with regard to acquisitions. There has been an intensive scientific discussion in the past years about the Real Options method for the evaluation of investments and mergers & acquisitions as in practice usually the management tries to capture future developments with static methods of capital budgeting. For example, future cash-flows are discounted with a fixed risk-adjusted discount rate. Therefore, the Real Options approach has been applied very rarely as it has the reputation of high complexity and poor practicability in daily business. However, the use of present values and capitalized values may produce pitfalls in acquisition decisions as strategic investment decisions might be characterized by a wide range of possibilities to react flexibly to a fast changing environment.
In chapter 1, the term Mergers & Acquisitions (M&A) is defined and the motives as well as the relevance of M&A transactions for different branches are described in detail. Furthermore, the process and the different phases of a merger or an acquisition are explained.
Chapter 2 presents traditional evaluation methods of static net present value, sensitivity analysis, Monte Carlo and decision tree. These classic methods are discussed and a comparison is drawn among these techniques in regard to practicability. At the end of this chapter, a evaluation is presented in regard to specific situations with the mayor parameter of uncertainty and flexibility for the application of these classic methods.
The basic concept of option pricing is described in chapter 3. In addition, the Black-Scholes equation and the underlying assumptions are explained in detail in order to understand financial options, which are the basic for the Real Options approach. At the end of the chapter, an example of a call and put option is discussed in order to understand the functioning of options.
Chapter 4 presents an introduction and definition of the Real Options method. Furthermore, the value drivers and the value creation due to the application of Real Options are discussed and analyzed in detail. After the discussion of the functioning of Real Options, a comparison of the analogy between financial Options and Real Options is done in order to possible differences. In this context, the limitations of the analogy of financial and Real Options are presented. Finally, […]
The objective of this dissertation is to examine the application of Real Options for the evaluation of companies with regard to acquisitions. There has been an intensive scientific discussion in the past years about the Real Options method for the evaluation of investments and mergers & acquisitions as in practice usually the management tries to capture future developments with static methods of capital budgeting. For example, future cash-flows are discounted with a fixed risk-adjusted discount rate. Therefore, the Real Options approach has been applied very rarely as it has the reputation of high complexity and poor practicability in daily business. However, the use of present values and capitalized values may produce pitfalls in acquisition decisions as strategic investment decisions might be characterized by a wide range of possibilities to react flexibly to a fast changing environment.
In chapter 1, the term Mergers & Acquisitions (M&A) is defined and the motives as well as the relevance of M&A transactions for different branches are described in detail. Furthermore, the process and the different phases of a merger or an acquisition are explained.
Chapter 2 presents traditional evaluation methods of static net present value, sensitivity analysis, Monte Carlo and decision tree. These classic methods are discussed and a comparison is drawn among these techniques in regard to practicability. At the end of this chapter, a evaluation is presented in regard to specific situations with the mayor parameter of uncertainty and flexibility for the application of these classic methods.
The basic concept of option pricing is described in chapter 3. In addition, the Black-Scholes equation and the underlying assumptions are explained in detail in order to understand financial options, which are the basic for the Real Options approach. At the end of the chapter, an example of a call and put option is discussed in order to understand the functioning of options.
Chapter 4 presents an introduction and definition of the Real Options method. Furthermore, the value drivers and the value creation due to the application of Real Options are discussed and analyzed in detail. After the discussion of the functioning of Real Options, a comparison of the analogy between financial Options and Real Options is done in order to possible differences. In this context, the limitations of the analogy of financial and Real Options are presented. Finally, […]
Leseprobe
Inhaltsverzeichnis
ID 7575
Zajicek, Marc: Mergers & Acquisitions a Real Option valuation approach of investment
decision under uncertainty
Hamburg: Diplomica GmbH, 2004
Zugl.: FOM Fachhochschule für Oekonomie und Management Essen, Fachhochschule,
MBA-Thesis / Master of Business Administration, 2003
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Printed in Germany
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II
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Contents
Contents ... II
List of Figures...IV
List of Tables ...V
List of Abbreviations ...VI
Introduction... 1
1
Mergers and Acquisitions ... 3
1.1 Definition... 3
1.2 Motives ... 5
1.3 Processes and Phases ... 8
2 Traditional
Evaluation Methods ... 12
2.1 Static Net Present Value... 12
2.2 Sensitivity Analysis ... 13
2.3 Monte Carlo Simulation... 14
2.4 Decision Trees... 15
2.5 Comparison of Capital Budgeting Methods... 16
3 Option-Pricing Theory ... 17
3.1 Basic Concept... 18
3.2 Black-Scholes ... 20
3.3 Example... 22
3.3.1 Call Option... 22
3.3.2 Put Option... 23
4 Real
Options... 25
4.1 Introduction and Definition ... 25
4.2 Value Drivers ... 26
4.3 Value Creation ... 29
4.4 Payment Structure ... 30
4.5 Analogy between Financial Options and Real Options ... 32
4.6 Limitations of the Options Analogy ... 34
4.6.1 Ownership and Competition ... 34
4.6.2 Nontradability... 35
-
III
-
4.6.3 Option Compoundness ... 35
4.7 Classification... 36
5
Real Options versus DCF-Method... 42
5.1 Comparison of Real Options and DCF ... 42
5.2 Problems with the Application of Real Options ... 44
5.2.1 The Exercise Date ... 44
5.2.2 Risk Neutrality ... 45
5.2.3 Volatility ... 45
5.2.4 The Exercise Cost ... 45
5.2.5 Non-Exclusiveness of Underlying Asset ... 46
5.3 Case Study ... 46
6
M&A and Real Options... 50
6.1 Classification of Real Options with M&A ... 50
6.1.1 Value of existing Real Asset ... 50
6.1.2 Strategic Options ... 50
6.1.3 Operational Options... 51
6.1.4 Finance Options ... 51
6.2 Case Study Microsoft... 52
6.2.1 Introduction... 52
6.2.2 Strategic Investments of Microsoft... 53
6.2.3 Evaluation of MDO Options ... 55
6.2.4 Results and Interpretation... 58
7 Conclusion... 60
Literature ... 62
Enclosure ... 65
-
IV
-
List of Figures
Figure 1: Manifestations of Mergers & Acquisitions... 5
Figure 2: Categorization of branches in regard to the relevance of M&A ... 6
Figure 3: Structure of the Acquisition Process... 8
Figure 4: Decision Matrix for Method Selection ... 17
Figure 5: Call Parity Value... 19
Figure 6: Put Parity Value... 19
Figure 7: Call Option... 23
Figure 8: Put Option ... 24
Figure 9: Influencing Factors of Company Value... 26
Figure 10: Asymmetric Payment Structure of Project with Option To Defer . 30
Figure 11: Asymmetric Payment Structure on Basis of Real Options... 31
Figure 12: Payoff of Waiting Option... 37
Figure 13: The Valuation of Managerial Flexibility ... 49
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V
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List of Tables
Table 1: Analogy between options on financial assets and options... 33
Table 2: Real Options Versus DCF Method ... 44
Table 3: Microsoft selected financial data 1996-2002... 55
Table 4: Microsoft parameter values for option calculations... 58
Table 5: Added sales implied in Microsoft 1999 options... 59
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VI
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List of Abbreviations
CCA
Contingent
Claims
Analysis
CRM
Customer
Relationship
Management
DCF
Discounted
Cash
Flow
ERP
Enterprise
Resource
Planing
M&A
Mergers
&
Acquisitions
MDO
Market
Dominance
Option
NPV
Net
Present
Value
R&D
Research
and
Development
WACC
Weighted Average Cost of Capital
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1
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Introduction
The objective of this dissertation is to examine the application of Real Op-
tions for the evaluation of companies in regard to acquisitions. There has
been an intensive scientific discussion in the past years about the Real Op-
tions method for the evaluation of investments and mergers & acquisitions as
in practice usually management tries to capture future development with
static methods of capital budgeting, for example future cash-flows are dis-
counted with a fixed risk-adjusted discount rate. Therefore the Real Options
approach has been applied very rare as it has the reputation of high
complexity and poor practicability in daily business. However, the use of
present values and capitalized values may produce pitfalls in acquisition
decisions as strategic investment decisions might be characterized by a wide
range of possibilities to react flexibly to a fast changing environment.
In chapter 1, the term Merger & Acquisitions is defined and the motives as
well as the relevance of M&A transactions for different branches are de-
scribed in detail. Furthermore, the process and the different phases of an
merger or an acquisition are explained.
The chapter 2 presents traditional evaluation methods of static net present
value, sensitivity analysis, Monte Carlo and decision tree. These classic
methods are discussed and a comparison is drawn among these techniques
in regard to practicability. At the end of this chapter, a evaluation is presented
in regard to specific situations with the mayor parameter of uncertainty and
flexibility for the application of these classic methods.
The basic concept of option pricing is described in chapter 3. In addition, the
Black-Scholes equation and the underlying assumptions are explained in de-
tail in order to understand financial options, which are the basic for the Real
-
2
-
Options approach. At the end of the chapter, an example of a call and put
option is discussed in order to understand the functioning of options.
Chapter 4 presents an introduction and definition of the Real Options
method. Furthermore, the value drivers and the value creation due to the ap-
plication of Real Options are discussed and analyzed in detail. After the dis-
cussion of the functioning of Real Options, a comparison of the analogy be-
tween financial Options and Real Options is done in order to possible differ-
ences. In this context, the limitations of the analogy of financial and Real Op-
tions are presented. Finally, the classification of Real Options in regard to
managerial flexibility in different situation and option for company is dis-
cussed.
The chapter 5, a comparison of the Real Options and DCF method is done.
From the lessons learned of this and previous chapters, the problems of the
application of Real Options in practice is explained in detail. The end of this
chapter is the presentation of a case study with the application of Real Op-
tions and DCF in order to show mayor differences in the evaluation perspec-
tive of investment opportunities by applying these methods and possible con-
trary results.
Last but not least, chapter 6 present the application of Real Options with
M&A transactions. Here the specific classification of Real Options in regard
to M&A is presented and a applied case study of Microsoft's acquisitions in
the past is described and analyzed. Finally, the results are discussed in re-
gard to the relevance of the evaluation of acquisitions by the Real Options
approach.
At the end of the dissertation, a conclusion is drawn in regard to the topic and
the fulfillment of the given objective of the diploma thesis.
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3
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1 Mergers and Acquisitions
1.1 Definition
The term Mergers & Acquisitions is originally coming from the Anglo-Saxon
region and there is no general accepted definition, which can be found in the
literature. In a wider sense, M&A transactions describe the acquisition and
sale of companies, which may also comprise all kinds of interlocking relation-
ships. However, the constituent characteristic is the change of ownership
concerning equity capital of a corporation.
One definition in the literature that can be found is as follows: The combining
of two or more entities into one, through a purchase acquisition or a pooling
of interests. This differs from a consolidation in that no new entity is created
from a merger
1
.
The author Pausenberger defines company acquisitions as the purchase of
the disposal of rights over existing combination of production factors
2
. An-
other definition describes the flexibility and ability to act as a strategic plan-
ning of a company
3
.
The differentiation of the wording acquisition and merger can be described by
the degree of independency of the involved partners. A merger is an amal-
gamation of two or more companies, which have been economic independ-
ent by then. However, one of the participating parties will loose his legal in-
dependency.
There are two kinds of mergers, which can be defined: One company can be
taken up into another company, which is characterized by loosing his legal
and economic independency and will be integrated into the partner company.
The classic kind of a merger is the creation of a new organizational unit with
1
Please see http://www.investorwords.com
2
Please see Pausenberger in Schmusch, Page 9
3
Please see Sieben in Schmusch Page 10
-
4
-
the transfer of assets of the involved companies and the deletion of the com-
panies after fulfillment of the transaction. Currently the merger of equals is
often proclaimed, which is the ideal case and implies a 1:1 relation of both
partners. However, the suggested equality is abolished when only one com-
pany occupies the management positions. In most cases, this is done due to
public relations in order to present no takeover with a looser of this obvious
acquisition. One example for such a behavior is the merger of Daimler and
Chrysler, which demonstrates the decisive actions by the German company
after the economic crises of Chrysler
4
. In this context, the wording take over
is often mentioned. This expression describes the process of taking posses-
sion of a company against the will of the management and therefore this can
be categorized as a hostile takeover
5
.
Under the term acquisition the purchase of a company respective company
shares is executed by the transfer of shares (share deal) or by the transfer of
all or specific commodities and liabilities as well as the combination of the
both. With the acquisition of a company, the economic independency is re-
stricted or totally abolished. From a management point of view, the action of
a merger as well as an acquisition is a strategic measure, which implies the
influence to company policy. This fact differentiates the M&A transaction from
a strategic alliance, which normally does not require equity involvement.
However, the building of a joint venture is included with the M&A term. Joint
Ventures are a form of cooperation between one or more companies, which
in most cases build a new organization unit respective company with new
capital share and often with production factors like know-how, patens, etc.
This advantage of joint ventures is the circumstance that the original compa-
nies are not influenced in regard to their independency and influence of the
partners is only executed through the new company.
6
4
Please see Lucks, Page 23-24
5
Please see Schmusch, Page 11
6
Please see Lucks, Page 24-25
-
5
-
The Figure 1 presents the a.m. different manifestations and types of Mergers
& Acquisitions.
Figure 1: Manifestations of Mergers & Acquisitions
1.2 Motives
One of the most important reasons for the increased M&A transactions is
based on fast changes coming from the markets. The consequence from this
development is the optimization of resources, which supports growth by ac-
quisitions. The increased intensity of competition within the international mar-
kets lies in the globalization of markets. The globalization is characterized by
a growing convergence of technical norms, demand structure and consumer
behavior, which enables companies to distribute world wide standardized
products by cost effective mass production. Furthermore, the deregulation as
well as liberalization of important infrastructure markets like the energy mar-
ket leads to lower barriers for the entrance to national markets and makes it
-
6
-
easier for the international expansion strategies of companies. This devel-
opment results in a higher price competition and consolidation pressure in
line of businesses, which leads to increased M&A activities.
7
The Figure 2 presents the categorization of branches about the relevance of
M&A activities. Here are many branches, where there is a high pressure con-
cerning M&A transactions, whether it is volume or dynamic driven due to the
described tendencies like e.x. globalization tendencies for the so called "Old
Economy". Another example may be the biotechnology as an example for the
so-called "New Economy", where there is high demand for knowledge in or-
der to innovate new technologies. These demands for knowledge may be
fulfilled by the acquisition of new companies in order to achieve these objec-
tives. The consequence of these requirements are adjustment reactions re-
spective M&A transactions of companies in regard to the changed environ-
ment and competition conditions in order to fulfill business objectives.
Volume driven
M&A activities
(e.x. Banks, Insurance)
Volume
and
Dynamic
driven
M&A activities
(e.x. Telecommunication)
Little
M&A activities
(e.x. local services)
Dynamic driven
M&A activities
(e.x. biotechnology)
High
Low
Dynamic within branch
Relevance
of size
High
Low
Figure 2: Categorization of branches in regard to the relevance of M&A
8
7
Please see Lucks, Page 6
-
7
-
From a scientific perspective, the reason for M&A transactions is based on
an economic approach. In general, there are three general areas, which can
be differentiated in the theory of monopoly, efficiency, and evaluation. The
theory of monopoly describes the aim to restrict competition and to increase
market influence, which results in monopoly profits of the merged companies.
In contrast to the mentioned theory, the main objective of the efficiency the-
ory is to achieve synergy potential. The synergy potential can be distin-
guished in operational, financial and management oriented effects. For the
operational focus, the realization of cost cutting, the avoidance of redundant
work and the digression of fix costs by economies of scale as well as effects
by economies of scope is the main objective.
9
Finally, yet importantly, there is the tendency to differ between the a.m. de-
scribed strategic and investment oriented M&A projects. The objective of in-
vestment oriented M&A projects are classic capital investments. Strategic
objectives are focused on the achievement of long-term objectives
10
Finally, the shareholder value perspective is one of most important reason,
why companies enter M&A activities. The theoretical discussion about the
topic value based oriented approach was done by Fruhan and Rappaport at
begin of the eighties. Rappaport defined the first approach for the cash flow
planing oriented company, which is not only focused on individual investment
projects, but on the evaluation of extensive corporate strategies
11
. Further-
more, the indication is given that the company, which is the origin of the pro-
cess of strategic implementation, has to be evaluated itself and in regard to
the market. This is even more important concerning the company growth by
acquisitions
12
. In order to maximize the shareholder value, M&A projects
8
Please see Lucks, Page 8
9
Please see Girkinger, Page 5-6
10
Please see Girkinger, Page 6
11
Please see Rappaport in Schmusch, Page 29
12
Please see Rappaport in Schmusch, Page 29
-
8
-
offer value driver like the improvement of competition situation, taken advan-
tage of synergies, improvement of management, etc.
1.3 Processes and Phases
The acquisition process of an M&A transaction can be seen as sequential
part processes, which have interdependencies between each other. In this
process, there are many different tasks, which are partly in a very complex
structure of input and output relationship type to each other. In the Figure 3 a
coarse structure of the M&A process is presented and the elements will be
now be described in detail.
Figure 3: Structure of the Acquisition Process
13
13
Please see Rockholtz, Page 32
-
9
-
In order to define the acquisition strategy, the acquiring company has to have
a profile of the strengths and weaknesses of its own. Furthermore, the
knowledge of the strategic success position is important, which enables the
company to be successful above average today and in the future in compari-
son to their competitors.
14
Successful industrial acquiring companies have
defined a very clear acquisition strategy in order to achieve, for example, the
transfer of know-how or restructuring objectives. This implies a very careful
evaluation of the company and its environment in order to find value gaps
and as a consequence opportunities. Finally, the decisive selection criteria
and the identification of potential candidates are defined.
15
With the detailed definition of the acquisition strategy, a requirement profile is
developed for potential acquisition candidates. This profile includes a detailed
specification of ideal partners in regard to company individual conditions and
compatibility to the acquisition strategy. Companies, which are of interest as
an acquisition object can be examined and pre selected by external informa-
tion like annual reports, press news, information of M&A departments of
banks or by personal contact. The result of such a selection is a short list of
companies, which fulfill the criteria. After the first contact, the joint interest for
further negotiation between the companies and the access to further informa-
tion to the acquiring company is determined.
16
If there is mutual interest between the acquiring company and the seller, both
parties will agree upon a due diligence in order to execute an extensive
analysis. The due diligence is of high importance as all necessary information
is available and will be prepared and used in order to achieve a fair evalua-
tion of the value of the acquired company.
Before this due diligence is executed a discretion and confidential agreement
is signed. One of the information, which is provided to the acquiring company
14
Please see Rockholtz, Page 33
15
Please see Girkinger, Page 40
16
Please see Rockholtz, Page 34-35
-
10
-
is the company profile respective sales memorandum.
17
On basis on the pro-
vided document as well as other oral information by the seller, the buyer has
the opportunity to compare the profile of the acquisition object with the re-
quirement of the ideal profile. If the elemental requirements are fulfilled, the
potential buyer will document his sustainable purchase intention by a letter of
intent. Furthermore, the buyer will provide a non-binding bid to the seller.
18
In practice, Due diligence reports can be applied upon the entire company or
just cover separate company areas as follows:
19
· Commercial Due Dilligence
· Technical Due Dilligence
· Legal Due Dilligence
· Financial Due Dilligence
· Tax Due Diligence
· Environmental Due Diligence
The areas, which are of importance of the buyer in regard to the whole trans-
action depends in general on the interest of the potential investor as well as
on the kind of target company. For instance, the technical equipment and the
free production capacity is not so important for trading as for production
companies.
In dependence of the results of the due diligence, the acquisition projects will
be interrupted or negotiation is continued with the expected positive outcome.
In the phase of the evaluation, the potential buyer will value the company
financially in order to receive a fundamental estimation for the individual pur-
chase price. Based on the information of the due diligence, the provided
17
Please see Binder/Lanz, Page 19
18
Please see Born, Page 85
Details
- Seiten
- Erscheinungsform
- Originalausgabe
- Jahr
- 2003
- ISBN (eBook)
- 9783832475758
- ISBN (Paperback)
- 9783838675756
- DOI
- 10.3239/9783832475758
- Dateigröße
- 678 KB
- Sprache
- Englisch
- Institution / Hochschule
- FOM Essen, Hochschule für Oekonomie & Management gemeinnützige GmbH, Hochschulleitung Essen früher Fachhochschule – Wirtschaftswissenschaften
- Erscheinungsdatum
- 2004 (Januar)
- Note
- 1,7
- Schlagworte
- akquisition realoption option pricing theory black scholes
