Essay Example on Mergers vs Acquisitions: Understanding Comparable Transaction Valuations

Introduction

Acquisitions and mergers have become a common scene in modern business as firms struggle to grow and retain profitability. Mergers occur when firms of equal net worth combine to form one company while acquisitions take place when a bigger company acquires a smaller company. However, in an attempt to appease the management and shareholders of the small company acquisitions are therefore considered to be just like mergers. On the other hand, comparable transaction valuations methods include mechanisms used to determine the cost of firms by comparing their current value to that of similar businesses. These methods are important before mergers and acquisitions to ensure that the resulting company is able to plan and focus on the achievement of set goals. Reasons for acquisitions and comparable transaction valuation methods are explained below.

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Reasons for Acquisition

The biggest reason for acquisitions is to create synergies through economies of scale. This aims at reducing the company's cost of production and therefore the price of their goods and services. Economies of scale enable the company to acquire raw materials at a lower price; hence it is able to acquire them in bulk (Foerster, 2015). This advantage also allows the company to bargain for loans at lower interest rates hence promote their ability to improve the quality of their goods and services hence maximum growth.

Acquisitions help firms to increase their profitability through cross-selling due to the increased market size. The profitability of the new firm can also increase due to the effectiveness of marketing strategies used by both companies earlier on (Chui, 2017). The management of both companies is also able to come together and promote innovation through harnessing knowledge and skills from employees of both companies. This factor provides more ability for the company to secure more sales hence increased profits.

Acquisitions are also used to deal with "Agency Problems." Agency problems occur when managers or company agents quit from focusing on the growth of the company and direct funds towards their personal needs and satisfaction (Chui, 2017). This results in poor performance and, in many cases, the collapse of the enterprise. Therefore, an acquisition from another company provides an opportunity to save the company mostly through the sacking of the agents involved in mismanagement and redirecting the company towards growth and profitability.

Comparable Transactions Valuation Methods

Price-Earnings Method

According to Foerster, the price-earnings method is directly determining the equity of the firm through; a business projected earnings as per share the following year, appropriate forward-looking multiple, and the number of common shares outstanding. It is, therefore, a simple but not very accurate since the value of shares cannot be priced fairly in the market.

Enterprise Value-to-EBITDA Method

This method is based on relative valuation and is similar to the price-earnings mechanism but does not focus on a firm's earnings. This method determines the value of the entire business using multiple of the projected EBITDA (Foerster, 2015). The method includes estimating the business value first and then deducting other claims or liabilities to give the value of equity.

Conclusion

It is clear that acquisition is an efficient strategy in the modern day of helping businesses to stay afloat in the midst of tough competition and unpredictable economies. Valuation is crucial to determine the input that the new company is bringing on board. It is important to apply various valuation methods so as to reduce errors and come up with accurate value.

References

Chui, A. B. (2017, June 19). Improving merger and acquisition decision-making using fuzzy logic and simulation. International Journal of Engineering Business Management. Retrieved from https://doi.org/10.1177/1847979017711521

Finnerty, J. D., & Emery, D. R. (2004). The Value of Corporate Control and the Comparable Company Method of Valuation. Financial Management, 33(1), 91-99.

Foerster, S. (2015). Financial Management, Concepts, and Applications. Pearson.