Business valuation in M&A: the case of Family Dollar

Hello. My name's Michael McDonald. This is a case study for Henry Stewart Talks. Today study is entitled Business Valuation in Mergers and Acquisitions: the Case of Family Dollar.

So what are mergers and acquisitions? Well, mergers and acquisitions is just a couple terms that describe the process in which one company acquires another company. Usually, this is in the realm of publicly traded companies, but it doesn't have to be. For example, sometimes publicly traded companies acquire small, or large, privately held companies. And sometimes, large privately held companies will even acquire publicly traded companies. There's a few hundred mergers and acquisitions every year. The size the U.S. Stock Market has shrunk in terms of number of firms from roughly 8,000 firms in the late 1990s to about 5,000 firms today. So much of that shrinkage in the market is a result of mergers and acquisitions. This implies, then, that is there's maybe 200 M&A deals per year on average. As a result it's very important to understand this topic. This is very common for large companies to have to deal with this type of issue.

Now before we get to the valuation on mergers and acquisitions, it's important to understand some of the terminology. In particular, when one company is looking to acquire another company, the buying, or acquiring, firm is called the suitor firm, or the acquirer company. The company that is going to be bought, or acquired, is called the target company, or the acquiree, or the buyout target. Suitor firms, generally, are looking for target firms that are a good fit with their business, and which can provide good value to their shareholders. After all, a responsible suitor firm is trying to maximize the value for their own shareholders. So they would never do an acquisition which is destructive to that valuation. We'll get to some ways in which mergers and acquisitions don't always work out as intended later on in the presentation. But generally, suitor firms are looking to buy, or takeover, target firms at the lowest price they can. Now, the reality is that in an M&A deal, there's almost always a premium on the target firm's stock price in the buyout deal. In particular, if a target firm is trading, at say, $50 a share on June 1st, and a merger is announced, on say, June 15th, the target firm will almost always be bought in that merger at a price higher than $50. In particular, there's this premium over that $50 price, it is called a buyout premium. That buyout premium is frequently anywhere from 10%, so $5 per share, to 20% or 30%, $10 or $15 a share, even a 40% or 50% buyout premium is not unheard of. Sometimes, if word of the merger leaks before the announcement of the actual acquisition itself, some of that buyout premium will be embedded in the stock price in advance as investors start to expect a buyout premium. So why is a buyout premium needed in cases like this? What do you think? Why would a target company have a buyout premium on their stock? And B for that matter, why would a suitor firm be willing to agree to pay more on June 15th for the stock, than the stock was trading for on June 1st. Would a target firm ever accept a buyout at that June 1st price, at the price its stock was currently trading at? And then, for that matter, what do you think would be likely to happen to the target firm's stock price assuming that the acquiring company did try to buy them at exactly the price they were trading for?