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Business valuation in M&A
Published on April 28, 2021 11 min
Other Talks in the Series: Finance for Non-Finance Professionals
Hi, and welcome to Business Valuation in Mergers and Acquisitions or M&A. I'm Dr. Michael McDonald, and today I'd like to talk to you about how we go about doing business valuation when we're considering M&A deals.
Mergers and acquisitions are a term that's used to describe the process through which one company acquires another company. In particular, we're usually talking about publicly-traded companies in these kinds of circumstances. We don't have to be, but that's typically what's going on. The company that is looking to acquire another company, that is the company that is buying another firm is called the suitor firm while the company that is being acquired or being bought is called the target company.
Now typically, suitor firms look for target companies that are a good fit with the suitor's existing business and provide good value for suitor shareholders. Suitor firms generally offer to buyout or takeover target firms at a premium through the target firm's stock price prior to the news of that suitor's interest.
Why would a buyout premium be needed in cases like this though? For instance, let's just imagine that we've got, say, General Electric looking to buy a smaller company, let's say ABC Company. Why would General Electric need to offer more to ABC shareholders than the current stock price? What do you think? Would you ever have a target firm that would accept a buyout at the same price the stock is currently trading at? If ABC stock is trading at $50 a share for instance, and GE comes in and offers $50, or $50.01, or $49.99, would that target firm shareholders ever say, "Yes. I do want to take that buyout?" What do you think? Now, let's just imagine for a minute that GE again comes in, they're going to buy ABC shares at $75 per share. That's the buyout offer they've offered, and yesterday ABC was trading at $50 per share. What do you think will happen to that stock's price, to ABC's price in this case when shareholders learn that ABC is going to be the target of that buyout attempt? What's likely to happen to the stock price?