M&A Selection Criteria & Evaluation Process: Company Analysis

After identifying a suitable market to enter, the next stage of  evaluating a potential acquisition target is to conduct a detailed  analysis into the target company to determine if it is investment  worthy. Generally, we should consider a few criteria: (1) the commercial  value of the Target’s business model, (2) the Target’s financial  condition and (3) if the Target is subject to any material legal risks.

Is the Target’s business model commercially attractive?

The first step of the process is to understand the Target’s business  model. It is imperative to fully understand how the business operates  and if there is any potential for growth. We should study the Target in  the context of the industry to assess if the business model is viable in  the long run.

Next, we should consider the market position that the Target is in.  It is important to study the value chain of the industry and assess  where the target firm fit in. Furthermore, we should examine the  dynamics of the industry and determine if the Target has a competitive  positioning.

Following which, work should be done to assess the products and  services offered by the Target. This is where potential revenue  synergies between the Acquirer and the Target can be identified.  Synergies can be harnessed from cross selling of products/services  between the two firms, sharing of distributions channels or  complementing the existing product/service portfolio.

Lastly, we should consider any technical expertise that the Target  possesses. It could be in the form of intellectual property rights,  research & development knowledge or certain trade secrets. There  could be integration of the technical expertise with the Acquirer’s  business to enhance the overall value of the combined firm.

Is the Target’s financial condition desirable?

A thorough analysis of the Target’s financial forecasts is a  cornerstone in determining the desirability of any investment. After  all, any purchase consideration for a firm must be compensated with the  future returns that the Target can generate.

The first consideration for the Target’s forecast should be on the  revenue. This is where we consider the Target’s business model and  determine the factors that drive the revenue. We should consider the  growth of the Target’s market and whether the firm is able to gain  market share based on the strength of its competitive advantage. In  addition, revenue projections should also account for the potential  synergy between the two firms.

Next, we should consider how the operating margins of the Target will  look like. We should understand the cost structure and if they are  going to change to support any future strategic goals. Furthermore,  projections on costs should account for any synergies of the combined  entity. In addition, capital budgeting should be done to assess how much  capital expenditure is needed for future expansion.

Lastly, we should decide on the optimal capital structure, in terms  of both debt and equity, the Target firm should hold. This is to take  advantage of any available debt headroom to lower the cost of financing  the acquisition while avoiding taking on too much risky leverage.

Under most circumstances, the Acquirer usually assumes all the  liabilities of the Target after the acquisition is complete. Therefore,  it is imperative to uncover all potential acquisition risks, hidden  liabilities and problems that the Target may have. The due diligence  process will cover the organizational structure, operating license,  material contracts and any pending litigation that the Target is facing.

In order to increase the success of a M&A, a great deal of work  has to be done to determine the risk and reward that a Target firm can  provide. All these will help determine what is the fair purchase price  of the Target and help with the overall integration process. If done  well, the synergies of the merger will prove the attractiveness of the  deal and generate superior returns for the investors of the combined  firm.

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