Tag: funds
Sep
25
Assess High Potential Candidates in Depth
Once you have narrowed your list of candidates to a handful of realistic possibilities, you will begin the detailed work of valuing each candidate and identifying your strategy for creating value. You will need a plan that more than earns back the purchase price, including a premium that you would have to pay to complete a deal. With takeover premiums running 30 percent to 40 percent and more above the pre-acquisition market values, you will want to be sure the synergies are both large and clearly identified.
When undertaking a detailed evaluation of the remaining candidates, keep in mind the distinction between the value to you and the price you will need to pay. Your obvious objective should be to maximize the former while minimizing the latter. The essential starting point is a clear understanding of the value of the company to you under your ownership. This consists of its standalone value, as operated by current management; likely net synergies from the combination, after taking into account potential lost business from disruption, and transactions costs, such as restructuring charges and deal fees. The more specific you can be in assessing each of these areas, the better prepared you will be for negotiations and subsequent integration.
Standalone value should be looked at from multiple perspectives, including average securities analyst estimates, past performance, and management pronouncements. Likewise, synergies should be categorized and quantified wherever possible. You should also assess how long it will take to capture the synergies. And don’t forget about the impact of competitor reactions to your deal that could have a financial impact on the combined firm.
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Oct
03
Economic Value versus Reported Book Value
Economic value represents the net market value of the assets and liabilities at a moment in time. It represents the value if the assets were sold and used to buy back its liabilities assuming that their sale and repurchase have no direct impact on market prices:
Economic value = Market value of assets ? Market value of liabilities Economic value is very different from the accounting-based definition of value, where reported
shareholders’ funds are given by:
Shareholder funds = Book value of assets ? Book value of liabilities
Under the accounting version a bank’s value remains unchanged whether rates rise or fall. There are three methods that may be used to account for securities holdings. In some
countries all three methods are used depending on the security’s classification:
Carried at cost. Under this method the value of the security on the books is left unchanged at the acquisition price. In a rising interest rate environment this will result in a reported book value that is greater than a bank’s economic value. Marked-to-market – income statement. Under this method the security is revalued at the current market price. Any unrealized gain or loss is taken through the income statement. Marked-to-market – balance sheet treatment. The security is again revalued at current market price. The unrealized gain or loss is not, however, taken through the income statement but is reflected in an additional account within shareholders’ fund. This account is usually called something like “Reserve for unrealized gains or losses on securities”. The loss or gain is only taken through the income statement when realized.
Accountants employed by banks, regulatory bodies or working for standards bodies have an ongoing tussle over whether, and how, to make bank accounting policies provide a realistic picture of the underlying economic value. Banks have by and large resisted moves towards market-based valuations on the grounds that this would make their reported earnings increasingly volatile and that it is difficult to determine a market price for many of their loans.
The result has been, and is likely to continue to be, an uneasy compromise that accepts implicitly that published bank accounts do not provide an accurate measure of economic value. This compromise involves the acceptance of a number of internal inconsistencies.
An example of this inconsistency would be at a bank that has both fixed rate mortgages and fixed rate bonds. There will be a negative impact on the economic value of both the mortgage loans and the bonds if interest rates rise.
In most countries banks are required to recognize the fall in the value of the bonds but will not have to recognize the fall in the value of the fixed rate mortgages.
One of the problems associated with not “marking to market” all investments is that it can provide an incentive for banks to sell investments that have a market value above their book value while retaining other instruments on which the bank has a paper loss. This will result in a book value that is inflated relative to its economic value and artificially inflate reported earnings.
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