Merger and Acquisition values have gone wild – it’s too easy to spend someone else’s money

If you assemble the ingredients of a fast-growing company: an affable management team, ultra-low interest rates, skilled corporate finance advisers, and a sprinkling of testosterone-fuelled buyers whose coffers are overflowing with cash and then light the blue touch paper, it’s not surprising that the ensuing auction or Initial Public Offering (IPO) can often get out of hand.

Potential buyers are usually out-bidding each other for the prize, in some cases pushing the price into the stratosphere with little logic or reference to traditional valuation models.

The same pattern applies with both private sales and public listings. The feeding frenzy hits new peaks as groups rush to raise funds. Companies across the globe have tapped up investors for trillions of dollars of equity and easy-to-borrow debt.

It’s too easy to spend other people’s money when fund managers are criticised for keeping cash that has been raised in the bank. Then add to that the hundreds of thousands of new investors who spent part of lockdown stock picking on the internet, day trading or running their own portfolio – driving quoted company valuations even higher.

Take the IPO last December of Airbnb which had a value of $18b at the beginning of lockdown. Their IPO last December on Nasdaq valued them at $42b and now have a valuation of over $100billion which is more than the value of Marriot and Hilton hotels combined. It’s value now is over 20x revenue. Not bad for a company that barely breaks even and doesn’t pay a dividend.

It’s important to understand the way that fund managers and deal makers are paid. Over-incentivised buyers can lead to unethical investment decisions and in extremes can tilt the entire investment process into troublesome behaviour.

When smaller private companies are sold for sky-high multiples, they are often followed by extreme measures of cost cutting, redundancies and so-called synergies that can destroy value. A recent Cass Business School study of 600 global senior corporate executives, found that only 61 per cent of buyers believe their last acquisition created value.

Here are some things to bear in mind, once the lawyers, bankers and corporate finance chiefs have left and moved on to their next victim.

If you’re a buyer and going to overpay for an acquisition, it’s important to come back down to earth and work out a plan to “create value beyond the deal”.

• Organisations should only acquire companies as part of a clear strategic vision that is aligned to the long-term goals, not because they are opportunistic.
• Put culture at the heart of everything. It’s people who make the most difference to growth prospects. Make sure that the top team are incentivised in a proper, sophisticated and tax efficient way.
• Have a proper communication and integration strategy before you sign the deal. Work out what the first 1000 days post-acquisition will look like. Prioritise and plan for value creation early on rather than assume that it will automatically happen.

Like any sensible buyer, know what your maximum price is before you enter the auction room and the adrenaline kicks in. Would you really be bidding this much if it was your own money?