CFO.com

Should You Rethink Assumptions About M&A Valuations?

Can't get the math to work on a prospective deal? You might need to reassess your hurdle rate.

著者：Michael Robbins and Hubert Shen

First published on 11月 05, 2015
min read


This article originally appeared in CFO.com. Global mergers and acquisitions have reached high levels this year. Yet many chief financial officers, treasurers, and other executives assessing M&A opportunities continue to remark, “I just can’t make this deal pencil out.” For every buyer, it seems, another dozen potential buyers have been walking away because their valuation models show they will not earn adequate returns. They might have strong balance sheets, abundant cash, and prospective targets that could add strategic value, yet many still choose to sit on the sidelines in the interest of being prudent with their shareholders’ capital. This has led cautious companies into a no-growth trap: They wind up holding on to their cash, or returning it to shareholders through dividends and share buybacks. For CFOs discarding potential deals, should they simply wait for better valuations and in the meantime continue returning capital to shareholders? Some companies are opting for an alternative. They are reassessing internal hurdle rates — the minimum rate of return they will accept — so that they accurately capture current capital markets conditions. Reassessing hurdle rates effectively expands the universe of attractive investment opportunities, whether they be M&A or organic. Two factors account for higher-than-necessary hurdle rates. One is companies’ reluctance to lower hurdle rates as much as declines in their weighted average cost of capital. (The WACC is what a company expects to pay its creditors and investors, on average, for their stake in the company.) The other is the acquisition premium placed on potential deals to compensate for their risk. Our analysis shows that the WACC of S&P 500 companies has steadily decreased from an average 10% in 2010 to 8% in 2014. However, many CFOs have not lowered their internal investment hurdle rates as quickly or as far. Believing that interest rates must rise again soon, they have adopted a more conservative approach. In addition, the risk premium they give to acquisitions (typically 200 to 300 basis points) and their general conservatism toward WACC (typically 50 to 100 basis points) have not changed, further building in conservatism on a lower base. Interest Rates Will Remain Low If deals are not penciling out because potential buyers cannot get comfortable with the growth projections sellers have embedded into the price, then that may be a reasonable constraint. On the other hand, if the conservatism stems from worry that long-term interest rates will soon rise, that’s another matter. There is evidence that long-term interest rates will remain low for awhile, even as the U.S. Federal Reserve begins the process of normalizing monetary policy. For one thing, capital superabundance continues to prevail, with about $600 trillion in global financial assets available for investment. The law of supply and demand means that the cost of capital will likely remain low. It’s also worth noting that the current level of rates is close to the long-term average over the past two centuries. A prolonged period of capital surplus likely will be characterized by persistent low interest rates and thin real rates of return. The implication for executives hunting for acceptable deals: Reevaluate internal investment hurdle rates and portfolio investment return targets accordingly. Without these adjustments, they may end up parking capital on the sidelines indefinitely while waiting for higher-return opportunities that will not materialize. It’s true that valuation multiples in today’s environment still seem rich by recent historical measures. Yet investors cannot invest in opportunities of the past, and very few can accurately time the valuation of assets in the market. They must make capital allocation decisions and trade-offs against the only options presently available. Executives who still worry about timing this market at high valuations could consider a series of smaller investments or acquisitions over time, rather than one big acquisition that may be more susceptible to timing risk. Bain’s analysis shows that frequency and materiality both matter. Building M&A capabilities with a series of smaller acquisitions often leads to better returns over time. In addition, the more a company’s market capitalization comes from its acquisitions, the better its performance is likely to be. More broadly, the most successful acquirers think about their portfolio of assets for the long term. They understand that strategic investments complementing the company’s core business can unlock more value than deals that simply pencil out in the near term. If you’re finding deals that are attractive but too expensive, a reevaluation just might lead to a different conclusion. Michael Robbins, a Washington, DC-based partner with Bain & Company, is a leader of the firm’s corporate finance practice in the Americas. Hubert Shen is a principal with the practice and is based in Los Angeles.

This article originally appeared in CFO.com.

Global mergers and acquisitions have reached high levels this year. Yet many chief financial officers, treasurers, and other executives assessing M&A opportunities continue to remark, “I just can’t make this deal pencil out.”

For every buyer, it seems, another dozen potential buyers have been walking away because their valuation models show they will not earn adequate returns. They might have strong balance sheets, abundant cash, and prospective targets that could add strategic value, yet many still choose to sit on the sidelines in the interest of being prudent with their shareholders’ capital.

This has led cautious companies into a no-growth trap: They wind up holding on to their cash, or returning it to shareholders through dividends and share buybacks. For CFOs discarding potential deals, should they simply wait for better valuations and in the meantime continue returning capital to shareholders?

Some companies are opting for an alternative. They are reassessing internal hurdle rates — the minimum rate of return they will accept — so that they accurately capture current capital markets conditions. Reassessing hurdle rates effectively expands the universe of attractive investment opportunities, whether they be M&A or organic.

Two factors account for higher-than-necessary hurdle rates. One is companies’ reluctance to lower hurdle rates as much as declines in their weighted average cost of capital. (The WACC is what a company expects to pay its creditors and investors, on average, for their stake in the company.) The other is the acquisition premium placed on potential deals to compensate for their risk.

Our analysis shows that the WACC of S&P 500 companies has steadily decreased from an average 10% in 2010 to 8% in 2014. However, many CFOs have not lowered their internal investment hurdle rates as quickly or as far. Believing that interest rates must rise again soon, they have adopted a more conservative approach.

In addition, the risk premium they give to acquisitions (typically 200 to 300 basis points) and their general conservatism toward WACC (typically 50 to 100 basis points) have not changed, further building in conservatism on a lower base.

Interest Rates Will Remain Low

If deals are not penciling out because potential buyers cannot get comfortable with the growth projections sellers have embedded into the price, then that may be a reasonable constraint. On the other hand, if the conservatism stems from worry that long-term interest rates will soon rise, that’s another matter.

There is evidence that long-term interest rates will remain low for awhile, even as the U.S. Federal Reserve begins the process of normalizing monetary policy. For one thing, capital superabundance continues to prevail, with about $600 trillion in global financial assets available for investment. The law of supply and demand means that the cost of capital will likely remain low. It’s also worth noting that the current level of rates is close to the long-term average over the past two centuries.

A prolonged period of capital surplus likely will be characterized by persistent low interest rates and thin real rates of return. The implication for executives hunting for acceptable deals: Reevaluate internal investment hurdle rates and portfolio investment return targets accordingly. Without these adjustments, they may end up parking capital on the sidelines indefinitely while waiting for higher-return opportunities that will not materialize.

It’s true that valuation multiples in today’s environment still seem rich by recent historical measures. Yet investors cannot invest in opportunities of the past, and very few can accurately time the valuation of assets in the market. They must make capital allocation decisions and trade-offs against the only options presently available.

Executives who still worry about timing this market at high valuations could consider a series of smaller investments or acquisitions over time, rather than one big acquisition that may be more susceptible to timing risk. Bain’s analysis shows that frequency and materiality both matter. Building M&A capabilities with a series of smaller acquisitions often leads to better returns over time. In addition, the more a company’s market capitalization comes from its acquisitions, the better its performance is likely to be.

More broadly, the most successful acquirers think about their portfolio of assets for the long term. They understand that strategic investments complementing the company’s core business can unlock more value than deals that simply pencil out in the near term. If you’re finding deals that are attractive but too expensive, a reevaluation just might lead to a different conclusion.

Michael Robbins, a Washington, DC-based partner with Bain & Company, is a leader of the firm’s corporate finance practice in the Americas. Hubert Shen is a principal with the practice and is based in Los Angeles.