Valuation : Question 9
How do you go about valuing a company for a merger-acquisition? What are the most frequently used ratios? Are there any standard formulas? How do you calculate goodwill?

In practice, a non-cash merger (or acquisition) requires first that the target company be valued. Then the acquiring company must be valued, since it must issue new shares to the target’s shareholders.

Shares are then exchanged (x shares in the target company for y shares in the acquiring company), on the basis of the exchange ratio set out in a valuation report on the shares of the two companies.

In order to determine this relative value, a full valuation of the two companies must be made using standard methods (discounted cash flows and comparable multiples or transaction methods, sum-of-the-parts method, described in chapter 40 of the Vernimmen). There is no ready-made formula. It is customary in the mergers and acquisitions business however, to examine the impact of the exchange ratio on the performance metrics generally monitored by the market. The most frequently used reference metrics are net income, cash flow, dividends, market capitalisation and shareholders’ equity.

It is very unusual for one company to acquire another for exactly its book value. Generally speaking, there is a difference between the acquisition price and the portion of the target subsidiary’s shareholders’ equity attributable to the parent company even after taking into account latent capital gains.

This difference is called goodwill. See chapter 6 of the Vernimmen for a discussion of goodwill.