M&A valuation

Acquisitions buy growth, capabilities, market share or cost savings faster than building them. The buyer's board must believe the target is worth more inside the combined company than the price paid. Synergies — cost and revenue — bridge that gap.

A merger model tests whether the buyer's earnings per share rise (accretive) or fall (dilutive) after the deal. The key comparison: the cost of the acquisition currency versus the target's earnings yield. Paying with stock is accretive if the buyer's P/E is higher than the P/E paid for the target.

Cash costs the after-tax interest it would have earned; debt costs the after-tax interest rate; stock costs the inverse of the buyer's P/E. Compare each to the target's earnings yield (inverse of the purchase P/E). Cheapest currency first usually gives the most accretive structure, limited by leverage and ratings.

Cost synergies (closing duplicate offices, procurement savings) are more reliable than revenue synergies (cross-selling). Analysts haircut announced synergies and phase them in over two to three years, net of integration costs. Overestimated synergies are the most common reason acquisitions destroy value.

Accretion is not value creation. A deal can be accretive and still overpay. Boards also look at return on invested capital versus the cost of capital, the effect on credit ratings, and strategic fit. Present all of these, not just the EPS bar chart.