Coatings World - September 2016

Strategies & Analysis

by Patrick Jones, VP M&A, CHEMARK Consulting (Part 2 of a 3 Part Series

This month the Business Corner re- turns to the topic of mergers and acquisitions with the second installment in our three-part series. The initial column in this series took a look at the driving forces shaping today’s middle market M&A environment and introduced three buyer classes: Strategic Buyers, Private Equity and the Family Office. In this column we will look at some of the conventional wisdom associated with so-called Strategic Buyers versus Private Equity and, with the some basic financial modeling, compare and contrast why these two buyer classes take different approaches to deal making.

FantasyChem – A Fictitious
Specialty Chemicals
Manufacturer

To set the stage let us create a fictitious
chemical company that would be consid-
ered an attractive acquisition opportunity
in today’s market. For the purpose of this
illustration, we are going to focus on a
few basic financial parameters and their
impact on value creation. We will assume
that the qualitative aspects of the company
are what we would expect of a high qual-
ity enterprise – no environmental issues,
differentiated and defensible product tech-
nology, competitive cost structure with
high quality manufacturing, and effective
leadership and management.

The Strategic Buyer

Generally when we think of a strategic
buyer, we are thinking of a publicly trad-
ed company. As such we would expect a
conventional approach to capital bud-
geting in which the capital structure and
balance sheet are managed independently
from investment decisions. Theory holds
that the firm should invest in projects that
meet or exceed its weight-average cost of
capital (WACC) and reject investments
that fail to meet this hurdle. Therefore,
firms often use discounted cash flow
(DCF) analysis and internal rate of return
(IRR), the rate at which the sum of the
discounted project cash flows equal the
net investment, to select and prioritize
investments of their available capital.
An example of a prototypical DCF
analysis of FantasyChem is presented in
the green box above. Our strategic buyer
ignores any specific financing consider-
ations, such as interest costs, in its review
of FantasyChem and instead focuses its
attention on determining the upper limit
of its valuation range by calculating the
purchase price at which the IRR is equal
to the WACC. In its analysis, our strategic
buyer begins with FantasyChem’s basic fi-
nancial performance and historic growth
rate, assumes a modest synergy (raw ma-
terials savings perhaps) of 3% under new
management, and calculates that it can
pay up to $158 million, 6.3x EBITDA,
M&A Conventional Wisdom – Cliché or Reality?