Effectiveness Of M&A: How Can You Evaluate It?

Can we consider performance metrics to be accurate if they are based strictly on financial statements?

There is no universal methodology for evaluating the effectiveness of mergers and acquisitions. Can we consider performance metrics to be accurate if they are based strictly on financial statements? Unfortunately, no, because these indicators do not take into account the cost of capital of the company, as well as do not allow judging the achievement of the main goal of any company, namely, increasing its value. In addition, financial statement data can be subject to various interpretations/processes and therefore may not reflect the real financial condition of the company. The choice of valuation method directly depends on the type of synergy to be assessed.

There are various approaches which emphasize the need to estimate risk in the analysis of synergies. This is due to the probability of resetting the synergistic effect due to the high level of risk. Thus, the world practice has developed two main approaches to assess the effectiveness of M&A: qualitative and quantitative. The essence of these approaches is to measure the effectiveness of the merger as a whole, i.e., the total value of assets, gross sales for a certain period; analysis of the financial condition and financial performance of the management company and specific participants of the merged structure and the effectiveness of individual units of the merged structure.

Quantitative methods

Quantitative methods are divided into prospective (evaluation of the M&A transaction before it has been done) and retrospective (evaluation of the M&A transaction after it has been done).

Prospective methods

• Income approach (appropriate for the assessment of synergies, takes into account risks, takes into account investment motives);
• Cost approach (is reasonable if there are problems in the forecasting of future cash flows of enterprise or if the enterprise is close to bankruptcy).

Retrospective methods

• Accounting method (temporal comparison of financial indicators before and after the transaction);
• The market method involves an analysis of the company’s stock returns before the transaction and after the transaction;
• The combined method is a combination of accounting and market methods and, accordingly, includes an analysis of share prices and an analysis of indicators calculated based on accounting statements.

Qualitative evaluation methods

Qualitative evaluation methods are typically used at the initial stage of planning and the search for acquisition candidates for enterprise integration. Among qualitative evaluation methods, the most popular are: SWOT-analysis, STEP-analysis, Porter’s 5 competitive forces; General Electric-McKinsey matrix and the Boston Consulting Group (BCG) matrix.

To obtain a comprehensive assessment of the effectiveness of M&A transactions, it is recommended to use several methods simultaneously at different stages of the transaction. The right combination of approaches will allow for the neutralization of certain weaknesses of individual approaches.

The results of the analysis of the internal state of the company and the state of the external environment will allow evaluation of the compliance of the company’s capabilities with the market demands.