Merger Valuation

A recent article in CFO outlines potential pitfalls in mergers. For example, the article advises avoiding over-optimism about the company, a flaw discussed in behavioral finance. The article also argues that the bidder should not pay for synergies unless they are well defined. For example, one CFO said that his company paid for synergies in one acquisition because the target would be rolled into a current division, which allowed for cost savings from eliminating part of the existing management, the board of directors, and other expenses that the target incurred. However, he would not include synergies if the target were in an entirely new business. The last pitfall we would like to mention here is to keep financial models honest. Logical errors are much more common than mathematical errors. For example, if margins are increasing, this cannot be infinite. After all, you can never get a 100 percent margin, and something a lot lower is more reasonable.