Essentially, the model divides the future operations of the target into three time frames:
In addition to analyzing the assets of a potential target and accounting for them in several ways, acquirers also need to factor in the abandonment value — the amount a business or operation would capture if it later was sold. The authors note that even if an operation is sold at a loss, the business recaptures some of its initial investment, which it can redeploy elsewhere.
When it comes to the parts of a target company that fall into the H3 bucket, analysis should consist entirely of its OV; that’s because the assets are so uncertain that a credible NPV analysis isn’t possible.
It’s a role that will be especially important, given the upswing in the number of M&A deals. In 2010 coach outlet, M&A increased in all regions of the world oakley womens sunglasses, according to Intralinks, a provider of global M&A data. Between 2009 and 2010, deal activity jumped by nearly two-thirds in Asia-Pacific, 55 percent in Latin America, one-third in Europe, and 26 percent in North America.
Horizon Two (H2) contains operations that are generating fast-growing revenue streams, and show promise to make large contributions to profitability in several years. These businesses may become core businesses in the medium term.
This happens because acquirers often face “pressure to make deals pay off quickly in terms of earnings per share,” the authors write. That creates a “bias to discount value creation tied to future time horizons.”
When valuing a target business, acquirers need to analyze its assets and opportunities, place them in the relevant category, and then value them accordingly. For those falling into H1 coach outlet, this typically means a net present value calculation.
Horizon Three (H3), not surprisingly, represents opportunities that may come down the road in the form of new products or markets. They show both great promise and uncertainty.
For assets and opportunities that are classified as H2, it probably means using net present value along with what the paper’s authors call opportunity value, or OV. This accounts for the “upside surprise that cannot be captured through strict NPV analysis,” they say. It involves a “disciplined analysis that is based on range estimates relating to how the future might unfold.”
With that surge in activity oakley womens sunglasses, it would seem like every deal that should be getting done actually is. However, that may not be the case, according to a recent paper from Knowledge@Wharton. In “M&A’s Overlooked Pitfall: The False Negative,” the three authors, Alexander B. van Patten, Mehrdad Baghai and Ian C. MacMillan, state that outdated valuation methods can lead companies to bid less than potential targets actually are worth.
The first is what McKinsey & Co. calls the Three Horizons model, as outlined in this issue of the McKinsey Quarterly.
In their calculations, many companies on the hunt focus on net present value (NPV). While that’s OK as far as it goes, they also need to incorporate two other frameworks.
So oakley womens sunglasses, instead of relying just on a a net present value calculation when pricing a target company, acquirers also should consider opportunity value and abandonment value. “We need to expand our analytical tools to include the potential returns that may lie in the more uncertain H2 and H3 realms of an acquisition,” the paper’s authors say.
Horizon One (H1) represents core business operations that provide the greatest profits and cash flow currently.
As this Business Finance story from 2010 notes, the role of treasury and finance in M&A continues to grow. One key area in which these functions can contribute is in accurately valuing M&A targets.
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