An informal discussion on the valuation of enterprises by investment Institutions (13): Does the acquisition necessarily create value?

through investment

In the last two chapters we discussed the difference between industrial capital and VC/PE and the great power of synergy, but there are still a few things to explain. So now we're back to a very basic question: how do businesses create value?

The enterprise is through the investment to create the future cash flow, thus produces the value, certainly the investment return must be bigger than the capital cost. The faster the enterprise's income grows, the more capital it invests, and the greater the value it creates, on the premise of high returns. Here I would like to introduce a formula similar to the law of conservation of energy in physics, dr.2 it as the principle of value conservation in investment, whose central idea is that any behavior that does not increase the future cash flow of an enterprise does not create value. That is, within a certain range, value is conserved and unchanging. When an enterprise simply tries to change the ownership of its cash flow, but does not change its "discretionary cash flow" of the total, you can refer to the law. For example, to swap debt for equity or to issue bonds to buy back equity. It looks like the cash flow has changed, but it doesn't really change its "main business cash flow." The popular analogy is: These behaviors are only changed a vest, or the long steamed bread twist into a round, but will not change the intrinsic value of the enterprise.

For example, my friend, Xiao Y, opened a small supermarket in the United States, assuming that the supermarket is worth 100,000 of dollars, the company has no leverage and produces 10,000 dollars of net cash flow every year. Now suppose the supermarket from the bank loan 20,000, the value conservation principle tells us this supermarket still is worth 100,000, is 120,000 of total assets and 20,000 of the debt, because the net cash flow generated by the store or 10,000 U.S. dollars, unless the company generated cash flow changed (of course, if he can lend out 1 million dollars, then the situation is changed, I mean only change or within a limited range. But interestingly, in the United States, borrowing can really change the cash flow, because the interest paid is tax deductible. With the company's tax cut, the available cash flow has increased. In addition, debt has incentives, we can think that little y will work harder, because she needs to use cash to repay the debt in time, which will also increase the company's cash flow. In any case, the point I'm talking about is that the value of a company will not change as a result of a change in the creditor's right or the structure of the equity, but it can change as a result of the changes in cash flow (tax breaks or efforts).

The principle of value conservation can also be applied to the acquisition behavior of enterprises. How do corporate acquisitions create value? We believe that the real value will be created only if the cash flow of the two companies is increased or the future increases. These increases in cash flows come mainly from synergies (synergy), such as lower costs, faster revenue growth, or more effective management.

For example, in the first quarter, "260" spent 200 million yuan on the acquisition of "270", the following year, "260" found that the acquisition actually to the merged company each year to save more than 10 million yuan cost, thereby increasing the operating profit of 20%. In this way, the cost savings after acquisition adds value to the enterprise. and "260" investment holding "21 points" after the development of new products is very smooth, "21" also fully utilize the "260" in the industry's brand and channel advantages, new products on sale, sales than before the estimated increase of 100%. Similarly, after the merger of the income increase, increased cash flow, for the acquisition of enterprises to create value.

The above two examples reflect the fundamental improvement in corporate performance, not just the increase in marginal benefits. Therefore, these two mergers and acquisitions are to create value. But some mergers and acquisitions are controversial, and I'm going to cite a traditional industry example to try to explore the issue.

A tall student in the south runs a company called "Fighting the Landlord" industrial gas companies. The company's operating model is mainly on-site gas supply, this model is very simple, that is, in the need for gas customers on-site installation of gas, and then in accordance with the flow of gas and unit price to calculate operating income. This type of gas supply equipment investment is large, generally speaking a set of equipment contract life of 15 years. In accordance with the customer's current maximum demand for special customization, if the future demand for more customers, gas supply devices need additional investment. "Landlords" are currently valued at 100 million yuan. Since the company's business is mainly concentrated in the South, 2014, p classmate plans to develop the northern market. However, although the on-site supply market returns, but the business development time and effort, from the past experience, a year if there are 3-5 projects have been very impressive. In order to enter the northern market faster, the P students who do not lack capital want to enter through the way of mergers and acquisitions. After several months of target screening, p classmate took a fancy to the company "two Kings four Two". Not only does the company's clients not overlap with the "landlords", but more importantly, the business model is almost identical. "The two Kings four two" in the northern market has been developed for 10 years, the current valuation of 200 million yuan.

If the "landlords" acquired "two Kings four Two", what is the value of the company after the consolidated statement? Can you really play a good hand to kill "peasant"? According to the business model of field gas supply, because each project is independent operation and accounting, and the duration, risk and cost are different, at the same time, because of sales radius and regional restrictions, marketing staff, technicians and construction personnel can not be integrated to reduce costs, so the combination of the two, The cash flow between the two companies will not increase. The two companies are independent, no different from the past, or have the same expected cash flow. After the merger of the company's value of 300 million yuan, of which "Dou landlord" or the value of 100 million Yuan, "two Kings four Two" value of 200 million yuan. In terms of the principle of conservation of value, such mergers and acquisitions have not created value.

But some "smart people" see additional value. For example, "landlords" are expected to have a net profit of 2015 of 10 million, then 10 times times their earnings, and the expected net profit of "two Kings four two" is 25 million, and his P/E ratio is 8 times times. So what is the P/E ratio of the consolidated company? The most direct calculation is that the total value of the two companies is 300 million yuan, the total net profit is 35 million yuan, then the P/E ratio should be 8.6 times times, between the two P/E. Well, things could get out of shape, these "smart people" think that if a company buys another company, the market will have to apply a higher p/E ratio to the company, which is high. In other words, once the "landlords" bought the "two Kings four Two", the latter's value would be artificially pulled up to 250 million yuan, because these "smart people" think the market is unresponsive. Will not perceive the difference between two companies. In this way, the company's value will be 350 million yuan, inexplicably added 50 million yuan in thin air.

If the above example is true, then all acquisitions will create value, regardless of who is the buyer, or the seller, the low P/E companies will always find a high price-earnings ratio of the backers of the valuation pull up. Then the acquisition can create corporate value, but dr.2 that the above "smart" is clever in the long run, is _ theory, because any no synergy of the acquisition does not create value, but a large number of two-tier market participants and analysts do not think so, as long as the acquisition of hearing is like a shark smell of blood in droves , regardless of 3,721 start to fry, will chase high, and investors themselves will create a variety of stories and themes, scarred but happy. But often over time, there will always be dust to dust, soil return to the soil, and can be a high position or additional benefits may only be large shareholders or a few institutions. In fact, every real entrepreneur understands this, it is simple: if you do not know where to increase cash flow, then the market will not be fooled for too long, because "out of the mix, sooner or later it will be."