Acquisition Premium

  

Lumber company A has had a devil of a time negotiating with the Lumberjack Union, but it buys company B so that they can go from five million acres to eight million acres of forest to kill, digest, and turn into scratchpads.

With a highly unionized labor force, both lumberjack companies had only 10% margins, and few resources to invest in technology. Combined, however, with their enormous new scale, it makes financial sense to replace two-thirds of their lumberjacks with robots, a.k.a., the Tree Slayers.

The would-be acquired lumberjack company B knows the math, because they've taken a couple of awesome finance courses on Shmoop, and while as a stand-alone company they might be worth 14x earnings, as they key to unlock the Tree Slayer and a new era of high-margin tree cutting, lumberjack company B will be smart enough to demand a big acquisition premium.

That is, instead of their steady state 14x earnings valuation, they'll ask for and probably get something closer to 20x earnings or more, as the acquisition premium here is warranted in the creation of this new behemoth tree cutting company, which everyone is happy about.

Except the trees. And the squirrels who lived in them. And the birds. And the atmosphere...

Related or Semi-related Video

Finance: What are accretive v dilutive v...18 Views

00:00

Finance allah shmoop what are at creative dilutive and neutral

00:07

acquisitions All right people Well it's all about the multiples

00:12

you work for boring co dot com You make stationery

00:16

roller coasters for the faint of heart And you grow

00:19

revenues at about ten percent a year All right well

00:21

your stock trades at about twelve times earnings and you

00:23

really want to buy your would be competitors Let's bounce

00:27

dot com which makes concrete bounce houses Yeah they're made

00:31

in russia What do you expect Unfortunately let's bounce has

00:34

been growing revenues at about fifteen percent but because they

00:37

make such a much more exciting than you do product

00:41

people are really into inflicting pain on themselves these days

00:45

Well they trade at thirty times earnings thirty years Fifteen

00:48

they're thirty they're willing to be bought but they'll want

00:51

thirty six times earnings for the privilege That is a

00:54

twenty percent premium toe where they trade today And they

00:57

only want stock no cash you know because the primary

01:01

shareholders would all suffer a huge tax bill if they

01:04

took cash so they'll only take stock Yours All right

01:08

So this is a conundrum You traded a low multiple

01:11

Twelve times your shareholders own you because you are a

01:15

quote value story unquote meaning that your cheap but you

01:20

are a low risk company Now if you try to

01:23

buy a growth company and pay a high multiple for

01:26

it well you risk alienating your shareholder base and that's

01:29

bad like they'll sue you in elected Different forces will

01:33

do different things but if you do buy let's bounce

01:36

while the combination would be really powerful birthday parties everywhere

01:39

would be a thrill a minute or something like that

01:42

Well the problem is that a twelve times earnings company

01:45

paying thirty six times earnings to acquire a competitors is

01:48

dilutive to that twelve times earnings company That is the

01:52

combined company If each piece were equal and they just

01:55

merged as equals a mow their m o ya that's

01:59

what they're called Well they would not have one Half

02:02

of the combined company is being valued at twelve times

02:06

earnings when it was a standalone company and then another

02:09

piece valued at thirty times as a stand alone but

02:13

combined at a price of thirty six times that's twelve

02:17

plus thirty six or forty eighth and divided by two

02:21

Companies combining here so the new company should the stock

02:25

price is all remain flat at the proposed acquisition or

02:28

merger Price set would be trading at twenty four times

02:32

earnings and we're talking really slow so you could follow

02:34

the map All right well the combination of born cohen

02:37

let's bounce would have been diluted to boring co because

02:40

it's multiple of twelve would've been diluted down via the

02:43

high multiple paid for let's bounds and the combination would

02:47

have been act creative too Let's bounce because now they're

02:50

stock will traded around twenty four times earnings instead of

02:53

thirty times earnings Right obviously had both companies traded the

02:56

same multiple of earnings when they combined Well there'd be

02:59

no dilution or at creation for either side and the

03:02

merger would simply be called neutral sort of like someone's

03:05

reaction to a roller coaster that neither rolls nor coasts

03:09

Yeah it's sort of like doing these videos are just

03:12

just keeping it real enough No we love doing good 00:03:14.905 --> [endTime] bye

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