Valuation in Acquisition Analysis & Risk management

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Valuation in Acquisition Analysis


Valuation should play a central part of acquisition analysis. The bidding firm or
individual has to decide on a fair value for the target firm before making a bid, and the
target firm has to determine a reasonable value for itself before deciding to accept or reject
the offer.
There are also special factors to consider in takeover valuation. First, the effects of
synergy on the combined value of the two firms (target plus bidding firm) have to be
considered before a decision is made on the bid. Those who suggest that synergy is
impossible to value and should not be considered in quantitative terms are wrong. Second,
the effects on value, of changing management and restructuring the target firm, will have to
be taken into account in deciding on a fair price. This is of particular concern in hostile
takeovers.
Finally, there is a significant problem with bias in takeover valuations. Target
firms may be over-optimistic in estimating value, especially when the takeover is hostile,
and they are trying to convince their stockholders that the offer price is too low.
Similarly, if the bidding firm has decided, for strategic reasons, to do an acquisition, there
may be strong pressure on the analyst to come up with an estimate of value that backs up
the acquisition.



Risk management: Identification, assessment, monitoring and mitigation/control
The fourth principle states that banks should identify and assess the operational risk inherent
in all material products, activities, processes and systems. Banks should also ensure
that before new products, activities, processes and systems are introduced or undertaken,
the operational risk inherent in them is subject to adequate assessment procedures.
Amongst the possible tools used by banks for identifying and assessing operational
risk are:
• Self- or risk-assessment. A bank assesses its operations and activities against a menu
of potential operational risk vulnerabilities. This process is internally driven and often
incorporates checklists and/or workshops to identify the strengths and weaknesses of the
operational risk environment. Scorecards, for example, provide a means of translating
qualitative assessments into quantitative metrics that give a relative ranking of different
types of operational risk exposures. Some scores may relate to risks unique to a specific
business line while others may rank risks that cut across business lines. Scores may
address inherent risks, as well as the controls to mitigate them. In addition, scorecards
may be used by banks to allocate economic capital to business lines in relation to
performance in managing and controlling various aspects of operational risk.

• Risk mapping. In this process, various business units, organisational functions or process
flows are mapped by risk type. This exercise can reveal areas of weakness and help
prioritise subsequent management action.
• Risk indicators. Risk indicators are statistics and/or metrics, often financial, which can
provide insight into a bank’s risk position. These indicators tend to be reviewed on
a periodic basis (such as monthly or quarterly) to alert banks to changes that may be
indicative of risk concerns. Such indicators may include the number of failed trades,
staff turnover rates and the frequency and/or severity of errors and omissions.
• Measurement. Some firms have begun to quantify their exposure to operational risk
using a variety of approaches. For example, data on a bank’s historical loss experience
could provide meaningful information for assessing the bank’s exposure to
operational risk.