Question

Can anyone help to demystify these two questions?
"You are an M&A analyst, working for the investment banker for the acquirer in a friendly takeover, valuing the target company." Why the valuation is likely to be high?
"You are an M&A analyst, working for the investment banker for the target in a friendly takeover, valuing the target company." Why is the valuation likely to be low?
Thanks!

Answer 1

Could you clarify the context in which you read these questions? Because that may help a bit...

Answer 2

This is a question in the Valuation course. It is asking about the valuation bias. It is actually asking "if you are an investment banking analyst working for the acquirer/target in a friendly takeover, do you tend to come up with a higher or lower valuation of the target?"
And one more question, what if it is a hostile takeover?
Thanks a lot!

Answer 3

Ok, that's what I thought (that there is a fallacy being committed). What I suspect is that the investment banker for the acquirer is using the acquirer's weighted average cost of capital in the firm's valuation. However, this is NOT correct since it does not take into account the riskiness of the firm being acquired (it automatically assumes that the firm is of "average" riskiness relative to all the rest of the acquiring firm's investments). I believe that this approach (of using the wrong discount rate) is one reason why Bruce Wasserstein acquired the nickname "Bid 'em Up Bruce".

However, another possible reason for a higher valuation coming from the acquiring firm is because there may be certain synergies to be had from the merger (which would justify a price which is above the current market value of the company). However, when it comes to M&A, these purported synergies are almost always wildly optimistic (and, thus, rarely materialize).