8 - Applying Relative, Asset-Oriented, and Real-Option Valuation Methods to Mergers and Acquisitions

Abstract

This chapter addresses alternative methods of valuation. These methods include relative valuation (i.e., market-based) methods, asset-oriented methods, real-options analysis (i.e., contingent claims), and replacement cost. Relative-valuation methods include comparable company, comparable transactions, comparable industry techniques, and value-driver-based valuation. Asset-oriented methods include tangible book value and liquidation- or breakup-valuation techniques. The chapter discusses in detail how to look at merger and acquition (M&A) valuation in the context of real options. This involves identifying preclosing, and postclosing strategic and tactical alternatives, and associated risks available to M&A participants. Real-options valuation is illustrated both in the context of a decision tree framework and as call and put options, when the assets underlying the option exhibit the characteristics of financial options. A weighted average valuation approach, which attempts to incorporate the analyst's relative confidence in the various valuation methods, also is discussed. The chapter concludes with a summary of the strengths and weaknesses of the alternative valuation methods (including discounted cash flow) and when it is appropriate to apply each methodology.