Abstract
Indonesia offers a lot of promising growth opportunities and particularly to the banking industry, a combination of attractive macro-economic conditions and introduction of new regulatory policies as well as reformation to consolidate and strengthen the banking sector primarily by M&A activity provides an attractive backdrop for acquisition of Indonesian banks by foreign investors. In this paper, we introduce real options theory as an alternative to a traditional project valuation for a bank acquisition that would allow the acquiring firm to recognize the options embedded in their investments. The objective of this case study is to analyze, from real options perspective, whether the acquisitions of the target firm compliment the acquiring firm. The methods use for the analysis are DCF, Black-Scholes and Binomial Lattice that would help determine the project real value, which result suggested that the acquiring firm should reconsider their options. On this thesis, the DCF method suggesting that the acquisition of Bank Y by Bank X does increase the value of Bank X but there would not be added value on the synergy itself. While from the real options perspective, the project value (with and without real options flexibility) is worth less than the target firm underlying assets and has doubtful prospect.
Highlights
During the last twenty years, mergers and acquisitions (M&A), both domestic and international, have become the front line strategic option for organizations attempting to have competitive advantage over its competitors
There are four widely used methods for valuing target firms, which is market multiple analysis, the corporate valuation model that estimates a firm’s operating value as the net present value (NPV) of projected cash flows called discounted cash flow (DCF), free cash flow to equity (FCFE) model and adjusted present value model which ideally suited for situation with changing capital structure
The binomial lattice method result suggesting that there would be no abandon option embedded in the acquisition project of Bank Y, considering the negative result on the real option value (NPV with real options flexibility)
Summary
During the last twenty years, mergers and acquisitions (M&A), both domestic and international, have become the front line strategic option for organizations attempting to have competitive advantage over its competitors This is due to increasing competition, new financing possibilities and changes in regulation all over the world. The value of a firm’s growth options may be enhanced through acquisitions by decreasing the exercise price, increasing the present value of future profits earned upon exercise, and allowing for greater flexibility in timing the exercise of the options. Another option that could be achieved through acquisitions is synergy gains. According to real options theory, a project could be promising when NPV > 0 and NPVq > 1, when NPVq > 1 but NPV < 0 the project should not to be proceed (refer to below graph)
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