Valuation Methodology for M&A to Be Revised




When SPAC (Special Purpose Acquisition Company) was introduced, overall financial markets including investors were excited and expected to provide a boost for M&A activities. For your information, SPAC is a kind of investment vehicle for the purpose of pursuing the acquisition of target company.

To begin with, SPAC should list itself at stock markets before looking for a target company. However, it turns out that most SPACs had failed to acquire target companies until the deadlines of acquisition (SPAC must merge with a target for a certain period of time after go public, otherwise, it should delist itself and liquidate its asset right after). Among some causes of failing SPACs, the certain restriction on acquisition valuation; setting minimum discount rate (10%) and limited valuation methodology to be blamed.

When SPACs or investors estimate the value of target, mostly unlisted target companies need to be evaluated. The evaluation is about measuring the value of company, showing how much an investor or acquirer should pay for the target. However, based on the current rule and restriction, there is a possibility that the target might be undervalued. Without a doubt, this causes an overall stagnation in M&A activities. Only big deals and M&As between listed companies are being done. So, in order to facilitate corporate restructuring process by merger and acquisition, financial authority expects to mitigate the current rule of valuation practices.

Korea’s national financial watchdog, FSS (Financial Supervisory Service), recently announced that they will allow ‘generally acceptable valuation methods’; DCF (Discounted Cash Flow) model, and DDM (Dividend Discounted Model). The current valuation method for unlisted target companies will be terminated. Please refer to the table below illustrating a comparison between the current and the revised method.



As the revised rule allows generally acceptable valuation methods, more M&A deals are expected on the basis of a reasonable estimation. Failing SPAC will be able to find a target under the reasonable valuation. As for a target company, a company is less likely to be undervalued under the revised rule of valuation, which will encourage a negotiation with investors or acquirers as well.

However, interest parties, investors or target companies, should be cautious on this change. Newly accepted valuation methods tend to be biased, depending on target companies as well as evaluators. Proposed methods, DCF, DDM, shall be estimated based on projected cash flows for the next three to five years, at least. The figure shall be initially crafted by target companies rather than by evaluators. If evaluators stick with the proposed figure provided by the target, obviously the value can be overvalued. On the other hand, the value shall be substantially lower, if evaluators are too skeptical on the proposed cash flow.

Since no valuation is perfectly accurate, a method capable of reflecting various characteristics of a target company is considered better for a reasonable valuation. To make a deal done, in other words, to satisfy interest parties, investors and targets, and officially appointed evaluators should be able to strictly measure proposed figures with holding reasonable guidelines and perspectives. Also, both parties should be able to acknowledge valuation figures and negotiate a fair value.



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