Experience RS

Why Now? A Multiples-Based Approach to Understanding M&A

How do management teams know when it’s the right time to hunt for acquisitions? There are many motivators behind this complex decision but price, more specifically the relative price of acquisition candidates, is a critical factor. While it might appear that if prices rise the assets become more expensive, this isn’t the whole story.

If two companies can each deliver $1/year in earnings, they should have the same “price,” all else equal. If they have different “prices,” rationally you would acquire the cheaper company since you would receive the same earnings from each.

We can measure the “expensiveness” of a company by dividing its “price," or enterprise value (EV, total share value plus net debt) by its earnings, or EBITDA (earnings before interest, taxes, depreciation and amortization), to calculate an EV/EBITDA ratio. A company with a lower ratio is arguably less expensive than one with a high ratio.

Relative expensiveness provides insight into why large-cap E&P companies such as APC recently became acquisition targets. Figure 1 illustrates that large-cap E&P companies historically traded at a ~10x EV/EBITDA multiple. In other words, acquiring them would cost $10 to buy $1 of EBITDA, making them more expensive than supermajors trading at ~6-8x. This cost difference collapsed in 2017 as both groups began trading at ~6x EV/EBITDA. This convergence presented a window for opportunistic buyers to acquire quality assets at a discount relative to their historical cost.

FIGURE 1 | Multiple Convergence of Supermajors and North American Large-Cap Producers


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