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Don’t use multiples to measure M&A success, please

Vartika Gupta

Engages in research and discussions on capital market diagnostics, financial modeling, M&A, valuation, and cost of capital

David Kohn

Leverages his deep understanding of corporate finance and valuation to provide an investor perspective and help clients identify value-creating strategies

Combines broad cross-sector experience with decades of service to clients in value creation, corporate strategy, capital-markets issues, and M&A transactions

Works at the intersection of strategy and finance with high tech, industrial, and pharmaceutical clients to identify and prioritize corporate strategies for restructuring, performance improvement, and growth

Using multiples to determine whether your merger or acquisition will create value over time can complicate, rather than clarify, your analyses. If you don’t believe us, do the math yourself:

Scenario 1. A target company priced at $500 million is acquired for $600 million, resulting in an acquisition premium of $100 million. In this case, let’s assume that the deal helps the acquirer realize $200 million in synergies, so this merger ends up with a net present value of $100 million. It’s value accretive—but depending on the target company’s multiple at the outset of the deal, this transaction could still end up diluting the acquirer’s multiple over time. In our hypothetical example, for instance, the resulting EV/EBITA1 multiple (14) is lower than the acquirer’s original multiple (20) (exhibit).

Underlying economics, not multiples expansion, is marker of success in M&A.
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Scenario 2. Now consider the same deal, with the acquisition premium of $100 million, but in this case, let’s assume that the acquirer captures no synergies. The merger destroys $100 million in value—and yet, the acquirer’s multiple may still increase over time. In our hypothetical example, for instance, the resulting EV/EBITA multiple (12) is higher than the acquirer’s original multiple (10).

Clearly, when it comes to determining the value of M&A deals, net present value remains king.

1. “EV/EBITA” refers to the ratio of enterprise value to earnings before interest, taxes, and amortization. This is a measure of the cash flow available to a company.

Vartika Gupta is a solution manager in McKinsey’s New York office, where David Kohn is an associate partner; Tim Koller is a partner in the Denver office; and Werner Rehm is a partner in the New Jersey office.

For a full discussion of market dynamics, see Valuation: Measuring and Managing the Value of Companies, seventh edition (John Wiley & Sons, 2020), by Marc Goedhart, Tim Koller, and David Wessels.