Real Options in an M&A Setting: A Case Study of Novo Nordisk

Abstract

The objective of the paper is to examine to what extent real option models can be a useful supplementary tool to traditional valuation methods in measuring the value of synergies from mergers and acquisitions deals in practice. The thesis has been based on the principle that the value of a target firm, in the context of a merger and acquisition transaction, is the stand-alone value of the target firm plus a combination of real options that can create synergies exclusively available to the acquiring company. These options are considered out-of-the-money for the target firm’s management and can only be developed into exercisable in-themoney options through the utilization of the resources and capabilities of the acquiring firm. The academic literature has described real option models as a possible tool for measuring the value of management flexibility to respond to changing conditions and circumstances, which should give a more accurate value of a project or investment opportunity. However, this approach appears to have gained less traction in practice than in the theoretical world. The significance of accounting for managerial flexibility becomes particularly pronounced when dealing with projects or investments market by uncertainty. Despite being widely used in practice, traditional valuation models fall short in their ability to capture the value of managerial flexibility. Consequently, companies relying solely on traditional valuation analysis for valuing target companies in M&A transactions and their associated synergies fall inevitably into the trap of underestimating the value of the investment and may end up not investing enough in uncertain but highly promising investment opportunities. Theory suggests that real option can offer a solution to the pitfalls in traditional models, as it provides a framework to account for managerial flexibility, enabling companies to capture the value of uncertain opportunities. To investigate the gap between practical adoption and theoretical prominence, a literature review and a practical case study form the basis for substantial knowledge and understanding of the applicability of real options to measure the value of synergies within a merger and acquisition transaction. We examine the extent to which real options models can be a useful supplementary tool to traditional valuation methods in measuring the value of synergies from mergers and acquisitions by examining the real-life case of Novo Nordisk’s acquisition of Dicerna Pharmaceuticalswith the application of the DatarMathews and Fuzzy Pay-off methods. The paper demonstrates that real options valuation can serve as a valuable supplement to traditional valuation methods when valuing synergies. In particular, in situations where the DCF value of synergies is moderately positive, or somewhat negative the project, therefore, lies in what we call the “option zone”.