Valuing M&A Synergies with Real Options

Abstract

The objective of this thesis is to research whether different Real Option Valuation (ROV) approaches can be used as an addition to the classic Discounted Cash Flow (DCF) model in mergers and acquisitions (M&A) to justify the acquisition price from the acquirer’s perspective. Specifically, this research examines how real options are implemented to value potential synergies not captured by the DCF during periods of high uncertainty, such as those experienced during the COVID-19 pandemic.
Previous literature has established that traditional valuation methods, such as DCF, are effective for valuing companies with stable and predictable cash flows. However, the model presents limitations and falls short in capturing the value of synergies in M&A transactions because they are unpredictable. To address this, the literature suggests ROV as an adequate method for valuing managerial flexibility under high uncertainty. However, the application of ROV as an addition to DCF in valuing the target company, particularly during periods of considerable market turbulence like the COVID-19 pandemic, has not been explored.
To explore this, GN Store Nord’s acquisition of SteelSeries is used as a case study. The identified operating synergies are uncertain due to market conditions and require substantial management action. The ROV models used to value these synergies are the Datar-Mathews model by Mathews, Datar, and Johnson (2007) and the Fuzzy Pay-off method developed by Collan, Fullér, and Mézei (2009). In this application of models, the Datar-Mathews method and Fuzzy Pay-off method yield synergy values of DKK 1,408 million and DKK 1,456 million, respectively. When values are added to the DCF, the total estimated deal value for SteelSeries is DKK 8,586 million (DMM) and DKK 8,656 million (FPM).
In conclusion, the research found that incorporating ROV methods, in addition to the DCF model, can effectively value synergies and justify a higher acquisition price. This demonstrates their utility in assessing M&A synergies under uncertain conditions in the gaming peripheral market.