Deal Valuation: Inclusion of Costs to Achieve_Part 1

Just as there are differing perspectives on which valuation method yields the best results, there are also different perspectives on whether costs to achieve belong in the valuation models.  In this post we will present arguments for both inclusion and exclusion of costs to achieve.

Arguments for Excluding CTA
Proponents of glossing over or omitting costs to achieve will point out, often correctly, that accurate estimates of such costs are too difficult to calculate.  They also correctly argue that taking time to calculate and include these costs will “bog down” the process, and potentially cause the loss of the deal. 

The latter argument has merit.  You will spend more time on valuation if you attempt to include realistic CTA; furthermore, if the deal is competitive (meaning there are other interested buyers) you may be including costs that reduce your valuation relative to other bidders.  This will almost certainly be true if you are a publicly traded or otherwise highly regulated company with heavy compliance requirements that finds itself bidding against privately held enterprises and/or private equity.  If you are assuming a full integration target operating model, your CTA will also certainly be higher than a bidder that plans to leave the acquisition alone, even if they are also including CTA in their models. 

What happens, then, is that costs to achieve are commonly either omitted from deal models altogether or else they are vaguely alluded to with some very high-level estimates.  Often existing run-rate costs are used, with perhaps a few small one-time cost numbers associated with simple items such as separation costs for redundant staff.  Regardless of anticipated post-close target operating model, it has been my experience that full CTA inclusion is uncommon outside of best-in-class acquirers. 

Arguments for Including CTA
The most obvious argument for including CTA in the deal models is, of course, to get a better picture of the projected return on the investment.  Including these costs, with their anticipated timing, allows you to estimate cash flows, calculate returns, and determine if the fully costed deal clears your internal capital hurdle rate.  It also provides some defense against shareholder litigation, showing that you applied sober diligence to your investment of their capital. 
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But capital stewardship is not the only reason to consider inclusion of CTA.  A fully costed estimation process helps to validate your target operating model selection and to also identify key dependencies on your integration critical path while there is still time to consider these factors in your overall evaluation of the deal as a strategic move.  It can help set realistic expectations as to the timing of joint operations.  The latter may suggest that while an acquisition is appropriate, there is not enough time to adequately integrate in response to a particular market dynamic, indicating that another strategic move is required in the near term.
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Conclusion
Since I am a former accountant it probably comes as no surprise that I am a big proponent of including CTA in the deal models whenever feasible.  This not only provides the opportunity for better investment evaluation, but also forces the team to slow down enough to consider whether the desired timing of synergy realization is practical and meets the strategic needs of the acquirer.