12/6/17

I'm curious to see how other Corporate Development shops calculate WACC. I personally have worked in two different Corporate Development groups, one large-cap (>$25-50B, Industrials) and one mid-cap ($2-10B), Tech / Software), and the approach to WACC is completely different between the two shops.

At the mid-cap (where I am now), we start off with a equity risk premium based on a market index (i.e. S&P for U.S./domestic deals) coupled with a proprietary matrix based on revenue scale, profitability threshold (EBITDA or Cash), market positioning, and barrier to entry, to derive a WACC.

Would be great to hear how other Corp Dev shops approach WACC. Thanks in advance.

Comments (16)

10/31/17

I wish I could offer you some more advice on how to calculate WACC other than the obvious, but we have FP&A regularly update WACC and then send us their calculations when complete.

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11/1/17

Hmm interesting. Can you clarify whether the WACC being used is the buyer's WACC or seller's WACC? From what I've seen, the standard seems to be to use the seller's WACC to risk-adjust for the potential target you are acquiring. However, one could argue perhaps that the WACC should be a blended rate that incorporates both the Buyer and Seller's equity and debt structures as you are essentially valuing the two companies as combined. Would like to hear your thoughts on this topic.

11/1/17

I think someone with a deeper understanding of financial theory would be more qualified to answer this, but in my experience, the WACC you use should be the buyer's WACC because the buyer will be the remaining entity and the buyer's capital structure will be the remaining capital structure post-transaction. Ideally, I think you would use a target WACC (assuming you think it will change post-close or if your firm is changing its capital structure), but it really should not make much of a difference in your valuation.

11/1/17

Thanks for your perspective. I can understand the debt portion of WACC under the Buyer's capital structure, but not so sure the equity portion of WACC should reflect the risk profile of the Buyer. Said another way, if you are buying a riskier asset, your WACC post-merger should reflect a riskier cost of equity. Anecdotally, value destroying M&A is a reality, but companies tend to only shine light on their successful deals.

12/6/17

Disagree. WACC is the target/seller's cost of capital, unaffected. Consider a $10 billion market cap company evaluating two $100 million acquisitions. One is stable and safe, and the other is unproven and risky. If you blend the target and acquiror's wacc weighted by market cap (which is only logical) the wacc of the buyer is going to dwarf that of both targets, making them look equally risky. But they aren't.
Only time a blended WACC makes sense, IMO, is when you are PV'ing the synergies, and even then, the wacc should be weighted by relative contribution of synergies, not market caps of buyer and seller.

11/1/17

If you are referring what WACC to use for your valuation, I would say whatever your hurdle rate.

If you are talking about actually calculating your own Company's WACC, we have similar process that @Sil mentioned. We update once a year from corporate FP&A

11/1/17

Just as a small aside, some companies actually have a different hurdle rate than their WACC. If you want to be conservative with your investments, your hurdle rate might be 1% to 2% higher than your WACC.

11/1/17

In the context of M&A, my group never uses our company's realized WACC for merger modeling / valuation purposes. If you don't mind me asking, can you provide information on the industry/vertical and size of your company?

11/1/17

All I can say is that it is a F1000 industrial manufacturer. I would prefer not potentially giving myself away :)

11/3/17

Apologize. Perhaps, I may have over reached.

11/3/17

Nothing to apologize for. It's hard to express tone online, haha.

Best Response
11/14/17

As background, I'm a VP in a tech/media investment bank with prior experience in corp dev doing Cross Border M&A and prior to that I was in valuations at an accounting firm. Only reason I say all this is because this conversation has been held at each of these places and I'll provide the below general consensus. I say general consensus because I've learned over the years there is no one right way, but just ones that are more defensible.

For a strategic M&A deal, you usually value the target with the buyer's hurdle rate, which is typically a few hundred basis points above their WACC (this is the buyer's WACC given the buyer cares about its own ROI and not the sellers; plus it controls the capital structure going forward). For example, when I worked at a Fortune 50 our WACC was sub 10%; however, our hurdle rate was closer to 15% because that was the return we demanded. Furthermore, the particular transaction I have in mind was a cross border deal in a Tier 2 economic country, so the hurdle rate became even higher (closer to 18%).

All this said, if you want the intrinsic value of an entity, then you use the entity's own WACC, regardless of buyer. A smart strategic will do both valuation exercises and recognize what the seller may be willing to sell for and negotiate from there, all while keeping in mind its POV to be sure it achieves its hurdle rate.

Lastly, I saw someone above mention the use of a matrix model to arrive at a WACC - this is more commonly known as a build-up approach. Unfortunately, this approach is typically considered flawed in academic circles (think Damodaran and Grabowski), although I have seen it done before. Instead, stick to CAPM or modified CAPM (i.e., using size, country, and alpha premiums). Of course alpha premium being a bllsht premium, but hey what's valuation really other than a little bit of math and a whole lot of art. good luck!

11/16/17

Thanks for your perspective, very interesting and helpful. To clarify, we do use modified CAPM, with the modified part a risk-adjusted premium based on a propriety matrix (criteria mentioned in my original post). We look at a ton of private companies in nascent markets touching A.I. / machine learning / IoT, sensors, etc. and so sometimes CAPM is not all that useful given lack of peers and even if there are, a lack of information on those peers. Hence, the reason we use a proprietary matrix to risk adjust the WACC.

12/6/17
dltrois:

As background, ... Of course alpha premium being a bllsht premium, but hey what's valuation really other than a little bit of math and a whole lot of art. good luck!

Agree. I've worked at a large bank (IB/AM/PB) in the Corp Dev/M&A team. We received it both from our Group Capital Management and contrasted it with our FIG team's input. We also had our internal model, to haveour own perspective. YOu can imagine that we had 3 different answers each time! from our simple version out of bloomberg terminal inputs, to our forward-looking Capital Group with complex projections on capital usage, Basel 2 (at that time) etc. During thefinancial crises, there was no otherway, but to look for CDS as a source of "market risk" to come up with a sensible approximation (think of swimming in a pond with dark swans).

Now I work at a mid-cap,for afew years leading the Corp.Dev. M&A team. A sizable multi-disciplinary project was launched to come up with a unified WACC (facilitates comparison and capital allocation across projects/regions on a "fair" basis and not everyone comingwith their own "adjusted wacc). Group Treasury in lead, we developeda mix of academic approach and business reality (we are present in >50 countries, expanding into some with limited financial/cap. market info... think of Bolivia three years ago), following a classic WACC build-up (think of the tree step-by-step inputs. Group Treasury manages the WACC now, which is used internally for all projects (M&A, CAPEX, Tenders, etc) and is updated regularly by them.

Personally, I'm quite pragmatic about wacc. It serves as a discount rate for risk-adjusting my FCF. Think of what's my target return to cover my risk / level of RoA/RoE / hurdle rate. As dltrois mentiones, this is a buyer's view. We also develop a "market view" taking both a "asset/target wacc" and "market wacc" (peers average), just to test boundaries and for negotiation tactics. Run a best estimate that you can defend and is accepted by key stakeholders and develop a sensitivity table... his way you can better gauge your risk. Some extreme cases havebeen useful in the past, given in particularly unforeseen geopolitical instability... so you know where you stand. My personaly opinion/approach and so far has been challenged but always accepted in our investment committees.

Sure, "target cap structure", "re-levered betas" (actually some of our M&A contribution from reviewing literature from Damadoran, Fernandez, Copeland/McK, etc. futile assumption over assumption), "ERP" etc can bring a "scientific touch"... and then, you don't have observable data for it! or someone comes with a "small cap premium of 3%" just like that! ... accurately incorrect or roughly correct. Currently we use spreads and CDS for industry (mostly large customers) to address additional risk to be covered.

As you can see, there is not one "corp dev wacc approach", but a series of approaches. CAPM is quite critised, perhaps the best you can defend from academia, but flawed. So alternative approaches may help validate or provide a different perspective to it.

I hope this practitioners views/experience helps you (2cts, discounted by the value already provided by the good inputs from others)...

In any event, if your project is floating because of the wacc/discount rate used... well.... not sure is such a great business case to sound with your BoD. Ahh! and please hand over the crystal ball, once you finished your calcs. Good luck!

11/16/17

Our Corp Dev group did not calculate WACC. It was handled by Treasury. As Sil mentioned above, we often used a discount rate higher than our WACC for DCFs. I think our leadership generally viewed acquisitions as riskier than your typical internally funded capex project (we'd been burned before) and preferred conservative assumptions. We also timed the market really well for our industry and raised a lot of debt at attractive rates. To think our WACC would stay at it's current level for 30+ years might be a bit aggressive.

12/6/17

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