Fundamentally, an acquired business can be viewed as a package of potential cash flows available for distribution to its owners sometime in the future. Discounting these future cash flows at the cost of capital of a potential acquirer represents the investment value of the business to that specific potential acquirer. Potential acquirers develop these future cash flows by examining the historical and current cash flows of the business and making a variety of assumptions concerning the future. Tank control, customer churn, customer mix, competition, and required annual reinvestment can all impact the future pattern and stability of cash flow. And all potential acquirers take such factors into consideration.
Also, potential acquirers will generally reflect the operating expense structures and corporate overhead of their own businesses when formulating these projections. Whether an acquirer plans to operate the business as a standalone entity or completely fold it into existing operations influences which operating expenses will be maintained, and which ones might be reduced or eliminated. Hence, potential acquirers can differ on their assumptions about potential future cash flows.
COST OF CAPITAL
Potential acquirers will vary in their weighted average cost of capital (WACC) used to evaluate the potential acquisition. Differences in sizes, capital structures, corporate tax rates, projected growth, and stability of cash flows all influence the nature and cost of capital available to the acquirers to fund the contemplated acquisition.
By way of example, consider two potential acquirers of SellerCo—BuyerCoA and BuyerCoB. Both BuyerCoA and BuyerCoB reach similar, but independent estimates of potential future cash flows for SellerCo—$250,000 with an annual growth rate of 5% for the next 10 years. But larger, creditworthy BuyerCoA enjoys a WACC of 8%, while smaller, riskier BuyerCoB has a WACC of 12%. Using their respective WACC to discount the package of future cash flows results in an 11% difference—BuyerCoA’s estimate of value of $1,095,000 versus BuyerCoB’s estimate of value of $985,000. In other words, BuyerCoA can afford to pay more.
SYNERGISTIC OPPORTUNITIES AND SAVINGS
Beyond standalone value, potential acquirers also evaluate acquisitions in terms of the economic benefits of putting the two organizations together. An acquirer that sells both distillates and HVAC services might acquire a local propane distributor with a perceived opportunity to market propane to existing dual-fuel customers in its account base. Or the combination of two propane businesses with overlapping delivery areas might present an opportunity for substantial expense reduction through routing optimization. To gauge the financial impact of such possible synergies, a buyer will create a pro forma financial model of the potential acquisition on both a standalone basis and a combined basis. All other factors being equal, an acquirer with a clearly identifiable set of synergistic opportunities can usually afford to present a higher offer than an acquirer without such opportunities.
MOTIVATION
Certainly, acquirers can have dissimilar motivations for pursuing a particular acquisition or similar motivations weighted differently by importance. This can influence their perception of the overall value of a propane business, at least on the margin. Larger businesses can attract higher valuation multiples compared with smaller ones, so one acquirer could be a multistate marketer positioning its business for future sale and might intend to use the acquisition to bootstrap the eventual sales multiple it receives. Another acquirer might be a private equity firm interested in employing a “roll-up” strategy in the propane industry and intending to use the acquisition as an initial platform company with which to make further smaller acquisitions. And yet another acquirer might be looking to opportunistically expand its current operating area. Such different motivations for completing an acquisition can cause potential acquirers to each see the value of a target propane business differently and impact how aggressively they might behave in a sales process.
CONCLUSION
Potential acquirers of propane businesses can develop very different perceptions of value. Understanding these key areas of differences—assessments of potential future cash flow, differences in their costs of capital, synergistic opportunities and savings, and motivations for pursuing the acquisition—can help a seller to better communicate the underlying value of its business in a way tailored to each potential acquirer and ultimately maximize the final price obtained in a sale.
