Approach to Model Development

As mentioned in Chapters 1–3, pre-M&A analysis is vital in the early stage of the M&A process. Failing to assess risk associated with M&A deals could cause M&A failure, and making M&A deals at the critical time can reduce uncertainties and take full advantage of the potential benefits of the M&A opportunities. However, previous studies on these aspects are limited. M&A are complicated and the decision-making involved is never easy. Firms are eager to seek rational tools to effectively reduce the fuzziness of human judgment and manage M&A deals, in particular by taking pre-M&A analysis, the critical time, and risk associated with M&A deals into account. However, no such practical tools for M&A analysis exist. To fill the gap and address the need, the proposed model is formulated and used to schedule M&A activities, to identify risks associated with the M&A process, and to judge the returns and risks arising from the M&A deals, so as to maximise the probability of success in M&A.

The proposed model consists of four main components: risk analysis, fuzzy critical path, cost-benefit evaluation, and decision rule and prioritisation. The approach of the model development is shown in Figure 4.1, followed by the construction of these components.

Figure 4.1M&A evaluation and prioritisation model

Risk Analysis: The model starts with recognising and listing out necessary M&A tasks which affect the outcome of M&A. These tasks can be identified by companies or

persons with rich experience in M&A deals. After that, a fishbone diagram is used to link up potential risks with relevant M&A tasks after the identification of M&A risks. This mapping process can help visualise what risk factors would affect the M&A tasks. Risk assessment can then be carried out accordingly to determine the overall risk level of the M&A deal. The higher the risk level is, the higher the cost the company has to pay. The estimated overall risk level is thus used to determine the cost fluctuation percentage of the M&A deal, which is subsequently considered in the fuzzy critical path analysis.

Fuzzy Critical Path Analysis: With the list of M&A tasks, critical tasks in the M&A process can be determined through an analysis of the critical path with fuzzy logic. These tasks highly influence the total duration of M&A deals. Without paying close attention to the tasks on the critical path, the deals are likely to be delayed and companies have to bear extra time, resources, and costs, and even suffer loss or fail to achieve goals. To mitigate the risk of time and reduce the potential of time delay, it is important for the companies to pay close attention to the critical path and allocate sufficient resources to those tasks in a timely manner for their initiation. Identifying the critical path in a precise manner by using fuzzy logic is essential. A list of M&A tasks on the fuzzy critical path and their durations are determined in this component, and are used as input for the cost-benefit evaluation. In addition, the total time required to complete the M&A deal is determined and serves as input for the decision rule.

Cost-benefit Evaluation: A simulation program is established to estimate the total budget for the M&A deal in a normal circumstance with the risk-bearing budget

percentage at 95% confidence. Such a cost estimation takes into consideration the cost fluctuation percentage determined from the risk analysis. The risk-bearing budget percentage is defined as the percentage change in the total budget for M&A deals, estimated from normal to certain circumstances. A higher risk-bearing budget percentage means the company has to pay more for the deals. The value of the target company in M&A deals is predicted by adopting the discounted cash flow analysis. By using the results of cost estimation and valuation, the adjusted rate of return (ARR) can be determined. The ARR is a new equation, which is created by improving the traditional IRR. The ARR is used to determine the rate of return on M&A investment. The details of the ARR are discussed in Chapter 4.4.3. The risk-bearing budget percentage and ARR calculated in this component are the input of the decision rule.

Decision Rule and Prioritisation: A decision rule using the IF-THEN statement based on the total time required to complete M&A, the ARR, and the risk-bearing budget percentage is defined to support decision-making on M&A deals. If there is more than one M&A deal at the same time, prioritisation would be undertaken to provide further evidence for decision-making. The output of this component is the ultimate one, which tells the decision maker which M&A deal is worthy of investment and which is not.