With Dominos UK, the company has in its annual report and in its press releases outlined its future expansion plans. There are figures readily available with respect to trends in its same store growth and with respect to its dividend policy. All of these factors should, in theory at least, be included in the current share price. The first step in valuing the company will be to ensure that this is the case.
Given that the price of the company today is expected to be the fair value of the companys future earnings, an acquiring firm would need to consider in its valuation the worth of Dominos as part of its operations. Thus, a bid would need to be done on the belief that its acquisition of Dominos would make Dominos more valuable than it already is. This is the concept of synergy, defined as “the specific increases in performance beyond those already expected for companies to achieve independently” (Sirower, 2000).
As such, the potential acquirer would need to evaluate the Dominos business in conjunction with its own. If the acquirer believes that it can help the franchisees run their operations better than they are currently doing, this may result in greater payments to head office. There may be opportunity to tie up two different fast food brands together to create synergies. This tactic has been used in the industry before, such as the creation of Yum Brands in the U.S. Or the tie-up of Wendys and Tim Hortons in Canada. Driving value in an acquisition often comes down to analyzing strategic synergies and exploiting those. The premium that the acquirer is willing to pay is reflective of those synergies.
When such synergies fail to emerge, shareholder wealth is destroyed rather than created in the course of the merger. Evidence shows that upwards of 60% of mergers ultimately fail to enhance shareholder value (Tetenbaum, 1999). Synergies often come down to operational synergies or marketing synergies. Valuing these is a rough science at best. There are some precursors to merger success, however. As noted, the acquirer should be a fast food company, as complementary operations increase the opportunity to cost savings and co-marketing efforts (Larsson & Finkelstein, 1999).
The valuation of the company to be purchased, therefore, needs to take into account the odds and magnitude of synergy derivation. A company should not pay on the basis of the best case scenario as they will almost surely overpay. The acquiring firm should make an estimate based on past acquisitions and the synergies those were able to generate, and should also take into account the result of other merger and acquisition activity in the industry.
In addition to operational synergies, there are also marketing synergies. The examples listed above both showed that complementary product lines can help to drive increased business to the company. Acquiring Dominos, for example, would give a firm access to over 500 retail locations and would give it high profile sponsorship partnerships, in addition to festival access currently enjoyed by the mobile Dominos units. A path marketing analysis can help the acquiring firm understand what synergies may be available and how they might be achieved, including the exploitation of captive sales gaps, tangible product gaps, price gaps, distribution gaps and promotion gaps (Weber & Dholakia, 2000).
Once the different synergies and their potential value is estimated, this will provide a ballpark for the potential synergy value of the acquisition.
The acquiring firm would then set this level as the ceiling for its bid. The reason for this is because while many acquisitions deliver synergies, they reduce shareholder value because the synergies fail to exceed the synergy premium paid at the time of the acquisition (Eccles, Lanes & Wilson, 1999).
A final step that must be considered by the acquiring company is the degree of financial synergy that will result from the transaction (Damodaran, 2005). In this situation, Dominos has both stable cash flows and from that a low cost of capital. The acquisition of Dominos therefore could lend financial stability to the acquiring firm and lower its cost of capital. The financial benefits of the merger must include these aspects in the synergy premium. With a lower cost of capital, all of the firms cash flows become more valuable. The opportunity may exist to restructure the acquiring firms existing debt as well, again lowering its costs. There are considerable financial synergies that would be gained from purchasing Dominos UK.
When all operating, marketing and financial synergies are taken into consideration, the bid can then be made. It is expected that the current value of the assets is already built into the stock price, so the synergy premium will be derived from this careful analysis of potential future benefits both to the acquiring firm and to Dominos UK.
Damodaran, a. (2005). The value of synergy. Stern School of Business working paper. Available at SSRN: http://ssrn.com/abstract=841486
Dominos Pizza Annual Report and Accounts 2009. In possession of the author.
Dominos press release. (2009). Dominos launches store on wheels to deliver pizza at top UK events. Dominos UK & IRL plc. Retrieved April 29, 2010 from http://www.dominos.uk.com/media_centre/pdf/Mobile%20unit%20090609.pdf
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Eccles, R., Lanes, K. & Wilson. T. (1999). Are you paying too much for that acquisition? Harvard Business Review. 77 (4) 136-46.
Larsson, R. & Finkelstein, S. (1999). Integrating strategic, organizational and human resources perspectives on mergers and acquisitions: A case survey of synergy realization. Organizational Science. Vol. 10 (1) 1-26.
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No author. (2010). Dominos wants bigger slice of pizza market. NEBusiness. Retrieved April 29, 2010 from http://www.nebusiness.co.uk/business-news/latest-business-news/2010/02/17/domino-s-wants-bigger-slice-of-pizza-market-51140-25853733/
Patel, K. (2007). Dominos Pizza makes strong start to new year. Hemscott. Retrieved April 29, 2010 from http://www.hemscott.com/news/comment-archive/item.do?id=21631
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Sirower, M. (2000). The synergy trap: How companies lose the acquisition game. Free Press.
Tetenbaum, T. (1999). Beating the odds of merger and acquisition failure: Seven key practices that improve the chance for expected integration and synergies. Organizatiaonl Dynamics. Vol 28 (2) 22-36.
Weber, J. & Dholakia, U. (2000). Including marketing synergy in acquisition analysis: A step-wise approach. Industrial Marketing Management. Vol. 29 (2) 157-177.
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