Acquisitions in Capital Expenditures
Incorporating acquisitions into net capital expenditures and value can be difficult and especially so for firms that do large acquisitions infrequently. Predicting whether there will be acquisitions, how much they will cost and what they will deliver in terms of higher growth can be close to impossible. There is one way in which you can ignore acquisitions, but it does come with a cost. If you assume that firms pay a fair price on acquisitions, i.e. a price that reflects the fair value of the target company and you assume that the target company stockholders claim any or all synergy or control value, acquisitions have no effect on value no matter how large they might be and how much they might seem to deliver in terms of higher growth. The reason is simple. A fair-value acquisition is an investment that earns it required return Ð a zero net present value investment.
If you choose not to consider acquisitions when valuing a firm, you have to remain internally consistent. The portion of growth that is due to acquisitions should not be considered in the valuation. A common mistake that is made in valuing companies that have posted impressive historic growth numbers from an acquisition based strategy is to extrapolate from this growth and ignore acquisitions at the same time. This will result in an over valuation of your firm, since you have counted the benefits of the acquisitions but have not paid for them.
What is the cost of ignoring acquisitions? Not all acquisitions are fairly priced and not all synergy and control value ends up with the target company stockholders. Ignoring the costs and benefits of acquisitions will result in an under valuation for a firm like Cisco that has established a reputation for generating value from acquisitions. On the other hand, ignoring acquisitions can over value firms that routinely over pay on acquisitions.