In early March, Standard Life, Scotland’s largest insurer and Aberdeen Asset Management announced £11bn merger. This merger would create one of the biggest European fund manager with around £660bn under management. Standard Life and Aberdeen shareholders would own two-thirds and one-third of the combined company respectively. This is reflected in relative market capitalizations of the two companies. Let’s analyse this mega deal using a simple valuation formula and provide some insights.
As we mentioned in our AT&T’s merger with Time Warner review, mergers take place when combining two entities can create value. This means that the combined entity’s value exceeds the sum of values of the two separate entities. Let’s have a look at this from a theoretical perspective. When valuing a company using the formula below, increase in the value of the company occurs due to the increase in the numerator – operating free cash flow (could be achieved for example by an increase in the earnings or cost reduction) or decrease in the denominator – WACC (could be achieved for example by an alternation in the capital structure of the company) or other factors.
Standard Life and Aberdeen’s merger could create value. First, combined entity could utilise the economies of scale, decreasing costs and so increasing FCFF. The bigger the company, the bigger the impact it has on the market. A large company is more likely to win the trust of the customers and is able to utilise its negotiating power to get better deals. Second, a greater diversification allows capitalising on evolving client demand worldwide, bringing in more clients and so increasing revenues. Third, the merger would allow both sides to leverage each other’s distribution networks, potentially bringing in more customers or more investments. Finally, a value could be created due to the specialisation of both firms in certain sectors (Aberdeen known as an emerging market specialist and Standard Life known for its multi-assets strategies) providing expertise of the combined entity in a broader aspect of markets. All these factors could increase numerator in the formula and so increase the firm value. If the capital structure of the combined entity leads to a lower WACC (weighted average cost of capital), denominator goes down and the value of the firm increases further.
According to the Standard Life’s analysis, there are £200 million of cost synergies expected to be realised within 3 years of completion. Furthermore, Sir Gerry Grimstone, Standard Life’s Chairman, claims that Aberdeen’s culture and values are complementary to those of Standard Life. Investors reacted positively right after the deal’s announcement with shares in both companies opening slightly higher in European markets and Aberdeen’s two largest shareholders, Mitsubishi UFJ Trust and Banking Corporation and Lloyds Banking Group have both given their support to the deal as well.
On the other hand, there are some concerns about the merger such as likely job cuts, the management structure of the combined company, and possible asset outflows. Interestingly, David Cumming, Standard Life’s head of equities, quit two days after the merger was revealed, which could provide investors with a hint that something unusual is going on behind the scenes.