What if a single transaction could dismantle the entrenched duopoly in U.S. payments processing, generate billions in synergies, and elevate a regional player to national prominence—while navigating intense antitrust review and investor skepticism? That was the core proposition of Capital One’s $35.3 billion all-stock acquisition of Discover Financial Services, unveiled in February 2024 and consummated on May 18, 2025, following a protracted regulatory process. As of March 2026, with one year of integrated operations, the results are unfolding: robust revenue growth and stabilizing credit quality, tempered by persistent ROE declines and integration costs exceeding initial estimates.

Building on my prior analysis of Cisco’s $28 billion acquisition of Splunk, where understated projections potentially left significant value untapped, this examination dissects the Capital One-Discover transaction for deal professionals and enthusiasts. We will detail the strategic rationale, trace the negotiation chronology, analyze the valuation framework in depth, evaluate its assumptions, review regulatory challenges, compare to analogous deals, assess post-merger outcomes, and extract key insights.

Strategic Rationale: Capital One’s Push for Scale and Independence in a Competitive Landscape

In consumer finance, where data analytics and network control drive margins, acquisitions are essential for maintaining competitiveness. Capital One, established in 1994 as a credit analytics specialist, had amassed $482 billion in assets through targeted lending products like the Venture rewards card and retail partnerships. However, by 2023, it faced pressures including elevated delinquencies in subprime segments, competition from FinTechs such as Affirm, and substantial fees paid to Visa and Mastercard for transaction processing.

Discover, with $143 billion in assets, offered a complementary profile: a focus on prime borrowers, a proprietary payment network processing 4% of U.S. card volume and extending to over 200 countries through Diners Club and PULSE, and a strong debit business. Despite these strengths, Discover contended with operational issues, including a 2023 card misclassification incident resulting in a $365 million charge and FDIC enforcement actions, alongside a CEO transition that pressured its stock.

The deal’s value proposition centered on vertical integration. Capital One anticipated $2.7 billion in pre-tax synergies by 2027, comprising $1.5 billion in cost reductions from eliminating overlaps in technology, branches, and operations, and $1.2 billion in revenue enhancements from internal debit routing, which could reduce interchange fees by 20-30%. Beyond efficiencies, the merger enabled cross-selling of premium products to Discover’s 100 million customers, advanced AI applications in lending, and broadened merchant networks to 70 million acceptance points. Following closure, Capital One shifted toward higher-end segments, reducing subprime exposure to emulate American Express’s model while enhancing fraud prevention through aggregated data.

“Critics are wary of the size of the deal, but some analysts say it could create a stronger challenger to Visa and Mastercard.” - Bloomberg

Challenges were evident: Potential cultural mismatches between Capital One’s agile culture and Discover’s established systems risked employee attrition, with 1,100 Discover positions eliminated by March 2026. Technology migrations posed outage risks, and antitrust concerns over the combined 30% subprime market share necessitated a $265 billion community benefits commitment, which critics argued overstated new investments at under $5 billion according to organizations like the National Community Reinvestment Coalition. Nevertheless, the merger promised to chip away at Visa and Mastercard’s over 80% market control, potentially lowering merchant costs over time.

One year post-closure, performance indicators show progress amid headwinds. Third-quarter 2025 revenues increased 23% year-over-year to $15.4 billion, bolstered by Discover’s assets, with organic purchase volumes rising 6.5%. Credit trends improved, with domestic card net charge-offs at 5.04% and delinquencies at 3.93% in early 2026. However, integration expenses exceeded projections, contributing to a $4.3 billion net loss in Q2 2025 from acquisition-related accounting, including $510 million in quarterly intangible amortization. Return on equity fell to 9.63%, below the sector average of 9.78%, leading to analyst downgrades such as Seeking Alpha’s Strong Sell rating, which forecasts an 11.6% downside to a $160.90 fair value due to efficiency shortfalls.

Negotiation Chronology: Mapping the Path from Initial Outreach to Regulatory Approval

Large-scale mergers require meticulous orchestration, often spanning months of discussions, assessments, and adjustments. Similar to the Splunk-Cisco process (initial engagement in 2021 leading to closure in 2023), the Capital One-Discover timeline involved strategic pauses and escalations and complexities.

The groundwork predated 2023, with both companies periodically evaluating growth opportunities amid rising interest rates, fintech competition, and regulatory pressures. Discover maintained independence but entertained advisor contacts following its July 2023 misclassification issue, which incurred a $365 million liability and prompted an FDIC consent order.

The process accelerated in August 2023: Discover’s CEO resigned on August 14, causing a stock decline. Chairman Thomas Maheras received inquiries, including from Stephen Crawford, an advisor to Capital One CEO Richard Fairbank, around mid-August. This led to a September 13 meeting in New York, where Fairbank proposed a stock-for-stock transaction at a 30% premium. Capital One had engaged Centerview Partners and Wachtell, Lipton, Rosen & Katz by mid-August.

In December 2023, the merger discussions between Capital One and Discover hit a significant roadblock when Capital One’s due diligence uncovered critical red flags related to Discover’s compliance and credit risk management. Key issues included a long-standing card product misclassification dating back to 2007, where certain credit card accounts were incorrectly placed in higher merchant pricing tiers, resulting in ongoing merchant settlement discussions, regulatory scrutiny, and an SEC investigation. Discover had already recognized approximately $290 million in estimated penalties as of September 30, 2024, tied to a 2023 FDIC consent order mandating enhancements to consumer compliance, governance, and risk practices. Additionally, concerns arose over the adequacy of Discover’s compliance management system and credit risk framework, which Capital One deemed insufficient for alignment with its standards and regulatory expectations. These findings prompted Capital One’s management to inform Discover on December 7 that it would not proceed, citing the diligence status and external factors like Discover’s rising stock price, which would necessitate a higher exchange ratio.

The temporary halt, reviewed and affirmed by Capital One’s board on December 14, highlighted the potential for substantial remediation costs—estimated within the overall $2.8 billion in acquisition and integration expenses, including one-time fixes for Discover’s issues—and raised uncertainties around regulatory approvals, operational integration, and financial synergies. This pause delayed the process by several weeks, allowing time to assess whether the risks outweighed the benefits, but discussions resumed in January 2024 after market shifts and further evaluations, ultimately leading to the deal’s revival and completion.

Valuation Framework: A Detailed Examination of Projections, Dividend Discount Model, and Comparable Transactions

Valuations in this transaction were based on structured analyses by financial advisors Centerview Partners (for Capital One) and PJT Partners (for Discover). These relied on unaudited management projections, emphasizing conservatism amid economic uncertainty. The analyses incorporated standalone forecasts for both companies, adjusted for synergies, and excluded certain one-time items like Discover’s student loan portfolio disposition (implied NPV of ~$7.25 per share, excluded due to uncertainty). Below, we break down the key components into management projections, the dividend discount model (used as a proxy for DCF), and market comparables.

Management Projections: Building Blocks of Standalone and Synergized Forecasts

The unaudited prospective financial information formed the core inputs, derived from consensus estimates (e.g., from FactSet or street research) for near-term years (2024-2025) and extrapolated for longer horizons (up to 2030, varying by advisor). These projections included net income available to common shareholders (NIAT), earnings per share (EPS), return on average tangible common equity (ROATCE), tangible book value per share (P/TBV), risk-weighted assets (RWAs), total loans, and total capital returns (e.g., dividends and buybacks). Assumptions reflected steady growth amid economic headwinds, with Capital One targeting CET1 ratios of 13% and Discover 12% for capital adequacy. Synergies were layered on top: $2.7 billion pre-tax by 2027

• For Capital One standalone (Centerview’s view, 2024-2030; extrapolated with ~1% NIAT growth in 2026 and ~3% thereafter; RWAs ~3.5% annual growth from 2026)

• PJT’s Capital One standalone projections (2024-2028; NIAT growth 13% in 2025, 7% thereafter; loans/RWAs ~5% annual growth from 2025; capital returns at 68% payout ratio)

• For Discover standalone (Centerview’s view, 2024-2030; NIAT growth ~8% in 2026, 5% in 2027, 11% in 2028-2029, 4% in 2030; RWAs ~3% in 2026, 5% thereafter; 2024 includes student loan sale impact)

• PJT’s Discover standalone projections (2024-2028; NIAT growth ~10% annual average; loans/RWAs ~7-8% growth)

Dividend Discount Model: Discounting Future Cash Flows to Present Value

The primary valuation method was a dividend discount model (DDM), serving as a proxy for discounted cash flow (DCF) tailored to the banking sector. DDM was preferred over traditional DCF because banks’ cash flows are heavily constrained by regulatory capital requirements (e.g., Basel III and CET1 ratios), making free cash flow unpredictable and less relevant—leverage and capital structure are integral to operations, not separable as in non-financial firms. Instead, DDM focuses on distributable dividends (excess cash after maintaining capital buffers), providing a more accurate reflection of shareholder value in a regulated environment where dividends are stable and tied to risk management. This approach aligns with financial institutions’ unique dynamics, where working capital and capex have minimal impact, and earnings are often directed toward reserves rather than unrestricted FCF.

Centerview and PJT applied sensitivities to growth, discounts, and terminals, yielding implied per-share ranges for Discover. Centerview’s DDM (2024-2030 forecasts; discount rates 12.75-13.75% via CAPM: 4% risk-free, 1.4-1.5 beta, 5-6% equity risk premium; terminal P/E 8.5-10.5x on 2030 NIAT; perpetual growth implied ~2-4% in sensitivities): Implied Discover value $120.50-$141.75 per share (standalone), adjusting for synergies to support the exchange ratio (0.88-1.23x ex-synergies, 1.06-1.75x incl.).

PJT’s DDM (2024-2028 forecasts; discount rates 11-13%; terminal P/E 8.5-10.5x on 2028 NIAT): Implied Discover value $117.46-$145 per share.

Market Comparables: Benchmarking Against Peers and Precedents

Comparables analyses supplemented DDM, using selected public companies for multiples and precedent transactions for premiums. Peers were chosen for similarity in consumer finance/banking (e.g., focus on cards, lending).

These supported the deal’s premium as aligned with market norms, though critics noted limited fintech inclusion.Centerview’s comparable companies: P/E (9-11x 2024E EPS) and P/TBV (1.78-2.11x via ROATCE regression) for peers like American Express, Ally Financial, Synchrony Financial. Implied Discover ranges: $107.75-$130 (P/E), $103.25-$121 (P/TBV).

PJT’s similar: P/E 9-11x, P/TBV 1.78-2.11x, yielding overlapping ranges.

Premiums paid: 10-35% applied to Discover’s unaffected $110.49 price (February 16, 2024 close), implying $121.50-$149.25 per share.

Precedent transactions (selected banking deals) informed the range but were not detailed with specific multiples.

Reviewing the P/E comparables we see overlap with the sensitivity analysis and a rough triangulation approach on the final deal value at a roughly 10.5x P/E. This represented a 27% premium to Discover’s market value at the time of the deal.

Scrutinizing the Valuation: Assessing Assumptions and Potential Enhancements

The 27% premium appeared reasonable given Discover’s challenges, but parallels Splunk-Cisco’s conservative approach, where growth projections may have understated potential. NIAT forecasts (3-11% for Discover) overlooked opportunities in network globalization or AI enhancements. Discount rates (11-13.75%) were elevated; reducing to 10-12% might increase per-share value by $10-20.

Comparables were appropriate but limited; incorporating fintech benchmarks like SoFi (12-15x P/E) could justify higher multiples. The premiums range was expansive; a 20-30% banking median aligns with the deal’s 27%, yet deeper precedent transactions (e.g., Synchrony-Ally alignments) were underemphasized. Without alternative scenarios (e.g., 5-7% perpetual growth if synergies surpass $2.7 billion), Discover may have conceded $5-10 billion. Analyst views diverge: BTIG’s post-closure Buy rating cites $21.39 EPS potential, while others highlight ROE shortfalls, estimating fair value at $161.

Navigating Regulatory Hurdles: The Beltway Battles That Shaped the Outcome

Regulatory approval in banking mergers extends beyond financials to public policy. Antitrust concerns over subprime concentration attracted Department of Justice criticism, with groups like the American Economic Liberties Project deeming it anticompetitive and predicting fee hikes. Capital One rebutted by emphasizing network competition, though detractors questioned the efficacy of claimed efficiencies.

The process: Applications filed March 2024; July public hearings; extensions under Biden-era stringency. A post-election administrative change in April 2025 expedited Federal Reserve and OCC approvals, alongside Delaware clearance in December 2024. The $265 billion benefits package (focused on low- to moderate-income lending and branch expansions) was promoted as transformative but critiqued for minimal incremental value.

“Regulators have been tough on big financial mergers, though there are nuances in Capital One’s $35.3 billion takeover bid for Discover.” - New York Times

Benchmarking Against Peers: Contextualizing the Deal in Banking’s Consolidation Wave

To evaluate Capital One-Discover, consider it alongside 2025’s heightened M&A activity (over 150 announcements, with October’s $21.4 billion marking the peak since 2019). Comparisons include Fifth Third-Comerica, Huntington-Cadence, PNC-BBVA (2021 benchmark), and cross-sector to Splunk-Cisco.

Fifth Third’s $10.9 billion all-stock Comerica deal (announced October 6, 2025; expected Q1 2026 close) aimed for regional dominance, yielding a $288 billion entity with leading positions in the Midwest and Texas. The 1.8663 exchange ratio provided a 20% premium to Comerica’s 10-day VWAP ($82.88 implied). Synergies: $850 million gross pre-tax (35% of Comerica’s 2026 expenses), with revenue opportunities in payments and wealth. Timeline: Comerica explored options in summer 2025 amid liquidity issues; CEO contact September 18; Dallas meeting September 19; nonbinding indication September 23; finalization through September 30; execution October 5. Advisors mirrored Capital One’s (Goldman Sachs, J.P. Morgan). Valuations: Conservative DCF/comps supported fairness, with risks in integration and enhanced regulatory category. Unlike Capital One’s network focus, this emphasized footprint expansion, with milder antitrust but comparable community commitments.

Huntington’s $7.4 billion Cadence acquisition (mid-2025 announcement) created a $276 billion top-10 bank via Sunbelt growth and deposit diversification. Valuation: 1.5x tangible book value premium; synergies $800 million (30% cost reductions). Shorter timeline (6 months to close) leveraged regulatory easing. Early 2026 data indicates 15% EPS accretion but initial ROE pressure—echoing Capital One’s trajectory with less subprime exposure.

PNC’s $11.6 billion cash purchase of BBVA USA (announced November 2020; closed June 2021) offers historical perspective: 1.34x TBV and 19.7x 2019 earnings, with $900 million synergies (35% of BBVA expenses) forming a $560 billion national player. Integration overruns ($980 million expenses) delayed benefits, akin to Capital One’s cost escalations. Outcomes: 21% 2022 EPS lift, though the $88 billion benefits plan faced scrutiny—similar to Capital One’s. PNC achieved >19% IRR, illustrating long-term rewards despite early hurdles.

Post-Merger Assessment: Progress, Pain Points, and Forward Outlook

Retrospective analysis highlights resilience: Q3 2025 revenues rose 23%, with synergies advancing (e.g., debit routing implemented early 2026). Yet, Q2’s $4.3 billion loss, cost overruns, and subprime portfolio adjustments underscore challenges. Capital returns via $16 billion buybacks and dividend increases supported shares, but ROE declines indicate ongoing inefficiencies. Credit trends reflect normalization, with charge-offs steady and reserves easing.

“The Discover acquisition drove double-digit growth, but organic card spending and loans also expanded.” - PYMNTS

“[integration costs] will surpass the original $2.8 billion estimate.” - Capital One CEO Richard Fairbank stated during the Q2 2025 earnings call

The company added that it’s still on track for $2.7 billion in total net synergies, due to cost savings and revenue synergies from the combination. But it seems this is taking far longer to achieve than originally anticipated.

Key Insights and Implications: Synthesizing Lessons for Future Transactions

The Capital One-Discover merger exemplifies M&A’s capacity to transform sectors: a calculated integration of networks and data that navigated negotiations, valuations, and regulations to yield a payments contender. It demonstrates how deals emerge (opportunistic timing during vulnerabilities), valuations are constructed (through layered projections and sensitivities), and improvements can be made (by incorporating upside cases to maximize outcomes).

For dealmakers, the takeaways are pragmatic: Align pursuits with market lows for favorable premiums; integrate diligence pauses as risk mitigators; broaden comparables to include emerging peers; and prepare for regulatory variability, where shifts can compress timelines. In banking’s ongoing consolidation, this transaction signals opportunities in tech-enabled scale but warns of execution risks. Conservative assumptions can protect against downside, but can deprive shareholders of real value.

The companies

Cisco Systems was founded in 1984 and was (prior to the Splunk acquisition) known for their leadership in networking technology. They designed, manufactured and sold hardware, software and services. Key products included Routers, Switches and other Networking Equipment. In 2015, under CEO Chuck Robbins, the company made a major strategic pivot towards higher margin software and a subscription based business model. The software would integrate with their legacy software business and Cisco built strong capabilities in enterprise cybersecurity. In this way, they could serve enterprises “end to end” in their information flows.

Splunk was a San Francisco based software company highly specialized in cybersecurity and observability solutions with a strong focus on real-time analytics capabilities. The Splunk platform enabled enterprise customers to search, monitor and analyze massive volumes of machine-generated data, often unstructured in raw form, and provide insights in real-time. As the amount of machine generated data grew, so to did the attractiveness of Splunk’s technology. Their software was very popular among customers, who were extremely “sticky” once Splunk’s platform was adopted. Originally selling traditional “perpetual software licenses”, the company pivoted to a subscription model in 2017. By 2023, their Annual Recurring Revenues (ARR) were in around $3 billion (a roughly 10x increase over the previous 8 years).

M&A is about strategy

Cisco’s interest in Splunk was no accident. In fact, there were good reasons to think Splunk’s products would fit well into Cisco’s wider portfolio.

1. Cisco would increase the breadth and depth of their product offerings. Splunk was a market leader in cybersecurity and observability markets. Cisco had capabilities in this space via previous M&A, but Splunk would be a major boost.

2. Cisco would achieve faster growth and higher market valuation. Cisco’s pivot to higher margin, higher growth, subscription software businesses was no accident. These types of business command higher valuation multiples in the market as compared to Cisco’s legacy hardware business. Splunk fit the profile of what Cisco was looking for: double digit revenue growth, strong free cash flows and a subscription based business model.

3. Splunk would increase its growth potential as part of Cisco’s portfolio. Splunk had achieved roughly 10x revenue growth over the prior 8 years. They built their own sales channels in the United States, and were increasingly looking to international markets for growth. However, the road ahead was a long one and could be dramatically shortened if they could leverage Cisco’s large sales teams that already had significant international presence.

4. Both Cisco and Splunk would benefit from combined AI capabilities. AI was already changing the enterprise software markets, and both companies had been investing in AI capabilities. Cisco’s acquisition would effectively allow these teams to “combine forces” precisely when scale and speed were paramount in capturing AI-based opportunities

But the deal was not without some potential risks. The list below highlights two related to Cisco’s post-merger integration (PMI) risks, but it is by no means exhaustive.

1. The “conglomerate” vs. “pure-play” risk. Part of the rationale for the deal was that Splunk could more quickly penetrate high growth international markets leveraging Cisco’s established sales teams. Sounds good in theory, but practice can be a different matter altogether. Pure-play businesses tend to be highly focused vs. conglomerates, and selling a highly technical software service requires considerable focus. Splunk’s major competitors (e.g. DataDog) remain pure-play businesses. If Cisco’s sales network was unable, or less willing, to focus on Splunk’s offering (as it would be part of Cisco’s wider portfolio), then sales could stagnate or even lose market share. This would have to be a major focus of Cisco’s management team once the acquisition was complete.

2. Talent retention. Top software talent can be finicky. Splunk’s employees had been compensated with company stock in a company that had seen >10x revenue growth over the prior decade. Moreover, as Splunk switched to a subscription model, their high growth rate and free-cash-flow margins were poised to command a premium in the market. In other words, Splunk employees were in for a lucrative ride. They would now be “converted” to Cisco stock for compensation. Would top employees stay? This would also have to be a focus for Cisco’s post-merger integration (PMI) plan. …

Background of the merger

Nov. 15 2021: Splunk CEO, Doug Merritt abruptly steps down. No reasons are immediately given in the news, and Splunk’s share price drops ~18% on the news. Graham Smith, Chairman of the Board, becomes Interim CEO until a new permanent CEO is found.

Nov. 19 2021: Chuck Robbins, CEO of Cisco contacts Splunk’s Interim CEO regarding a potential interest in acquiring Splunk. I suspect Splunk had been on Cisco’s M&A radar for some time. They had a track record of growing through M&A and decided to take advantage of Splunk’s leadership void to make an offer and see if they could close a deal quickly. Hence the two day gap between Splunk’s CEO departure and the opening bid.

Dec 17, 2001: Splunk receives an unsolicited non-binding indication of interest to buy the company for $165 to $175 per share. This offer was subject to customary due diligence. Cisco requested access to certain non-public diligence information in order to allow continued due diligence. It seems that Splunk did not agree to the non-public disclosures, but did provide Cisco access to certain Splunk employees to discuss publicly available information about Splunk’s operations.

Jan 14, 2022: Cisco makes another non-binding offer to buy Splunk for $175 to $190 per share, again subject to further due diligence. Note that at this point, only publicly available information has been provided, but the Cisco’s price has gone up despite only 28 having passed since the first offer.

Jan 23, 2022: Splunk engages an external advisor to evaluate the sale of the business, including the valuation of Splunk’s business.

Feb 4, 2022: Cisco makes another non-binding offer to buy Splunk for $193 per share.

Feb 6, 2022: The two CEO’s speak over the phone, and Cisco’s CEO verbally offers $212 per share. At this point, Cisco’s offer has gone up from $165-$175 to $212 per share in only 51 days. Splunk does not accept the offer, citing the need for finding a permanent CEO and for their advisor to complete a study of strategic alternatives and valuation of the business. Later that day, Cisco withdrew its non-binding offer

Key lessons (so far):

1. Splunk remained committed to a formal and professional process. They knew they needed an external M&A advisor and a solid leadership team in place. Without these, they would be at a serious disadvantage in any sale despite Cisco’s increasingly priced offers.

2. Cisco was prepared to walk away. Buyers (and sellers) should be prepared to walk away if the conditions are not right. Splunk was not in a position to commit, and Cisco was not prepared to raise their offer much further. They likely had a “price at which to walk away” already in mind before they made the first bid.

3. Just because the first round “fails” does not mean all is lost. Cisco remained patient, and was able to re-engage later (as we will see)

4. Market timing can impact the price paid. From Dec 17, 2021 until April 4, 2023 there was a contraction in Spunk’s market. Splunk’s financial guidance was lowered and their stock price declined 15% while the overall Nasdaq dropped 19% and the S&P software and services index dropped 25%.

Apr 4, 2023: Cisco’s CFO contacts Splunk’s CEO (in place for ~12 months by this point) to evaluate whether the two companies could further explore an acquisition. With their leadership team now fixed, Splunk was in fine position to trigger a formal and professionalized process, and a confidentiality agreement is signed within two weeks. Splunk prepares their information memorandum and business plan, including financial projections for further analysis.

May 3, 2023: to Jun 19, 2023: Representatives of both companies engage in information sharing meetings to advance discussions on Splunk’s business, technology, operations and outlook (including financials and forecasts).

Jun 19, 2023: Based on their information memorandum and materials shared to date, Cisco makes a non-binding offer for $130 per share. At this point, Splunk’s share price had dropped to $108 per share (Cisco’s offer was a 20% premium). Note how much lower this is than the $212 verbal offer in Feb 2022.

Jun 21, 2023: Splunk’s Board of Directors meets to formally discuss Cisco’s offer. They reject the $130 per share offer, concluding that Splunk is worth more as a stand-alone business based on their business forecasts. But, they also agree to further explore the potential deal with Cisco. In addition, the Board established a “Transaction Committee” to handle future negotiations, as it is impractical to assemble the full Board of Directors for every offer development. This Transaction Committee also engages two external advisors for formal valuations, and one advisor for a “market check” to see if other bidders could be interested in buying Splunk. Splunk’s advisors now directly engage with Cisco’s financial advisors.

Key lessons (continued):

5. Both Cisco and Splunk are more disciplined in their approach this time. Splunk has engaged advisors and is following a clear structure. They also establish a dedicated “transaction committee” at the Board level to handle the negotiation process. These advisors support the Board in evaluating the price offered vs. the business value, as well as whether other bidders could be interested. Sellers should always have advisors on hand to ensure they are following a structured process and getting the right price for their business. A “market check” is absolutely critical in this case, as more bidders can increase the price.

6. Market timing changed the dynamic and the price offered. During the first Cisco offers in 2021, the market was higher. With a downturn in 2022 and 2023, Splunk revised their forecasts down to reflect the market changes. Cisco sensed another opportunity. Buyers should always be scouting the market for opportunities, and this should be part of an overall M&A strategy. Both buyers and sellers should be aware that overall market dynamics will impact the price. Financial statements and forecasts will also be updated during the M&A negotiation process.

Aug 27, 2023: After several rounds of discussions between Splunk and Cisco advisors (part of a typical due diligence deep dive), Cisco makes a revised offer to acquire Splunk for $142 per share. Splunk’s Transaction Committee discusses this offer with their advisors and concludes the price is still too low. They quickly discuss with the Board of Directors who then decides to make a counter-offer of $168 per share. Their advisor presents this counter-offer to Cisco’s advisor on behalf of Splunk. At this point both Boards are working through their advisors.

Aug 29, 2023: Cisco increases their offer to $146 per share (this is also done via their advisor to Splunk’s advisor). Splunk counter-offers $160 per share, stating that $146 continues to undervalue Splunk’s business.

Aug 30, 2023: A day of offers and counter offers. Both Cisco and Splunk, working through their advisors are sending offers and counter offers. Cisco offers $152 per share, Splunk counters with $158. Cisco offers $157 and Splunk accepts the offer. On the date of offer, Splunk’s share price closed at $120.28 and Cisco’s offer represented a roughly 30% premium.

Sep 2, 2023: Cisco and Splunk announce the deal, and sign an agreement that moves it towards a shareholder vote. Splunk shareholders would approve the sale roughly 80% to 20%.

Key lessons (continued):

7. M&A is a long process, taking months or years. Cisco first approached Splunk in 2021, but it took 1 year and 9 months before the final offer would be accepted (and more months before the shareholder vote could be completed).

8. Advisors are absolutely critical. They are necessary to be engaged throughout the M&A process. For the seller, it is important to engage an advisor as early as possible, often before an offer has been extended, in order to sufficiently prepare the company for sale. Information memorandums, financial statements, forecasts, business cases, management presentations all need to be prepared. Buyers will expect this as part of their due diligence. They will have advisors that will insist on it.

Management Projections / Financial Forecasts

A critical step is the preparation of financial projections for the business. These are different than typical forecasts, projections and estimates that companies do in the course of their normal business. Essentially, they take the existing management forecasts and extrapolate forward for a fixed period of time (in Splunk’s case, this was 10-years). Extrapolating out that far involves making assumptions about the future performance of the business and market. Sellers should be very diligent here as their assumptions and forecasts will be challenged by the buyer and inform both buyer and seller valuations (and by extension, their negotiating positions). Below we see the Management Projections used by Splunk’s advisors as a basis for valuation.

Generally speaking, this is pretty standard. However, I would actually offer a criticism here in that the forecasts are very conservative. For instance, the Baseline Management Projections were in fact less than the company’s growth performance over the previous 5 years. In one sense, this is prudent as management does not want to be too optimistic. But I would have advised having one projection scenario as an “Optimistic Scenario” rather than the two Sensitivity Projection Scenarios shown - both of which are more pessimistic than the Baseline. This would have been prudent given the increasing demand for Splunk’s services and overall long-term market growth trends. As we’ll see, these projections provide the foundation for subsequent valuations. By being too conservative, Splunk may well have left money on the table.

The valuation

Among the most critical roles an advisor plays is ensuring that the right price is paid for the business. To do this there needs to be a clear structure and logic behind the valuation in order to justify the price being negotiated. As we’ll see below, several different methods were used to advise Splunk’s Board of Directors on whether Cisco’s offer was indeed fair. Each method provides a range of output values. The methods used were (1) Discounted Cash Flow, (2) Comparable Company Multiples, (3) Comparable Transaction Multiples. These are described in detail below.

1. Discounted Cash Flow Valuation

   1. Net Present Value (NPV) of Splunk’s estimates future unlevered free cash flows based on the company’s most recent financial statements and management projections for the next 10 years (the “forecast period”). These projections include a Baseline and two alternative scenarios. A range of discount rates is also applied from 12% to 14%. The Terminal Value projections assume a perpetuity growth rate range of 3.0% to 5.0%.

   2. Net debt was then subtracted from the NPV value above and…

   3. Divided by the total amount of fully diluted shares outstanding. This arrives at a range of values for Splunk’s business for each of the business projection scenarios. The Baseline Management Projection gives an implied value of $132.50 to $196.81 per share [see table below]. The final agreed offer of $157 per share is below the midpoint of the baseline projection, but above the midpoint for Scenario 1 and above the high end of Scenario 2.

      

2. Selected Companies Analysis

   Comparable public companies were identified and their selected financial information with public multiples was compared. The companies were selected based on the advisor’s professional judgement using the following criteria: publicly traded firms in similar lines of business to Splunk and with similar business models and/or financial performance. Where needed, consensus estimates were based on 3rd party research. Using this information, the advisor compiled the following Revenue and LFCF multiples shown in the tables below.

   

   

   From here the advisor selected a representative range Revenue Multiple of 4.0x to 7.0x and a LFCF multiple of 15.0x to 27.0x to be applied to Splunk’s Financial Projections and dividing by the fully diluted shares outstanding to arrive at a per-share valuation for Splunk, summarized below:

   

   Note how the final offer price of $157 per share is much closer to the upper bounds of the EV/Revenue Multiple ranges, and roughly at the midpoint of the Baseline Management Projection for EV/LFCF multiple.

3. Analysis of Comparable Transactions

   68 public company transactions were selected for comparison to Splunk based on similar lines of business involved, similar business models and similar financial performance. For each of these transactions, they evaluated

   1. Enterprise Value as a multiple of consensus revenue targets for “next twelve months” (the “NTM Revenue Multiple”).

   2. Enterprise Value as a multiple of EBITDA consensus estimates for the next twelve months (the “NTM EBITDA Multiple”)

   3. Equity value as a multiple of consensus estimates of Levered Free Cash Flows (the “NTM LFCF Multiple”)

      Here is a list of the 68 transactions included in their analysis.

      

      

      

      

      Based on these 68 comparable transactions, the advisor selected a representative range of multiples to be applied to Splunk’s financial projections. The ranges selected were: NTM Revenue Multiple of 4.5x to 8.0x, NTM EBITDA multiple of 18.0x to 34.0x and an NTM LFCF multiple of 20.0x to 32.0x. This gave the following output estimates for Splunk’s value:

      1. NTM Revenue Multiple: Splunk value range is $97.37 to $178.26 per share

      2. NTM EBITDA Multiple: Splunk value range is $88.22 to $172.96 per share

      3. NTM LFCF Multiple: Splunk value range is $107.27 to $171.63 per share

      Note how the $157 offer is closer to the upper bound in each of these ranges based on prior comparable transactions. By this method, Cisco’s offer seems fair.

Some final thoughts for consideration

In this case, we have analyzed Cisco’s acquisition of Splunk for $28 billion or $157 per share. For Cisco, there was a strong strategic rationale for the deal. Splunk would complement their product offering in the increasingly competitive cybersecurity and observability segments. It would also fit nicely into their strategy of focusing on higher growth software subscription offerings. Splunk would also benefit by rapidly getting access to a global sales team that could boost their presence in international markets. To a large degree, Cisco and Splunk’s customers overlapped and there was a compelling case for these sales synergies.

The deal itself was not easy to close. The process took 21 months from initial indication of interest to final offer and another several months after before shareholders could vote their approval. Several key lessons were learned along the way (summarized in the transaction timeline). Advisors played a strong role for both buyer and seller to ensure a structured and logical process and price were negotiated.

Nevertheless, the Management Projections that were used as the basis for valuation analysis may have been too conservative. Given Splunk’s strong track record (10x revenue growth in prior decade) plus their market leading position in a high growth sector, at least one “optimistic scenario” should have been included in the analysis. By excluding this, they may have left a lot of money on the table. Market timing impacted the price paid. Cisco’s offer, though non-binding, was $212 at its highest point. The final agreed price was $157. Had an “optimistic scenario” been included in the Management Projections, the final price could have been higher.