M&A Questions
For an investment banker, why is a sell-side process typically shorter than a buy-side assignment?
As a practical matter, once a seller makes the decision to sell, it will usually be easier to find a buyer. So when working on behalf of the seller, the likelihood of completing a transaction tends to be higher. On the other hand, many companies regularly engage in market research and "dipping their toe in the water" type explorations of potential acquisition candidates. Thus, when working on behalf of a buyer, these engagements can drag on for months and can often end in no transaction.
Why are deferred tax liabilities created in transactions?
Deferred tax liabilities are created in deals because of deal-related asset write ups. Specifically, when a company is acquired, the book bases of its assets get written up to fair market value. However, when deals are structured as stock sales, the tax basis doesn't always get stepped up to align with the book basis write up. In this case, deferred tax liabilities are created at deal date to account for the fact that depreciation on assets written up will be higher for book purposes than for tax purposes.
Who determines the value of fair market write-ups in a transaction?
Independent appraisers, accountants and other valuation experts
What's the difference between a merger and an acquisition?
Mergers and acquisitions (M&A) refer to the combination of two businesses. The terms are often used interchangeably. A transaction can always be thought of as an acquisition, although a merger more often refers to an acquisition by two similarly sized companies, where the form of consideration is at least partially with stock so shareholders from both entities remain.
What are some balance sheet items that are commonly adjusted to fair market value in a transaction?
Property, plant and equipment as well as intangible assets are often significantly carried at book values significantly below market values. As a result, these assets tend to be written up the most in a transaction.
What are some reasons that a company might acquire another company?
Reasons to acquire another company include: Accelerate time to market with new products and channels, Remove competition (buying a competitor is called horizontal integration), Achieve supply chain efficiencies (buying a supplier or customer is called vertical integration)
Why should companies acquired by a strategic acquirer expect to fetch higher premiums than those selling to private equity buyers?
Strategic buyers may be able to benefit from synergies, which enable them to offer a higher price.
What are synergies? Why are they important in a deal? What are some examples of synergies?
Synergies are cost savings or incremental revenues arising from an acquisition. They are important because if any acquirer believes synergies can be realized, it would be willing to pay higher premiums. Examples of synergies are cost savings from eliminating overlapping workforces, closing redundant facilities, lower costs due to scale, cross selling opportunities, etc.
What are some of the common income statement adjustments related to a transaction?
Synergies, capital financing fees, incremental depreciation and amortization, additional interest expense, loss of interest income
Is it better to finance a deal via debt or via stock?
The answer depends on several factors. From the buyer's perspective, when the buyer's PE ratio is significantly higher than the target's, a stock transaction will be accretive which is an important consideration for buyers and may tilt the decision towards stock. When considering debt, the buyer's access to debt financing and cost of debt (interest rates) will influence the buyer's willingness to finance a transaction with debt. In addition, the buyer will analyze the deal's impact to its existing capital structure, credit rating and credit stats. From the seller's perspective, a seller will generally prefer cash (i.e. debt financing) over a stock sale unless tax deferment is a priority for the seller. A stock sale is usually most palatable to the seller in a transaction that more closely resembles a merger of equals and when the buyer is a public company, where its stock is viewed as a relatively stable form of consideration.
What is the accounting for financing fees?
They used to be capitalized and amortized, but are now reflected on the balance sheet as contra debt. They are still amortized over the term of the borrowing and are classified as "debt issuance costs" and embedded as a noncash expense within interest expense.
Are acquirers more likely to achieve revenue synergy or cost synergy expectations?
While both revenue and cost synergy expectations are often not fully achieved post transaction, revenue synergy assumptions tend to be less accurate than cost synergy assumptions. That's because cost synergies can map to specific cost cutting initiatives such as laying off workers and shutting down facilities while revenue synergies tend to be driven by higher-level, more uncertain assumptions around cross selling opportunities and new products.
If a company trades at a forward PE of 20.0x, and acquires a company trading at a forward PE of 13.0x. Assuming the deal is 100% stock-for-stock, and a 20% premium is being offered, will the deal be accretive in year 1?
Yes: stock for stock deals where the acquirer's PE is higher than target's are always accretive. Don't get tricked - a 20% premium just brings the target's PE to 13 + (13 x 20%) = 15.6 PE, still below the acquirer's.
Walk me through a simple M&A model.
An M&A model takes two companies and combines them into one entity. First assumptions need to be made about the purchase price and any other uses of funds such as refinancing target debt and paying transaction and financing fees). Then assumptions about the sources of funds need to be made - will the acquirer pay for the acquisition using cash, take on additional debt or issue equity. Once those basic assumptions are in place, the acquirer's balance sheet is adjusted to reflect the consolidation of the target. Certain line items - like working capital can simply be lumped together. Others need a little more analysis - for example, a major adjustment to the combined target and acquirer balance sheet involves the calculation of incremental goodwill created in the transaction, which involves making assumptions about asset write ups, and deferred taxes created or eliminated. Lastly, deal-related borrowing and paydown, cash used in the transaction, and the elimination of target equity all need to be reflected. In addition, the income statements are combined to determine the combined ("pro forma") accretion/dilution in EPS. This can be done as a bottom's up analysis - starting from the buyer's and seller's standalone EPS and adjusting to reflect incremental interest expense, additional acquirer shares that must be issued, synergies, and incremental depreciation and amortization due to asset write ups. Alternatively, the accretion dilution can be a top down, whereby the two income statements are combined starting with revenue and working its way down to expenses, while making the deal related adjustments.
Would acquirers generally prefer $100 in revenue synergies or $100 in cost synergies?
An acquirer would generally prefer $100 in cost synergies because all those cost savings after accounting for tax flow through to the bottom line, while revenue synergies have associated costs that reduce the bottom line benefit. For example - $100 in revenue synergies for a company with 40% pretax profit margins and a 25% tax rate would see $100 x 40 % x (1-25%) = $30 flow to the bottom line, while the same company would see $100 in cost synergies flow $100 x (1-25%) = $75 flow to the bottom line.
What does a goodwill impairment tell you about a deal?
Companies that have made acquisitions in the past are required to regularly estimate the value of their past acquisitions. A goodwill impairment happens when the acquiring company determines that the current value is lower than the original price paid for the target company. For example, if an acquirer paid $100 million for a business with $40 million in goodwill now estimates the value of the acquired business to be $70 million, the acquirer must recognize a $30 million goodwill impairment via retained earnings, bringing the goodwill balance down to $10 million.
What would you find included in an offering memorandum prepared by an investment banker in a sell-side process?
Company overview, industry overview, historical financial results, business segments, products, management and board of directors, risks
What is the impact of target NOLs in M&A?
Depending on the deal structure, target NOLs are either assumed by the acquirer (although their use by the acquirer is capped at an annual limit that's a function of the purchase price x the long term tax exempt rate) or are used to offset the seller's gain on sale (which, since the 2017 tax reform act, is capped at 80% of the target's taxable income).
When might a buyer prefer to pay for a target company with stock over cash?
For the acquirer, the main benefit of paying with stock is that it preserves cash. For buyers without a lot of cash on hand, paying with acquirer stock avoids the need to borrow in order to fund the deal. For the seller, a stock deal makes it possible to share in the future growth of the business and enables the seller to potentially defer the payment of tax on gain associated with the sale.
What does accretion/dilution analysis tell you about the attractiveness of a transaction?
From a valuation perspective, an accretive deal is not necessarily indicative of value creation for the acquirer and vice versa for dilutive deals. However, significant accretion or dilution is often perceived by buyers (and public company buyers in particular) as an indication of potential investor reaction to the transaction. Specifically, dilutive deals are feared by buyers to lead to decline in their share price after announcement. This fear is rooted in the notion that investors will apply the pre-deal PE ratio to the now-lower pro forma EPS. These concerns, while quite valid when viewed through the prism of buyers' short-term concerns about meeting EPS targets, or not actually relevant to whether a deal actually creates long term value for the acquiring company's shareholders, which is a function of intrinsic value of the newly combined company.
What are the most common balance sheet adjustments in an M&A model?
In an M&A analysis, some acquirer and target balance sheet line items can simply be lumped together. However, there are some line items that need to be adjusted to reflect both deal-related accounting and funding adjustments. On the accounting side: -Goodwill: Eliminate pre-deal target goodwill and create new goodwill from the deal -PP&E and Intangible Assets: Write up assets to fair market value as appropriate -Deferred tax liabilities: Create new deferred tax liabilities in a stock sale (Advanced concept- if not comfortable with this adjustment do not mention it) Target equity: Eliminate target equity from the consolidation On the funding side: Debt: Create new acquirer debt (if the deal was partially funded with debt) and eliminate Target debt (Target debt is often refinanced and reflected in the new acquirer debt financing, although in rare cases it can carry over) Equity: Increase the existing value of acquirer equity by the value of any new acquirer equity issued in the deal Cash: Reduce cash by the amount of excess cash used to fund the deal and pay transaction and financing fees with a corresponding reduction to equity (for the transaction fees) and to new debt (for the financing fees)
What are the most common income statement adjustments in an M&A model?
In an acquisition, the acquirer and target income statements are consolidated, meaning they are lumped together. Some of the line items, however, need to be adjusted to reflect accounting and deal funding issues. The most common adjustments include the following: Revenue: Increase consolidated revenue by any revenue synergies (if applicable) Operating expenses: Reduce consolidated expenses by any expected cost synergies Incremental D&A from write ups: Deals usually lead to higher noncash D&A from target assets due to asset write ups. This means incremental D&A expense due to write ups need to be added to consolidated D&A. Other expenses: Transaction fees are expensed on the income statement. Interest expense: Acquirer interest expense is adjusted up when debt financing is used to fund the deal. Target interest expense is eliminated when target debt is refinanced. In addition, financing fees are amortized over the term of debt and the noncash expense is recognized within interest expense. Interest income: Reduce interest income by the impact of any excess used to fund the deal Tax: All the adjustments above need to be tax-affected at the acquirer's tax rate. Share count for calculating pro forma EPS: Use the acquirer's pre-deal share count and add the number of acquirer shares issued in the transaction
Contrast asset sales vs 338(h)(10) election vs stock sales
In an asset sale, the seller sells the buyer assets. Each asset is contractually sold and once the buyer holds all the assets, it controls the business by virtue of having everything that made the seller's equity worth something in the first place. On the other hand, in a stock sale, the seller gives the buyer shares. Once the buyer holds all the target shares, it controls the business by virtue of being its new owner. In both approaches the buyer ends of owning the seller, but there are significant tax differences. In a stock sale, the buyer doesn't get a stepped-up basis in the seller's assets which means the buyer generally can't benefit from lower taxes down the road due to incremental deal related D&A. The seller on the other hand, is taxed only at the shareholder level (as opposed to both the corporate and shareholder level). In the asset sale, the buyer gets the incremental D&A tax benefits, but the seller potentially faces double tax - first on corporate level and then on shareholder level. A 338(h)(10) is something both buyer and seller can jointly elect to do which gives you the tax treatment of an asset sale without the hassle of actually exchanging individual assets, so for analytical purposes, it is an asset sale.
What happens to target NOLs in transactions?
The treatment of existing target NOLs depends on the structure of the deal. In asset sales/338, NOLs can either be used up by the target to offset any gain on sale on the corporate level. The acquirer does not get any remaining unused NOLs - they are permanently lost. In stock sales, the NOLs can be used by the acquirer going forward, but subject to an annual "IRC 382 limitation" - which limits the annual carryforward to a regularly published "long term tax exempt rate" times the equity purchase price.
How do you calculate offer value?
The offer value in the context of M&A refers to the equity purchase price being offered by the buyer to acquire the seller. Like equity value, offer value is calculating by multiplying fully diluted shares outstanding (including options and convertible securities) times the offer price per share.
What is the accounting for transaction fees in M&A?
Transaction fees include accounting, advisory and legal fees. They are generally expensed as incurred.
How do you calculate transaction value?
Transaction value in the M&A context refers to the target's implied enterprise value given the offer vale. As such, the transaction value equals the target offer value plus the target's net debt.
