M&A Questions
1. Walk me through a basic merger model.
"A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is made, and determines whether the buyer's EPS increases or decreases. Step 1 is making assumptions about the acquisition - the price and whether it was cash, stock or debt or some combination of those. Next, you determine the valuations and shares outstanding of the buyer and seller and project out an Income Statement for each one. Finally, you combine the Income Statements, adding up line items such as Revenue and Operating Expenses, and adjusting for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line; you apply the buyer's Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS."
20. Would a seller prefer a stock purchase or an asset purchase? What about the buyer?
A seller almost always prefers a stock purchase to avoid double taxation and to get rid of all its liabilities. The buyer almost always prefers an asset deal so it can be more careful about what it acquires and to get the tax benefit from being able to deduct depreciation and amortization of asset write-ups for tax purposes.
4. Why would an acquisition be dilutive?
An acquisition is dilutive if the additional amount of Net Income the seller contributes is not enough to offset the buyer's foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares. Acquisition effects - such as amortization of intangibles - can also make an acquisition dilutive.
17. All else being equal, which method would a company prefer to use when acquiring another company - cash, stock, or debt?
Assuming the buyer had unlimited resources, it would always prefer to use cash when buying another company. Why? Cash is "cheaper" than debt because interest rates on cash are usually under 5% whereas debt interest rates are almost always higher than that. Thus, foregone interest on cash is almost always less than additional interest paid on debt for the same amount of cash/debt. Cash is also less "risky" than debt because there's no chance the buyer might fail to raise sufficient funds from investors. It's hard to compare the "cost" directly to stock, but in general stock is the most "expensive" way to finance a transaction - remember how the Cost of Equity is almost always higher than the Cost of Debt? That same principle applies here. Cash is also less risky than stock because the buyer's share price could change dramatically once the acquisition is announced.
10. Why would a strategic acquirer typically be willing to pay more for a company than a private equity firm would?
Because the strategic acquirer can realize revenue and cost synergies that the private equity firm cannot unless it combines the company with a complementary portfolio company. Those synergies boost the effective valuation for the target company.
merger model version 2
Begin with having the acquirer's standalone EPS before the M&A transaction 1. Then first step is to determine the purchase price Through any valuation method 2. Build a sources and uses section -- To see how acquirer will finance transaction: cash, debt, or stocks 3. Combine acquirer and target company's standalone financials - REV and COGS - make pro forma transaction adjustments - Synergies - cost and revenue - Incremental interest expense 4. Calculate combined NI and calculate new share count - New share count = existing shares of acquirer + new shares issued by merger - any share repurchases 5. Can calculate pro forma EPS from here Combined NI / new share count accretion/dilution analysis Prom forma > acquirer EPS = accretive
1. What happens to combined multiples and accretion/dilution if the buy is twice as big and why?
Buyer has a greater weighting now, so multiples move closer to buyer's multiples Deal becomes less accretive bc the company that's making it accretive - the seller - now has a lower weighting
acquisition strategies
Horizontal integration: purchase of a business that expands the acquirer's business scale, geographic reach, product lines Seek economies of scale ands cope due to ability to leverage a fixed cost base and know how for greater production efficiency Vertical integration: seek cost efficiencies and potential growth opportunities by affording control over key components of the supply chain
1. Without doing math, what ranges would you expect for combined EV/EBITDA and P/E multiples
Depends on relative sizes of Buyer and Seller - more towards Buyer if buyer is bigger But in btween buyer and seller multiples
sell side M&A walk through
Sale of a company, division, business, or collection of assets1. organization and prep: identify seller objectives, perform sell-side advisor due diligence, select buyer universe, prepare marketing materials and confidentiality agreement2. first and second presentations and bidding3. negotiations4. closingrole of IB: provide strategic advice, guid client through each stage of transaction, facilitate successful closing and maximize value of company's sale
18. How much debt could a company issue in a merger or acquisition?
Generally you would look at Comparable Companies/ Precedent Transactions to determine this. You would use the combined company's LTM (Last Twelve Months) EBITDA figure, find the median Debt/EBITDA ratio of whatever companies you're looking at, and apply that to your own EBITDA figure to get a rough idea of how much debt you could raise. You would also look at "Debt Comps" for companies in the same industry and see what types of debt and how many tranches they have used.
What is goodwill and how is it calculated?
Goodwill is an intangible asset and reflects the value of a company that is not attributed to its other assets and liabilities. Goodwill =Equity purchase price paid for company - Target's book value (i.e. excess purchase price). This can remain on a company's balance sheet indefinitely barring impairment.
12. What is the difference between Goodwill and Other Intangible Assets?
Goodwill typically stays the same over many years and is not amortized. It changes only if there's goodwill impairment (or another acquisition). Other Intangible Assets, by contrast, are amortized over several years and affect the Income Statement by hitting the Pre-Tax Income line. There's also a difference in terms of what they each represent, but bankers rarely go into that level of detail - accountants and valuation specialists worry about assigning each one to specific items.
how do EV and equity value change with different purchase methods?
In M&A scenarios, change in purchase method won't affect EV/EBITDA, but will affect P/E EV rep all investors in co so cash, debt, stock wont affect EV combined But will affect combined equity value bc Equity value depends on amnt of stock issue, and combined NI is affected by cash and debt used
2. What's the difference between a merger and an acquisition?
In a merger the companies are close to the same size, whereas in an acquisition the buyer is significantly large
7. What is the rule of thumb for assessing whether an M&A deal will be accretive or dilutive?
In an all-stock deal, if the buyer has a higher P/E than the seller, it will be accretive; if the buyer has a lower P/E, it will be dilutive. On an intuitive level if you're paying more for earnings than what the market values your own earnings at, you can guess that it will be dilutive; and likewise, if you're paying less for earnings than what the market values your own earnings at, you can guess that it would be accretive.
16. Are revenue or cost synergies more important?
No one in M&A takes revenue synergies seriously because they're so hard to predict. Cost synergies are taken a bit more seriously because it's more straightforward to see how buildings and locations might be consolidated and how many redundant employees might be eliminated. That said, the chances of any synergies actually being realized are almost 0 so few take them seriously at all.
15. How are synergies used in merger models?
Revenue Synergies: Normally you add these to the Revenue figure for the combined company and then assume a certain margin on the Revenue - this additional Revenue then flows through the rest of the combined Income Statement. Cost Synergies: Normally you reduce the combined COGS or Operating Expenses by this amount, which in turn boosts the combined Pre-Tax Income and thus Net Income, raising the EPS and making the deal more accretive.
14. What are synergies, and can you provide a few examples?
Synergies: expected cost savings, growth opportunities, other financial benefits- Basically, the buyer gets more value than out of an acquisition than what the financials would predict. Cost synergies: headcount reduction, consolidation of overlapping headquarters and facilities, and the ability to buy key inputs at lower prices due to increased purchasing power - Economies of scales Revenue synergies: to the enhanced sales growth opportunities presented by the combination of businesses
21. A buyer pays $100 million for the seller in an all-stock deal, but a day later the market decides it's only worth $50 million. What happens?
The buyer's share price would fall by whatever per-share dollar amount corresponds to the $50 million loss in value. Note that it would not necessarily be cut in half. Depending on how the deal was structured, the seller would effectively only be receiving half of what it had originally negotiated. This illustrates one of the major risks of all-stock deals: sudden changes in share price could dramatically impact valuation.
3. Why would a company want to acquire another company?
The decision to buy another company (or assets of another company) is driven by numerous factors, including the desire to grow, improve, and/or expand an existing business platformSeveral possible reasons: - The buyer wants to gain market share by buying a competitor. - The buyer needs to grow more quickly and sees an acquisition as a way to do that. - The buyer believes the seller is undervalued. - The buyer wants to acquire the seller's customers so it can up-sell and cross-sell tothem. - The buyer thinks the seller has a critical technology, intellectual property or someother "secret sauce" it can use to significantly enhance its business. - The buyer believes it can achieve significant synergies and therefore make the deal accretive for its shareholders.
13. Walk me through the most important terms of a Purchase Agreement in an M&A deal.
There are dozens, but here are the most important ones: Purchase Price: Stated as a per-share amount for public companies. Form of Consideration: Cash, Stock, Debt... Transaction Structure: Stock, Asset, or 338(h)(10) Treatment of Options: Assumed by the buyer? Cashed out? Ignored? Employee Retention: Do employees have to sign non-solicit or non-compete agreements? What about management? Reps & Warranties: What must the buyer and seller claim is true about their respective businesses? No-Shop / Go-Shop: Can the seller "shop" this offer around and try to get a better deal, or must it stay exclusive to this buyer?
20. Let's say a company overpays for another company - what typically happens afterwards and can you give any recent examples?
There would be an incredibly high amount of Goodwill & Other Intangibles created if the price is far above the fair market value of the company. Depending on how the acquisition goes, there might be a large goodwill impairment charge later on if the company decides it overpaid.
11. Why do Goodwill & Other Intangibles get created in an acquisition?
These represent the value over the "fair market value" of the seller that the buyer has paid. You calculate the number by subtracting the book value of a company from its equity purchase price. More specifically, Goodwill and Other Intangibles represent things like the value of customer relationships, brand names and intellectual property - valuable, but not true financial Assets that show up on the Balance Sheet.
6. A company with a higher P/E acquires one with a lower P/E - is this accretive or dilutive?
You can't tell unless you also know that it's an all-stock deal. If it's an all-cash or all-debt deal, the P/E multiples of the buyer and seller don't matter because no stock is being issued.
17. Normally in an accretion / dilution model you care most about combining both companies' Income Statements. But let's say I want to combine all 3 financial statements - how would I do this?
You combine the Income Statements like you normally would (see the previous question on this), and then you do the following: Combine the buyer's and seller's balance sheets (except for the seller's Shareholders' Equity number). Make the necessary Pro-Forma Adjustments (cash, debt, goodwill/intangibles, etc.). Project the combined Balance Sheet using standard assumptions for each item (see the Accounting section). Then project the Cash Flow Statement and link everything together as you normally would with any other 3-statement model.
19. How do you determine the Purchase Price for the target company in an acquisition?
You use the same Valuation methodologies we already discussed. If the seller is a public company, you would pay more attention to the premium paid over the current share price to make sure it's "sufficient" (generally in the 15-30% range) to win shareholder approval.
what are complete effects of an acquisition
a. Foregone Interest on Cash - The buyer loses the Interest it would have otherwise earned if it uses cash for the acquisition. b.Additional Interest on Debt - The buyer pays additional Interest Expense if it uses debt. c. Additional Shares Outstanding - If the buyer pays with stock, it must issue additional shares. d. Combined Financial Statements - After the acquisition, the seller's financials are added to the buyer's. e. Creation of Goodwill & Other Intangibles - These Balance Sheet items that represent a "premium" paid to a company's "fair value" also get created.
what adjustments do you make to NI in merger model?
i. Synergies, D&A, foregone intr on cash, intr paid on new debt, shares
what is PPA?
newly acquired assets are re-evaluated and adjusted to their fair value Acquirer allocates the purchase price into assets and liabilities of target company acquired in transaction Components Net identifiable assets: total value of assets - liabilities Write up: adjusting increase to the book value of an asset if asset's carrying value < fair market value Goodwill: excess amt paid over the target company's net value
buy side M&A walk through
the purchase, sale, spin-off, and combination of companies, their subsidiaries and assets.Role of IB: The core analytical work centers on the construction of a detailed financial model that is used to assess valuation, financing structure, and financial impact to the acquirer. banker also advises on key process tactics and strategy, and plays the lead role in interfacing with the seller and its advisors - Understand investment criteria and target industries - Identify potential acquisition targets - Conduct due diligence on shortlisted companies, including financials and synergies - Perform valuation analysis using various methodologies - Structure the deal, negotiate purchase price and terms - Assist in drafting and negotiating definitive agreement - Coordinate closing activities, including regulatory approvals and financing - Provide strategic guidance throughout the acquisition process
