Basic Qs Flashcards
Why would a company want to acquire another company?
Good ROI/ EPS accretion
- market share
- business growth quickly
- seller is undervalued
- acquire customer base and up/cross sell
- seller has critical tech + intellectual property
- synergies
Walk me through a basic merger model
MM used to analyse the financial profiles of 2 companies, purchase price, and changes in EPS afterwards.
- make assumptions on price and payment method
- determine valuations and shares outstanding
- project income statements, then combine them by adding up line items
- adjust for cash/debt lines
- apply buyer’s tax rate to get the combined net income
- divide by new share count to determine combined EPS
- balance sheet and goodwill ideas too
What’s the difference between merger and an acquisition
In a merger, buyer and seller similar sized.
In an acquisition, buyer is significantly larger - often 2/3x bigger
Why would an acquisition be dilutive?
If the additional 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.
Is there a rule of thumb for calculating whether an acquisition will be accretive or dilutive?
Take the weighted average of the cost of cash, debt and stock, then compare to the yield of the seller.
If weighted cost< seller’s yield, accretive as purchase costs less than what buyer gets out of it
Does that rule of thumb always apply?
No, many assumptions dont hold up in the real world:
- seller and buyer having same tax. Rates
- no other acquisition effects like D&A
- no transaction fees
- no synergies
IMP: if you use seller’s current share price rather than the price the buyer is paying to purchase it, this rule breaks
A company with higher P/E acquires one with a lower P/E - accretive or dilutive
Trick
Only applies if it is an all-stock. Deal, as if all-cash/ debt, no stock ois issued so P/E pointless.
If all stock: accretive as buyer gets more in earnings for each £1 used to acquire the other company than from its own operations.
Why do we focus so much on accretion/ dilution.
Is EPS really that important
Are there cases where its ont relevant
EPS important because most investors value it and base their decisions on it.
- merger model also allows to find IRR in case of future sale, also to assess combined financial statements and how key items change
