BIWS Merger Model Questions CSV

Question 1

Walk me through a basic merger model…

Answer 1

A merger model is used to analyze whether a merger will be accretive or dilutive to the acquirer’s earnings. We analyze the financial profiles of both companies, the purchase price and the purchase consideration

Step #1: Enter key assumptions - includes offer price and purchase consideration

Step #2: Project Income Statements and combine the two company’s income statements, accounting for synergies, interest on new debt and foregone interest on cash used. Calculate combined Pro Forma Net Income.

Step #3: Divide Pro Forma Net Income by the new Diluted Shares Outstanding to get Pro Forma EPS and determine if the merger is accretive or dilutive in each year

BIWS Guide pg. 131 (Q1)

Question 2

What’s the difference between a merger and an acquisition?

Answer 2

Generally a merger involves two companies of roughly the same size while in an acquisition the buyer is considerably larger than the seller

BIWS Guide pg. 131 (Q2)

Question 3

Why would a company want to acquire another company?

Answer 3

▪ To fill in a product of service that they don’t currently offer
▪ To expand geographically
▪ To grow the size of the company and increase market share
▪ To capture key customers, employee talent, or intellectual property

BIWS Guide pg. 131 (Q3)

Question 4

Why would an acquisition be dilutive?

Answer 4

An acquisition is dilutive if the additional amount of Net Income the target contributes doesn’t offset the dilutive effect of 1) new shares issued, 2)interest on new debt, and 3) foregone interest on cash

BIWS Guide pg. 132 (Q4)

Question 5

What is the rule of thumb for calcluating if an acquisition in accretive or dilutive?

Answer 5

If the deal involves only cash and debt: Compare the additional Net Income contributed by the target to the interest expense on new debt * (1-t) and the foregone interest on cash * (1-t)

If the deal is an all stock deal, then the deal will be accretive if the buyer has a higher P/E than the seller.

If the deal is a mix of stock and cash/debt, then there is not quick rule of thumb

BIWS Guide pg. 132 (Q5-7)

Question 6

What are the primary effects of an acquisition?

Answer 6

1) Additional Shares Outstanding
2) Additional Interest on Debt Issued
3) Foregone Interest on Cash
4) Creation of Goodwill and Other Intangibles
5) Synergies

BIWS Guide pg. 133 (Q8)

Question 7

All else being equal, which method would a company prefer to use when acquiring another company - cash, stock or debt?

Answer 7

Generally a company would prefer to use cash because it is cheaper than using debt or stock. The foregone interest on cash is typically less than the interest expense on new debt. Stock is generally the most expensive of the three, since the cost of debt is generally higher than the cost of equity.

In some cases an executive might want to preserve the company’s cash balance or might feel that the stock is trading at a very high price, so there are exceptions.

BIWS Guide pg. 133&136 (Q9&17)

Question 8

Who is generally able to pay more for a company - a PE firm or a strategic acquirer? Why? What are two factors that may change this dynamic?

Answer 8

Generally a strategic can pay more because it can realize synergies that the private equity firm cannot.

Availability of leverage and the strategic having a depressed stock price may push things in the private equity firm’s favor

BIWS Guide pg. 134 (Q10)

Question 9

What does Goodwill represnet? How does it get created? How do we calcluate Goodwill?

Answer 9

Goodwill represents value that is not represented on the Balance Sheet - it includes things like customer relationships and brand names.

Goodwill gets created in an acquisition. We subtract Book Value (after adjustmenting assets up to Fair Market Value) from Purchase Price and record the difference as Goodwill.

P&R pg. 212 (includes footnote) & BIWS Guide pg. 134 (Q11)

Question 10

Describe the major classes of synergies and give an example of each

Answer 10

Revenue Synergies: A combined company generats more revenue than the sum of two independent companies. One example is cross-selling across customers or geographies
Expense Synergies: A combined company can cut expensees compared to the sum of two independent comanies. This is generally achieved through reducing headcount or consolidating factories/stores/other buildings

BIWS Guide pg. 135 (Q14)

Question 11

Are revenue or cost synergies easier to predict?

Answer 11

In most cases, cost synergies are easier to predict

BIWS Guide pg. 135 (Q16)

Question 12

How do we determine how much debt a company can issue in a merger or acquisition?

Answer 12

We generally look at the combined company’s LTM EBITDA figure and compare the Debt/EBITDA ratio of the combined company to comparables to get an idea of how much debt can be raised

BIWS Guide pg. 136 (Q18)

Question 13

How do we determine the Purchase Price for the target company in an acquisition?

Answer 13

1) We use the major valuation methodologies
2) We ensure that the premium paid relative to current stock price will be sufficient to win shareholder approval (comparable transactions may serve as a guide)
3) We consider whether the Purchase Price will make the deal accretive or dilutive

BIWS Guide pg. 136 (Q19)

Question 14

What happens when a company “overpays” for an acquisition?

Answer 14

Generally a large amount of Goodwill is created. If the acquisition does not produce the expected results, this Goodwill may become impaired in the future and reduce earnings

BIWS Guide pg. 137 (Q20)

Question 15

What types of sensitivities do we look at in a merger model?

Answer 15

We look at the major drivers of accretion/ dilution: Purchase Price, Purchase Consideration (% stock/cash/debt), Revenue Synergies, Cost Synergies

BIWS Guide pg. 138 (Q24)