Chapter 5- M&A Advisory – Part I Flashcards
- Mergers & Acquisitions (M&A) is a general term used to refer to a wide range of corporate transactions
Acquisition
Merger-of-Equals
Sale or Divestiture
Take-Over Defense / Proxy Contests
Strategic Partnership
Leveraged Buyout
Restructuring
Review of Strategic Alternatives
Special Committee Assignment
Why Do Companies Pursue M&A Transactions?
- Companies pursue M&A transactions to create shareholder value
- The guiding principle of value creation is that companies create value by investing capital at rates of return exceeding the cost of that capital
Buyer Rationale for M&A
- Accelerate growth
- Strong strategic fit
- Competitive positioning
- Economies of scale / synergies
- Diversification
- Excess cash to deploy
- Shareholder value creation
Seller Rationale for M&A
- Value maximization
- Wealth planning / liquidity
- Non-core assets or division
- Redeployment of capital
- Shareholder pressure
- Inability to compete
Idea Generation and Deal Sourcing
- Idea generation involves identifying and pitching potential acquisition targets, merger opportunities or other strategic transactions to a client
- A typical “acquisition opportunities” or “M&A brainstorming” presentation includes:
- Market / Company Update
- Summary of Potential Acquisition Targets
- Strategic Rationale for Each Target
- Qualitative Analysis for Each Target
- Actionability
- Market Implications
- Approach Strategy
- Financing Alternatives and Considerations
- If a client expresses interest in a particular idea:
the investment banker can focus their attention on building or strengthening the relationship with the target in an attempt to facilitate a deal
– It can take several years before an identified idea becomes “actionable”, however if a client decides to pursue an opportunity they will typically hire the bank that raised the idea with them
- An investment banker’s ability to maintain a pulse on
both the market and the competitive landscape in a particular sector: are critical to getting hired as an advisor
Buy-Side Advisory Responsibilities: * The typical buy-side mandate includes the following responsibilities:
– Evaluating the potential target and its industry to identify key opportunities and risks
– Assessing the strategic fit of the target and identifying potential synergies
– Construction of a financial model that reflects the anticipated results going forward
– Establishing a baseline view on value and sensitizing for upside and downside scenarios
– Providing analysis on the financial implications of the deal under various financing structures
– Providing general financial advice (market impact, communication strategy, etc.)
– Developing a view on the competitive bidding universe (ie. who else is bidding? what can they afford to pay?)
– Coordinating due diligence, including commercial, financial, environmental, legal, HR, IT and other
– Identifying potential red flags in the due diligence process and following up accordingly
– Formulating a bidding strategy and helping negotiate the final terms of the deal
The M&A Toolkit–>
- Investment banks rely on various valuation methodologies and financial analyses to assess the merits of an M&A deal, including the following:
Valuation Methodologies:
– Trading comps
– Precedent transactions
– Discounted cash flow analysis
– Leveraged buy-out analysis
– Sum-of-the-partsanalysis
Supporting Analyses (Not a Basis for Valuation)
– Accretion/dilution analysis
– Ability-to-pay analysis
– Cash vs. stock consideration
– Synergy assessment
– Future share price analysis
– Analysisofprecedentpremiums
Accretion/Dilution Analysis (Public Company Metric)
- Accretion/dilution analysis is used to evaluate the impact a potential transaction will have on the acquirer’s earnings per share or free cash flow per share
A deal is considered “accretive” if:
it results in an increase in earnings per share or free cash flow per share
Accretion is often a:
prerequisite for a public company to pursue an acquisition
Key assumptions in an accretion/dilution analysis include:
purchase price, financing mix and estimated synergies
Accretion/Dilution Rules of Thumb
- EPS accretion/dilution in a transaction is determined by the “value” of the target’s share price per dollar of earnings (ie. Price / Earnings ratio) relative to the value of the acquisition currency being used by the acquirer
In an all-stock financed deal:
if the acquirer’s P/E ratio is greater than the target’s P/E ratio at the acquisition price (ie. 15.0x vs. 10.0x), the deal will be accretive to the acquirer’s earnings
– The acquirer’s stock is more valuable – the market is paying more for a dollar of the acquirer’s earnings
* Because debt is cheaper than equity, using more debt as consideration will always make a transaction more
accretive
In an all-debt financed deal:
the acquirer’s P/E ratio is irrelevant as the equity value of the acquirer is no longer the acquisition currency we are using to finance the deal
– To determine the value of the acquirer’s currency in an all-debt financed deal you need to calculate the inverse of the acquirer’s after-tax cost of debt (ie. debt yield). The deal will be accretive if:
* 1 / [(Cost of Acquirer Debt) * (1 – Acquirer Tax Rate)] > Target P/E
Example:
* After-tax cost of debt = 4.0%
* 1 / 4% = 25.0x (the acquirer can pay 25.0x EPS and generate neutral accretion)
* To determine the breakeven after-tax cost of debt at a given purchase price, you use the inverse calculation: 1 / 10.0x = 10.0%
Limitations of Accretion/Dilution Analysis
- Accretion analysis assumes that the acquirer will retain its existing P/E multiple after the deal, which results in value creation (ie. constant P/E multiple * Higher EPS)
- In reality, P/E multiples reflect the market’s perception of the quality and growth of earnings and transactions that are accretive in the short-term are not necessarily accretive to value in the long-term
- In a perfect market, the acquirer’s pro-forma P/E multiple should reflect a blend of its pre-deal P/E and the target’s P/E proportional to the earnings contribution of each business
– If Company A has a P/E multiple of 10.0x and acquires Company B at 15.0x, an all-stock deal will be dilutive – However, Company A’s P/E multiple should expand to reflect the addition of Company B’s higher quality or
higher growth earnings - Accretion should always be examined within the context of the market’s perception of the price paid compared to the intrinsic value of the target (including potential synergies)
Ability-to-Pay Analysis (for Competing Bidders)
- Involves identifying potential competing strategic bidders and assessing their ability-to-pay with an accretion/dilution model (for publicly-traded strategic buyers) or LBO model (for financial buyers)
- Ability-to-pay is not a basis for valuation, but it can provide an indication of the price that competing bidders may be willing to pay in a competitive auction
- There are several factors that may increase or decrease a competing bidders relative ability or willingness to pay:
factors that may increase a competing bidders relative ability or willingness to pay:
- Significant synergy potential
- Very strong balance sheet (ie. debt capacity)
- Trade at a higher multiple than the target
- Viewed as a must-have asset / defensive play
factors that may decrease a competing bidders relative ability or willingness to pay:
- Minimal synergies
- Limited debt capacity (ie. requires equity)
- Trade at a lower multiple than the target
- Not viewed as a must-have asset
- As mentioned previously, an acquisition by a public company will always be viewed in the context of
the market’s perception of the price paid relative to the intrinsic value of the target (including potential synergies)
