Chapter 7 - Mergers and Acquisitions Flashcards
- Why might one company want to acquire another company?
There are a variety of reasons why companies make acquisitions, including
both the stated and unstated reasons. One reason is that the
buyer’s own organic growth has slowed or stalled, and needs to grow
in other ways (via acquiring other companies) in order to satisfy the
growth expectations of Wall Street. Another prominent reason is that
the buyer expects the deal to result in significant synergies. The buyer
may also view the target as undervalued, or view its own stock as overvalued.
Or, the CEO of the buyer wants to be CEO of a larger company,
either because of ego or legacy, or because he or she will get paid more
and have a higher profile. Other reasons include diversification or to
prevent a competitor from making the acquisition.
- Explain the concept of synergies and provide some examples.
In simple terms, synergy occurs when 2 + 2 = 5—that is, when the
sum of the value of the buyer and the target as a combined company is
greater than the two companies valued apart. Most mergers and large
acquisitions are justified by the amount of projected synergies. There are
two categories of synergies: cost synergies and revenue synergies. Cost
synergies refer to the ability to cut costs of the combined companies due
to the consolidation of operations (for example, closing one corporate
headquarters, laying off one set of management, shutting redundant
stores, etc.). Revenue synergies refer to the ability to sell more products/
services or raise prices due to the merger (for example, increasing sales
due to cross‐marketing, co‐branding, etc.). The concept of economies of
scale can apply to both cost and revenue synergies.
- What are some of the differences between a merger and a tender offer?
A merger can be used for friendly deals, while a tender offer can be
used for friendly or hostile/unsolicited deals. In a merger, the buyer and
seller negotiate the terms of the transaction and then the transaction is
put up for a vote from the seller’s shareholders. In a tender offer, the
buyer makes an offer directly to the target’s shareholders. A successful
merger will typically result in 100 percent of the shares being acquired,
while a tender offer typically will not. In a tender offer, the buyer will
typically have to effectuate a second transaction to acquire all 100 percent
of shares. Tender offers are also generally quicker to effectuate if
the purchase consideration is cash, while mergers are more likely if the
consideration is stock or if there are significant regulatory issues anticipated.
- What are some of the pros and cons of a stock versus asset purchase?
Advantages of a stock purchase are that it can generally be executed
faster than an asset purchase, and is generally used for acquisitions or
public companies. Another advantage of a stock purchases is that the
seller is not double taxed and in certain circumstances can put off all
taxes. Disadvantages of a stock transaction are that the buyer does not
get a step‐up of tax basis, and cannot pick and choose assets to acquire
and/or liabilities to leave behind.
An advantage of an asset purchase is that buyers can pick and choose
assets to acquire, and leave behind liabilities and contingent liabilities
that it does not want. Another advantage is that buyers get a step‐up in
tax basis. A disadvantage is that there is a double layer of taxes to the
seller. Another disadvantage is that transactions often take longer as
each asset needs to be valued and transferred.
- Do buyers generally prefer stock or asset deals?
Buyers tend to prefer deals structured as asset purchases even though
they tend to take longer to complete because of the step‐up of the tax
basis, and because of the ability to pick and choose assets and leave
certain liabilities behind.
- Do sellers generally prefer stock or asset deals?
Sellers tend to prefer stock deals because of the single layer of taxation
and because there are no bad assets or liabilities that remain.
- Walk me through a sell‐side M&A process.
In a typical sell‐side M&A transaction, known as a two stage auction
process, the investment bank representing the seller first sends out a
teaser to prospective buyers along with a confidentially agreement. The
investment bank will then send out a Confidential Information Memorandum
(CIM) to parties that are interested and have signed the confidentially
agreement. Buyers will then be expected to submit first round
non‐binding bids. The bank and the client will then select which buyers
get invited into the second round of bidding. Second round buyers will
get invited to management presentations and are given the opportunity
to do due diligence and use the data room. Binding final-round bids are
then submitted, and the sell‐side investment bank and its client will decide
who wins the auction. Following any further negotiations and due
diligence, the contracts will be signed and, following any regulatory or
other approval processes, the deal will close.
- Would an investment bank prefer to be on the sell side of an M&A deal
or the buy side?
An investment bank would generally prefer to be on the sell side of an
M&A deal because the sell‐side adviser is much more likely to receive a
success fee/transaction fee for the deal being completed.
- What are some of the marketing documents that bankers create when
working on a sell‐side M&A transaction?
Some of the marketing documents created by bankers when working
on a sell‐side M&A transaction include the teaser, confidential information
memorandum (CIM), and management presentation.
- What analysis might be done for an M&A assignment?
Some of the analysis performed by bankers on an M&A assignment
include valuation of the target and often detailed modeling of the target.
In addition, M&A–specific analysis frequently done includes an
accretion/dilution analysis, a full‐blown merger model, a contribution
analysis, and an analysis at various prices (AVP).
- Walk me through an accretion/dilution analysis.
The purpose of an accretion/dilution analysis (sometimes also referred
to as a “quick and dirty” merger analysis) is to project the impact
of an acquisition to the acquirer’s earnings per share (EPS) and compare
how the new EPS (pro forma EPS) compares with what the company’s
EPS would have been had it not executed the transaction.
In order to do the accretion/dilution analysis, we need to project the
combined company’s net income (pro forma net income) and the combined
company’s new share count. The pro forma net income will be the
sum of the buyer’s and target’s projected net income plus/minus certain
transaction adjustments. Such adjustments to pro forma net income (on
a post‐tax basis) include synergies (positive or negative), increased interest
expense (if debt is used to finance the purchase), decreased interest
income (if cash is used to finance the purchase), and any new intangible
asset amortization resulting from the transaction.
The pro forma share count reflects the acquirer’s share count plus the
number of shares to be created and used to finance the purchase (in a
stock deal). Dividing pro forma net income by pro forma shares gives
us pro forma EPS, which we can then compare to the acquirer’s original
EPS to see if the transaction results in an increase in EPS (accretion) or
a decrease in EPS (dilution). Note also that we typically will perform
this analysis using one‐year and two‐year projected net income and also
sometimes last twelve months (LTM) pro forma net income.
- What factors can lead to the dilution of EPS in an acquisition?
A number of factors can cause an acquisition to be dilutive to the
acquirer’s earnings per share (EPS), including: (1) the target has negative
net income, (2) the target’s price/earnings ratio is greater than the
acquirer’s, (3) the transaction creates a significant amount of intangible
assets that must be amortized going forward, (4) increased interest expense
due to new debt used to finance the transaction, (5) decreased
interest income due to less cash on the balance sheet if cash is used to
finance the transaction, and (6) low or negative synergies.
- If a company with a low P/E acquires a company with a high P/E in an
all‐stock deal, will the deal likely be accretive or dilutive?
Other things being equal, if the price to earnings ratio (P/E) of the
acquiring company is lower than the P/E of the target, then the deal will
be dilutive to the acquirer’s earnings per share (EPS). This is because
the acquirer has to pay more for each dollar of earnings than the market
values its own earnings. Hence, the acquirer will have to issue
proportionally more shares in the transaction. Mechanically, pro forma
earnings, which equals the acquirer’s earnings plus the target’s earnings
(the numerator in EPS), will increase less than the pro forma share
count (the denominator), causing EPS to decline.
- What is an analysis at various prices?
An analysis at various prices shows the implied acquisition premium
and various valuation multiples at range of different purchase prices.
- What is a contribution analysis?
A contribution analysis is an analysis that shows, usually in graphical
form, the percentage contribution of various metrics from both the acquirer
and the target that make up the combined company. Common financial
metrics include revenue, EBITDA, and net income. Non‐financial
metrics might include the number of employees, stores, or subscribers.
