Final Exam Flashcards
Two basic options for Merger currency
Stock swap or cash payment
What is required from shareholders to complete a merger?
50% shareholder vote
Merger of Equals
Two companies with roughly similar assets. Makes control premium LOWER
What is a Tender Offer? When is it used? What are it’s benefits?
When the acquiring company offers to buy target company’s stock directly from the shareholders. Used if Board of target company is against merger… If less than 100% of shareholders agree to sale, the rest are handled in a merger. If over 90% of shareholders agree, the rest can be “squeezed out” in a short-term merger. This is much faster than a merger.
Proxy Contest
Indirect method that is designed to gain minority representation on the board of the company.
Due Diligence
Investigating a company’s business before an acquisition.
Documents for an M&A
An acquiring company will either have to file a Merger Agreement or a Stock Purchase Agreement. If more than 20% of the acquiring company’s shares are issued, a shareholder vote is required.
Material Adverse Change (MAC)
If there is a substantial material change in the economic substance of one of the companies involved, the transaction may be nullified and a breakup fee will most likely be charged.
What are the four alternative sale processes for “sell side”? Explain each one and how they compare to each other.
Preemptive - Identify the single most likely buyer
Targeted Solicitation - Contact two to five most likely buyers (Reasonable speed and strong control over confidentiality)
Controlled Auction - Contact subset of buyers, 6-20 potential buyers (Slower and creates undesired stock pressure)
Public Auction - Invites all potential buyers to auction (Takes longest, but maximizes prices because it can find “hidden buyers”)
Effects of cross-border transactions
Creates “flowback”: occurs when there is a stock for stock transaction where a US company acquires non-US company shares. So, shareholders may want to sell their shares because they don’t want to hold foreign stock, which puts downward pressure on stock
Creeping takeovers
An illegal tactic where someone would acquire shares in the market before the actual takeover.
Tax-free reorganization
If the goal of a stock for stock acquisition is to reorganize or rearrange the company, they can purchase the stocks and DELAY the taxes being paid until the target company sells the received acquirer shares. The tax is then based on the gain between the basis and the sales price of the shares.
IPO
Sale of all shares of a subsidary to new public shareholders. If cash received by parent is greater than their tax basis, then the process is taxable.
Carve-out (Define and explain)
The sale through an IPO of a portion of shares of a subsidary in exchange for cash. Usually less than 20% of the subsidary is sold to reduce the chance of depressing the share price (high influx of shares, supply up). Can cause issues with conflicts of interest if the sold off company pursues business with its parents competitors.
Spin-off (Define and explain)
Parent gives up control over subsidary by distributing subsidary shares to parent company shareholders on a pro-rata basis. NO cash received by parents, just redistributing shares. Usually, the company will do a carve-out (minimize down pressure), then complete the spin-off and subsidary receives acquisition currency and incentive compensation for management.
Split-off (Define and explain)
Parent company delivers subsidary shares only to parent’s shareholders if they are willing to exchange for the parent’s shares. Premium is often offered to incentivize them.
Tracking stock
Separate parent stock is distributed to existing shareholders through a spin-off or carve out. Gives parent more control over subsidary, but rules of separation are unclear and cause problems.
Shareholder rights plan
Implementation of a “poison pill” where non-hotile shareholders are offered around 50% off shares to increase ownership of these non-hostiles. Used as a defense strategy, it makes it harder for hostile takeover, or at least raises the price.
Risk Arbitrage
When traders buy target company’s stock and short acquiring companies stock. They do this because the target company’s share price often drops at the time of announcement, so if traders buy then, they receive the acquiring company’s stock, which is in excess value of the price you bought it for because that exchange ratio price is generally higher than what the target company’s share is at early on.
Comparable company analysis defined
Valuation method that doesn’t include premium so it usually isn’t used as full valuation. It uses multiples of the company and its competitors, then the derived value is compared to the competitors share price.
What multiples/financials does the comparable company analysis use and how does that get them to a valuation?
Main multiples: PE multiple (current stock price/EPS) EPS multiple (net income/outstanding shares). Once the PE range is determined, they multiply that by the company's earnings to get a valuation range of equity. Net debt is added on top because it will eventually have to be paid off by cash at hand.
Net Debt equation
short-term debt + long-term debt + capitalized leases + preferred stock - cash and cash equivalents
When is EV/EBITDA used?
When companies have differing capital structures
Comparable transactions analysis defined
This valuation method includes control premiums so they more accurately reflect purchase price. Uses transactions of similar companies to identify comparisons.
Process of comparable transactions analysis
They first find the EV/EBITDA of comparable companies and since the target company only has an EBITDA as of now, they can use the multiple to estimate an EV for them. Net debt is then subtracted from EV because that already includes debt in the calculation. After this, the share price can be determined by an estimated amount of shares sold (often around 20 million).
Discounted cash flow analysis defined
Valuation method that determines intrinsic value of the target company by relying on projected cash flows and assuming the EV is equal to the future value of its cash flows, discounted by the time of money and riskiness of cash flows.
How is the value of a company derived from a DCF?
They first need to determine the sum of the target company’s cash flows during the projected time period (usually 10 years). They also calculate the terminal value (TV) of the company (value at end of projection period). These are both discounted by the weighted average cost of capital (WACC). The end result is the net present value (NPV). The cash flows used are unlevered, which means that they do not include financing costs. EV represents the debt and equity so the unlevered cash flows is the cash available to these providers. To calculate TV they either use the EV/EBITDA with an EBITDA from a future projection or…. They use the perpetuity growth rate method: TV = FCF * (1+g)/(r-g), where FCF is free cash flows as of projected TV date, r = WACC, g = perpetual growth rate (expected inflation rate + long-term real GDP growth). In the end, the WACC, which is the blended cost of debt and quity, is applied to unlevered FCF and the TV to get the present value.
Do DCFs use synergies in their calculation?
A standalone DCF would not but normally they incorporate synergies such as revenue synergies.
Leverage buyout analysis (LBO) defined
Acquisition analysis done by Private Equity Firms to calculate the value to financial buyer, who facilitate the actual acquisition
Process of an LBO
By using the cash flow projections, TV, and present value determination, just like from DCF, they use them to solve for the internal rate of return (IRR), which is the discount rate that results in cash flow and terminal value equal to the initial equity investment. If the resulting IRR is below their targeted IRR, the financial buyer will lower the purchase price. Investment Bankers run LBO models and assume minimum IRR required by financial buyers. They can then solve for the purchase price that creates this targeted IRR. If the purchase price is above the current market value, then this indicates that the company would make an economically viable investment. LBO models also consider if the company has enough cash flow to pay down debts and dividends.
Sum-of-parts analysis
This looks to see if the sum of the valuations of the separate parts of the business are greater than it together. They create EV/EDITDA models for each segment of the business and value each part. They can then determine if a part of the company needs to be sold off in an IPO, carve-out, or spin-off.
Football field layout
Comparable companies analysis and DCF are often similar in valuation because they don’t include premiums, like a comparable transaction range does. A LBO provides a “floor value” for the company. So, investment bankers usually triangulate just over the DCF with synergies, which usally falls inside of the comparable transactions analysis.
