Full Merger Model Mechanics Flashcards
Why is the Purchase Price in an M&A deal NOT equal to the Seller’s Purchase Equity Value or Purchase Enterprise Value exactly?
The real price depends on the treatment of the seller’s cash and debt in the deal
In most cases, the Buyer will “replace” that seller’s existing debt with new debt, which doesn’t affect the cash price. And the buyer hardly ever uses the seller’s entire cash balance to fund the deal - at most, it might use a portion of it.
So the real price the buyer pays is usually between the purchase equity value and purchase enterprise value of the seller.
What information do you need from the buyer and seller to create a full merger model?
At the minimum, you need income statement projections for both companies over the next 1-2 years. But ideally, you will also create cash-flow projections that show how both companies’ Cash and Debt balances change over time.
You do not need full 3 statement projections for both companies - similar to a DCF analysis, cash flow estimates without full balance sheet projections are fine.
Why is a Sources & Uses schedule important in a full merger model?
The Sources & Uses schedule is important because it tells you how much the Buyer really pays for the seller.
The purchase equity value and purchase enterprise value can be deceptive.
S&U schedule is also helpful for reflecting more unusual scenarios, such as a seller using some if its cash in the deal or a buyer repaying its own debt.
What’s the purpose of a Purchase Price Allocation schedule in a merger model?
The main purpose is to estimate the Goodwill that will be created in a deal.
Goodwill exists because Buyers often pay far more for companies than their balance sheets suggest they are worth; in other words, the Purchase Equity Value exceeds the acquired company’s common shareholders’ equity (CSE).
Why do Deferred Tax Liabilities get created in many M&A deals?
DTL, represents the expectation that cash taxes will exceed book taxes in the future.
It gets created because Depreciation & Amortization on asset write-ups is not deductible for cash-tax purposes in a stock repurchase
As a result the buyer will pay more in cash taxes than book taxes until the write ups are fully depreciated.
What happens if the Acquirer purchases another company for a $1 billion Equity Purchase Price, but the Target’s Common Shareholders’ Equity is $1.5 billion?
Negative Goodwill cannot exist per the rules of IFRS and US GAAP
Record $500 million as a Gain on the income statement
Balance sheet: you do not record any Goodwill; you just add all the acquired assets and liabilities.
The balance sheet still balances because Net Income increases as a result of this gain. But this gain is non-cash, so the company’s cash balance declines and share holders’ equity on the L&E side increases.
What are the main adjustments you make when combining the Balance Sheets in an M&A deal?
You reflect the Cash, Debt, and Stock used in the deal, create new Goodwill, write up assets such as PP&E and other intangibles, and reflect refinanced debt. You also show new deferred tax liabilities and the write offs of existing DTLs and DTAs.
You must also write down the seller’s common shareholders’ equity and reflect transaction and financing fees.
