Key Rule #1 & #2 Flashcards
Why do M&A? (Macro reason)
acquirer will benefit from increased cash flow and profits
What does the discount rate mean to the acquirer?
the DR acquirer picks for the valuation of the deal is the minimum intended return of the deal
What is the IRR and DR if the target is undervalued?
IRR > DR
When is an acquisition made?
asking price < implied value (PV of future cash flows)
What are the 2 categories of M&A reasons?
financial and fuzzy
How do you tell if a target is undervalued?
selling price < implied price
IRR > DR
What should a deal do to the EPS?
neutral/ accretive
What is the definition of EPS?
Net Profit / common shares outsanding
What does EPS indicate?
profitability
An increase in EPS means what?
increase in profitability
Why do we care about EPS in M&A?
EPS reflects all effects of Acq
What is the difference between a merger and an acquisition?
- M: closer in size, ownership split more impt
- A: buyer much bigger
List the m&a funding sources from cheap to expensive
cash, debt, equity
What is the buyer’s first choice of funding?
excess cash
What are the 2 methods of using equity to fund m&a?
- issue shares to others for $ then pay
- issue shares to seller in exchange for their shares
What is the downside of using equity to fund your m&a?
dilute existing equity investors
What are synergies?
- 2 cos tgt produce a result not independently obtainable (greater than a + b)
Why do synergies make firms want to m&a?
- higher revenue
- lower expenses by combining, elimiate redundant services
- lower overall cost of capital
What are strategic reasons for M&A?
- fill in strategic gaps
- get access to certain channels
- broader market access
What are biz reasons for m&a?
- bargain purchase- cheaper to buy than to invest internally
- diversification- achieve more long term growth and profitability in a mature industry
- short-term growth- boost poor performance
- undervalued target- target is a good investment eg. sponsor acquiring poorly performing cos
How can you tell if an M&A deal makes sense?
- is it undervalued? (IRR vs DR, target price vs implied value)
- qualitative analysis- does it really achieve the biz aims
- is it accretive? increase EPS?
What is a merger model?
it measures estimated accretion/ dilution to an acquirer’s EPS from the impact of an M&A transaction
Why do we use EPS when evaluating a merger?
only easy to calculate metric that capture’s deal’s full impact
What aer the steps in a merger model?
- get financial stats for buyer and seller
- calculate purchase price
- estimate cash debt stock percentage to fund deal
- estimate weighted cost of acquisition
- Is the deal accretive or dilutive?
- combine both cos pre-tax incomes and adjust for acquisition effects
- calculate combined NI and EPS
- calculate EPS accretion/ dilution
What financial stats do you need from each co?
- Current EqV
- projected NI for year aft deal closes
and all the components
What is the purchase price otherwise known as?
Purchase EqV
What is the formula for Purchase Price (Purchase EqV)
current share price x (1 + control premium%) x no of shares
why does buyer pay a control premium?
- buyer acquiring the shares -> changing supply & demand for shares
- existing shareholders will demand premium if asked to give up 100%
How do you make sure the Purchase Price is reasonable?
- value the seller- DCF etc.
- look at comp deals: is % premium within range?
How do you determine how much equity to use in the purchase price?
only to degree which deal is accretive
What is the weighted cost of acquisition?
how much buyer is giving up in %tage terms to acquire seller
What is the formula for weighted cost of acquisition?
% cash used x after tax cost of cash +
% debt used x after tax cost of debt + % stock used + after tax cost of stock
What interest rate do you use to calculate after tax cost of cash in WCA?
the rate that the co is earning on its cash balance
How do you calculate after tax cost of debt for WCA?
- YTM of buyer’s current debt or
- YTM of peer companies debt or
- buyers average interest rate slight adddition b/c ot risk of acq
How do you calculate after tax cost of equity for WCA?
buyer NI / buyer EqV
(reciprocal of buyer’s PE mult)
What is yield of the premium?
how much buyer gets in NI for each $1 it spends to acquire seller
How do you calculate yield of premium?
seller NI/Purchase EqV
If not 100% all stock deal, how do you know if deal is accretive/ dilutive/ neutral?
WCA vs Yield of Seller
< = accretive
= neutral
> dilutive
If 100% all stock deal, how do you know if deal is accretive/ dilutive/ neutral?
Buyer P/E vs Seller P/E at purchase price
> accretive
= neutral
< dilutive
when buyer uses debt, what adjustments need to be made to combined pre-tax incomes?
- need to pay interest on debt in future
- decrease pretax income, decrease NI, decrease EPS
when buyer uses stock what, what adjustments need to be made to combined pre-tax incomes?
additional shares outstanding in the future
decrease EPS
when buyer uses cash, what adjustments need to be made to combined pre-tax incomes?
- subtract Forgone interest income on cash - b/c give up future interest income on that cash
decrease pretax income, decrease ni, decrease eps
b/c it’s a true cash cost b/c in combined pre-tax income already added that therefore need to subtract
how do you calculate buyer shares issued?
(purchase price x % stock) / buyer share price
what is combined ni formula?
combined pretax income x (1 - buyers tax rate)
what is total shares outstanding
shares issued in deal + buyers existing share count
formula for combined EPS?
combined NI / total shares outstanding
what happened to all the seller’s shares?
gone
EPS and accretion/ dilution
combined EPS v buyer standalone EPS before deal
> accretive
= neutral
< dilutive
