M&A Flashcards
Why would one company want to buy another one?
Because you think you would be better off after buying it!
- Build or buy. If a company is looking to expand into new areas or better something its down right now. It can consider to invest capital in building it organically or just straight buy another company that’s doing that; they would assess the opportunity cost of investing inorganically
- Synergies: if the target offers cost-cutting opportunities or complementary revenue streams.
Quantitatively: a buyer would acquire another company if the seller’s asking price is less than its implied value
-The buyer’s expected irr from transaction exceeds wacc
How can you analyze an M&A deal and determine whether or not it makes sense
Qual: Could the deal expand the company geographies, products, or customer bases, give it more IP, or improve its team?
Quant: analyze if seller is undervalued, as well as a comparison of the expected IRR to the buyer’s wacc
Finally EPS accredition/dilution is very important in most deals because few buyers want to execute dilutive deals
Walk me through a merger model (accretion/dilution analysis)
In a merger model, you start by projecting the financial statements of the Buyer and Seller. Then, you estimate the Purchase Price and the mix of Cash, Debt, and Stock used to fund the deal. You create a Sources & Uses schedule and Purchase Price Allocation schedule to estimate the true cost of the acquisition and its effects. Then, you combine the Balance Sheets of the Buyer and Seller, reflecting the Cash, Debt, and Stock used, new Goodwill created, and any write-ups. You then combine the Income Statements, reflecting the Foregone Interest on Cash, Interest on Debt, and synergies. If Debt or Cash changes over time, your Interest figures should also change. The Combined Net Income equals the Combined Pre-Tax Income times (1 – Buyer’s Tax Rate), and to get the Combined EPS, you divide that by the Buyer’s Existing Share Count + New Shares Issued in the Deal. You calculate the accretion/dilution by taking the Combined EPS, dividing it by the Buyer’s standalone EPS, and subtracting 1.
Why might an M&A deal be accretive or dilutive?
A deal is accretive if the extra Pre-Tax Income from a Seller exceeds the cost of the acquisition in the form of Foregone Interest on Cash, Interest Paid on New Debt, and New Shares Issued.
How can you tell whether an M&A deal will be accretive or dilutive?
Cost of Cash = Foregone Interest Rate on Cash * (1 – Buyer’s Tax Rate) x Cost of Debt = Interest Rate on New Debt * (1 – Buyer’s Tax Rate) x Cost of Stock = Reciprocal of the Buyer’s P / E multiple, i.e. Net Income / Equity Value. x Seller’s Yield = Reciprocal of the Seller’s P / E multiple, calculated using the Purchase Equity Value. Weighted Cost of Acquisition = % Cash Used * Cost of Cash + % Debt Used * Cost of Debt + % Stock Used * Cost of Stock.
Why do you focus so much on EPS in M&A deals?
Because it’s the only easy-to-calculate metric that also captures the FULL impact of the deal – the Foregone Interest on Cash, Interest on New Debt, and New Shares Issued.
Although metrics such as EBITDA and Unlevered FCF are better in some ways, they don’t reflect the deal’s full impact because they exclude Interest and the effects of new shares.
How do you determine the Purchase Price in an M&A deal?
If the Seller is public, you assume a premium over the Seller’s current share price based on average premiums for similar deals in the market (usually between 10% and 30%).
What are the advantages and disadvantages of each purchase method (Cash, Debt, and Stock) in M&A deals?
Cash tends to be the cheapest option; most companies earn little Interest Income on it, so they don’t lose much by using it to fund deals. It’s also fastest and easiest to close Cash-based deals.
The downside is that using Cash limits the Buyer’s flexibility in case it needs the funds for something else in the near future.
Debt is normally cheaper than Stock but more expensive than Cash, and deals involving Debt take more time to close because of the need to find investors.
