M&A Flashcards
Walk me through a basic merger model
A merger model is used to analyse the financials of two companies, the purchase price and how the purchase is made, and determines whether the buyers EPS increases or decreases.
Step 1 is making assumptions about the acquisition - the price and whether it was cash, stock or debt or some combination of those. Next, determine the valuations and shares outstanding of the buyer and seller and project out an income statement for each one.
Finally, you combine the income statements, adding up line items such as revenue and operating expenses, and adjusting for foregone interest on cash and interest paid on debt in the combined pre-tax income line; you apply the buyer’s tax rate to get the combined net income, and then divide by the new shares count to determine the combined EPS
Why would an acquisition be dilutive?
An acquisition is dilutive if the additional amount of net income the seller contributes is not enough to offset the buyers foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares
Is there a rule of thumb for calculating whether an acquisition will be accretive or dilutive?
If the deal involves just cash and debt, you can sum up their interest expense for debt and the foregone interest on cash then compare it against the sellers net income.
But if the deal consists of stock cash and debt, then it’ll be hard to assess
If all stock, usually can use the PE method to determine
A company with a higher P/E acquires one with a lower P/E - is this accretive or dilutive?
Can’t tell unless we know it’s an all stock deal. If it’s all cash or debt, p/e multiples don’t matter because no stock is being issued.
But generally getting more earnings for less is good and is more likely to be accretive.
What are the complete effects of an acquisition?
- Foregone interest on cash
- Additional interest expense on debt
- Creating of goodwill and intangibles
- Issue of new shares
- Combined financials
If a company could pay 100% of the purchase price with cash why would it choose not to do so?
Might need to save for something else
Buyer stock may be trading at all time high and it might be eager to use that instead - might be more expensive but executives value having a safety cushion in the form of a large cash balance
What’s the difference between goodwill and intangibles?
Goodwill typically doesn’t change and is not amortized unless there’s goodwill impairment
Intangibles by contrasts, are amortized over several years and affect the income statement by hitting the pre-tax income line
Is there anything else intangible besides goodwill and other intangibles that could also impact the combined company?
Yes purchased in-process R&D writeoff and deferred revenue writeoff
- Logic is that unfinished R&D is expensive to complete and as such the expense must be recognised as part of the acquisition
- This refers to the case where a seller has collected cash for a service but not yet recorded it as revenue, and the buyer must write down the value of the deferred revenue to avoid double counting revenue
What are synergies, can u provide an example?
Synergies are when 1+1=3 or 4 or 5.
Basically the buyer would get more value out of an acquisition than what the financials would predict.
There are two types: revenue synergies and cost synergies.
Revenue synergies: combined entity can cross sell products to new customers or up sell products to existing customers. Might also be able to expand into new geographies as a result of the deal
Cost synergies: combined company can consolidate buildings and administrative staff and can lay off redundant employees. Might also be able to shut down redundant stores or locations
How are synergies used in merger models?
Revenue: Normally you add these to the revenue figure for the combined company and assume a certain margin on the revenue - this additional revenue then flows through the rest of the combined income statement.
Cost: Normally you reduce the combined COGS or operating expenses by this amount which in turn boosts the combined pre tax income and thus net income, raising the EPS and making the deal more accretive
Are revenue or cost synergies mire important?
No one in m&a takes renevue synergies seriously because they are so hard to predict. Cost synergies are taken a little more seriously because you can envision the plants and buildings that can be consolidated.
However, chances of any synergies actually being realised are almost 0 so few take them seriously at all
All else being equal, which method would a company prefer to use when acquiring another company - cash, stock, or debt?
Assuming u limited resources, the buyer will always prefer cash
This is because cash is cheaper than debt given that interest rates foregone usually < 5 % whereas debt interest rates are always higher than that
Cash is also less risky than debt as there’s no chance the buyer might fail to raise sufficient funds from investors
Hard to compare the cost directly to stock but in general stock is the most expensive way to finance a transaction.
Cash is also less risky to stock because the buyers share price could change dramatically once the acquisition is announced
How much debt could a company issue in a M&a?
Generally you would look at comparable companies / precedent transactions to determine this. Use the combined company’s LTM EBITDA figure, find the median debt/ebitda ratio and apply to own EBITDA figure to get a rough idea of how much debt you could raise
