M&A modelling Flashcards
Quite simply, why might one company buy another company?
Because they think the item is worth more than what they are paying for it.
More specifically, the acquirer believes they will benefit from higher profits and cash flow afterward.
In addition, the acquirer might be able to grow its profits and cash flow to a similar, higher level on its own
To the market, what financial metrics are most important short-term when considering an M&A transaction?
EPS because reflects all the effects of an ac question: foregone interest on cash, interest paid on new debt, and the new shares issued to fund the deal
In addition, the price paid by the target must be reasonable
Does a company purely care about financial metrics when doing an M&A deal?
It is the reverse; in fact, the company denies to do a deal and then justifies it using financial criteria (i.e. EPS)
What financial reasons could a buyer use to justify the acquisition?
Consolidation / economies of scale
Geographic expansion
Gain market share
Seller is undervalued
Acquire customers or distribution channels
Product expansion or diversification
Other than financial reasons, what other reasons could there be for acquisitions?
Intellectual property / patterns / key technologies
Defensive acquisition
Acqui-hire (recruiting top-level executives)
Intangibles (grouped together)
What is the high-level overview of conducting a sell-side transaction as an investment banker?
Step 1: Plan the process and create marketing materials
Step 2: Contact the initial set of buyers
Step 3: Set up management meetings and presentations
Step 4: Solicit initial and subsequent bids from buyers
Step 5: Conduct final negotiations, arrange financing, and close the deal
In a sell-side transaction, what does a teaser do?
5-10 page teaser summarises the c9ompany, its financial profile, and why another company might want to acquire it
What does a CIM do?
50-100 pages of much the same content as a teaser; summarising the company, its financial profile and why another company might want to acquire it
In an M&A transaction, what is the definitive agreement?
An agreement between the buyer and seller, that defines the deal terms, such as the price, employee retention, treatment of stock options, and more
Would a company prefer to use cash or debt to do an acquisition?
Would prefer to use excess cash, as it is even cheaper than debt
What are the advantages and disadvantages of using cash as the primary financing method in an M&A transaction?
Advantages:
* Typically the cheapest method as interest earned on cash is very low
* Seller gets cold, hard cash immediately
* No-need for time-consuming financing
Disadvantages:
* Seller gets taxed immediately
* Seller cannot take advantage of potential upside in buyer’s stock price
What are the advantages and disadvantages of using debt as the primary financing method in an M&A transaction?
Advantages
* Typically cheaper than stock as cost of debt is lower than equity
* Seller gets cold, hard cash immediately
Disadvantages:
* Increased debt profile for combined company
Financing can be expensive/time-consuming
Seller also gets taxed immediately
Seller cannot take advance go potential upside in the buyer’s stock price
What are the advantages and disadvantages of using stock as the primary financing method in an M&A transaction?
Advantages:
* Can be cheaper sometimes if the buyer has a high stock price and P / E multiple
* Can be faster than raising debt financing
* Seller gets to participate in potential upside of the buyer’s stock price
* Seller is not taxed until the stock is sold
Disadvantages:
* More risk for the seller since the buyer’s share price could change
* There may be lock-up periods for the stock, and the seller might have to hold it for a long time before selling
* Fixed shares ve fixed value could make a big impact on the seller if the buyer’s share price changes a lot
What is the difference between a merger and an acquisition?
No mechanical difference, but buyer and seller tend to be closer in size in a merger, while the buyer tends to be much bigger in acquisition
Why is stock used more in a merger transaction?
If the companies are about the same size, the buyer is unlikely to have enough cash or enough debt capacity to acquire the seller through one of those.
Therefore, stock or majority-stock structures are far more common in mergers
Because of this focus on stock, the ownership split is far more important in mergers and can b3e a major negotiating point
Besides the shareholder concerns, why is EPS the focus in a merger analysis?
It is the only easy-to-calculate metric that captures the deal’s full impact
Why does EPS tend to be more important than EBITDA and NOPAT when management consider the financial impact of a merger?
Because they are before interest income and expense, as well as not reflecting the share count.
Why dont you use free cash flow per share and levered free cash flow per share in a merger analysis?
They’re affected by many items besides the acquisition, and no one agrees on the ext definition of levered FCF
What is the high level of process of building a simple EPS accretion / dilution analysis?
Step 1: Get the financial stats for the buyer and seller
Step 2: Determine the purchase price and cash/debt/stock mix
Step 3: Combine both companies’ pre-tax incomes and adjust for the acquisition effects
Step 4: Calculate the combined net income and EPS
What time-frame are financial figures are a merger model based on?
Always based on the projected figures in the year after the deal closes. So you must have the projected revenue, operating income, pre-tax income, net income etc for each company
What is the control premium?
Premium demanded by shareholders to release all of their shareholdings at once
In M&A modelling, why do you examine the purchase of the equity value, rather than enterprise value?
Because this is the bare minimum that the buyer must pay to acquire 100% of the seller’s shares
The buyer rarely, if ever, repays the seller’s debt balance - it just refinances and replaces it
How would you calculate the cost of debt for a company?
Usually look at the YTM of buyer’s current debt
Could also take the buyer’s average interest rate and assume a slight premium (due to the added risk from the acquisition)
What is the “practical” version of the cost of equity?
Using the inverse of the P / E multiple
Which company has the higher cost of equity, if one company has a P / E of 10x and another has a P / E of 20x?
The one with 10x, because P / E tells you how much an investor is willing to pay for $1 of earnings.
Therefore, a P / E of 20 vs 10 means investors are willing to pay double for every $1 of earnings, thus a lower cost / easier funds to the issuer
Check the link between cost of equity and P / E
Earnings yield i.e. E / P is cost of equity
In an all stock deal, what is a quick way of seeing if the transaction will be accretive?
Compare the P / E ratios. If the acquirer has a higher P / E ratio, the transaction will be EPS accretive
What acquisition effects come from using debt?
If a buyer uses debt, it will have to pay interest expense on that debt in the future, which will reduce its pre-tax income, net income and EPS
In M&A modelling, what acquisition effects come from using stock?
If a buyer uses stock, it will have additional shares outstanding in the future, which reduces EPS
What acquisition effect comes from using cash?
If a buyer uses cash, it will give up future interest income on that cash, which will reduce its pre-tax income, net income, and EPS. This reduction is called the “foregone interest on cash”
Why may one company buy another?
Because they think the company is worth more than what they will pay for it
In the specific case of business, they will look at EPS to decide if the deal is ‘worth’ it;
Why cant you use EBITDA and NOPAT to calculate the deal’s financial impact rather than EPS?
They are before interest income and interest expense and do not reflect the share count.
What is a practical version of the cost fo e3quity?
Tends to be buyer net income / buyer ewquity value, or the reciprocal of the buyer’s P / E multiple
