Merger Modeling Flashcards
Fundamentals
Merger Consequences Analysis (Affordability Analysis)
Determines what an acquirer could afford to pay for a potential target
Cost & Benefit
Ability of combined entity’s ability to generate cash. 1) Combined earnings; 2) cost synergies. Note: Paying cash and stock have costs…must finance the purchase with cash (by raising debt and paying interest on it) or by issuing its own stock…stock has no fixed costs like debt but it does dilute shares…each person has less returns
Pro Forma and Standalone
Pro forma - as if the deal was done and Standalone is if the Acquirer never undertook the deal. The central question, which is better or worse off after the deal as measured by it EPS, leverage or capitalization, and ownership structure.
Earning Per Share is used measure impact of a merger because
Usually based on 1 ro 2 year of future earnings as estimated by equity research analysts. EPS captures most of the transaction’s financial costs and benefits. Important because any change in EPS will affect the company’s share price because many investors use P/E Ratio multiples to assess the value of a company
Dilutive deal
Costs exceed benefits…Acquirer’s pro forma EPS is lower than its standalone EPS…will not be perceived positively by the investment community…Acquirer share price will fall.
Accretive deal
Benefits outweigh the costs…Acquirer’s pro forma EPS is higher than Acquirer’s standalone EPS. Acquirer’s share price will rise following the deal. Some deals are dilutive at first (first and/or second year) then become accretive because synergies may take time to be realized, while merger costs begin right away.
Breakeven deal
Costs equal the benefits at a given price, hence neutral impact on the EPS. The pro forma EPS will equal the standalone EPS…“break-even offer price” => because it is the inflection point between an accretive vs. a dilutive deal. This is the most an Acquirer can pay without the deal becoming dilutive.
Other Impacts of a Merger
1) Company’s balance sheet and risk profile - how much money can be borrowed; 2) Issues of ownership because stock is issued as a form of consideration; 3) Whether the deal should be financed via cash or stock only or a mix; 4) Discussion of taxes
Affordability Analysis vs. Valuation
There is a difference in what an Acquirer could pay for the target (Merger Consequences Analysis) vs. how much it should pay => public comparables analysis; acquisition comparables analysis and discounted cash flow analysis.
Strategic rationale
1) products & services; 2) customers; 3) distribution systems; 4) supply chain; 5) technology; 6) growth plans; 7) geographical location
Affordability vs. Strategic Rationale
Affordability looks at the first one or two years post merger…Strategic rationale looks at the long term…so even though a deal may be dilutive, its strategic rationale long term may suggest doing the deal.
