Merger Modeling Comprehensive (Reverse) Flashcards
The offer price and the unaffected stock price.
The unaffected stock price is the stock price before any news of an acquisition was released and thus increasing the stock price.
When conducting premium analysis, you want to use what stock price?
Yes. But, it must consider the opportunity cost of interest income.
If a deal is financed with cash, can a company tap into its balance sheet to use its own cash instead of using 100% debt?
Leverage ratios, no greater than 2.5x - 3.0x
Coverage ratios, no less than 5.5x - 6.0x
What are the thresholds for leverage and coverage ratios for investment grade companies?
- Impact to target’s shareholders
- Creation of deffered tax liabilities due to purchase accounting and write ups
- Stock vs asset purchase
What are 3 tax considerations in a merger?
Offer price x target’s diluted shares outstanding
Offer value is derived using public and acquisition comparables analysis and DCF anaylsis
What is the offer value?
Which methods are used to derive offer value?
- $275 million
- $137.5 million debt raised
$137.5 equity issuance
- $150 million
- 0.7639
- 7.639 million
- $4.95 million
- $62.35
- 61.039
- 1.021
- 0.0214 or 2.14% accretion
- $1.31 million
- 7.7x
- 2.1x
- 12.5%
50% stock 50% debt
Acquirer Information
Current price/share $18
Total existing debt $200
EBITDA $135 million
Existing interest expense $12 million
Tax rate 40%
Interest on new debt 6%
NI $53.4
Diluted shares outstanding 53.4
EPS $1
Target Information
Current price/share $22
Total existing debt $50 million
EBITDA $52.2
Existing interest expense $4
Total assets $370
Total liabilities $220
Existing Goodwill $25
NI $13.9
Diluted shares outstanding 10
EPS $1.39
Offer price/share $27.5
- What is the offer value?
- Show the split between debt raised and equity issuance
- What is the resulting Goodwill?
- What is the exchange ratio?
- What is the number of newly issued shares?
- What is the incremental after tax interest expense?
- What is the pro forma NI?
- What is the pro forma shares outstanding?
- What is the pro forma EPS?
- What is the accretion/dilution amount?
- What is the after tax cushion to be EPS flat?
- What is the pro forma coverage ratio?
- What is the pro forma leverage ratio?
- What is the target shareholder %
Synergies offset a higher premium paid for an acquisition.
Also, it offsets the potential incremental interest expense and depreciation/amortization.
Synergies offset what in regards to an acquisition’s price?
It tells what a company COULD pay.
What a company should pay is derived from public comparables, acquistion comparables, and discounted cash flow analysis.
Merger modeling aka accretion/dilution analyis tells us what a company could/should pay?
Offer value is almost equatable to Equity value
Transaction value is like enterprise value, which includes offer value plus the assumed liabilities. It measures the size of the transaction.
What is the difference between offer value and transaction value?
20% to 40%
What is the historical control premium?
Cost reductions, revenue enhancements, CapEx savings
What are the three main synergies resulting from M&A?
Total Debt / EBITDA
EBITDA / Interest expense
Companies could receive credit downgrades, thus reducing their ability to issue debt at lower rates in the future
What pro forma ratios do you analyze to determine credit risk?
What are the consequences of taking on too much debt?
The buyer appeals directly to the target’s shareholders to offer cash in exchange for their shares
What is a tender offer?
Offer price per share / Target’s standalone EPS
Relative P/E anaylsis should be used in a high % stock consideration transaction
What is the offer P/E multiple?
When should relative P/E analysis be used to analyze accretion/dilution?
Stock contributions are typically tax deffered until the stock is sold, while cash contributions are typically taxed immediately.
In regards to taxes, how are stock contributions different from cash contributions?
interest on new debt, increase in depreciable value, and new stock issues.
What dilutes the EPS figure in an acquisition using cash and stock?
It assigns % of acquirer and target to specif metrics such as EBITDA, NI, Sales, etc
Pro forma ownership analysis assigns ownership %s based on the acquirer’s stock and newly issued stock.
Contribution to NI, EBITDA, etc should closely match the ownership anaylsis, thus that is why it is important to compare them.
What is contribution analysis?
What is pro forma ownership anaylsis?
Why is it important to compare ownership and contribution analysis?
Pg. 109 of Merger Modeling
Purchase price - fair value of net identifable assets
Assets are adjusted to fair market value, typically written up, thus causing incremental depreciation etc.
More precise way:
Purchase price - book value of net identifiable assets = purchase price allocation
Purchase price allocation - write ups + resulting deferred tax liability = Goodwill
What is the formula for Goodwill in M&A?
Asset purchases and stock purchases
What are the two types of transaction structures for tax purposes?
Offer price
At what price does the acquirer use to repurchase shares using proceeds for options?
Outstanding
Do you use outstanding or exercisable options when calculating diluted shares?
1 / (interest rate % x (1-T))
Review P/E of cash
The resultant company takes on debt of the acquiree. Thus, it increases its debt load.
Even if a merger occured through equity issuance, how could the resultant company’s debt be impacted?
Expenses for consultants, accountants, and investment bankers. They are expensed as incurred. They are not recurring, thus they need to be adjusted for appropriate for pro forma analysis.
What are transaction expenses, and when are they expensed?
Diluting earnings and ownership. Will the target’s shareholders that are the recipients of the new shares have more ownership than the acquirer’s want?
What is a concern of issuing stock to finance a transaction?
22% target’s shareholders
78% acquirer’s shareholders
Acquirer’s shares 53.4 million
Newly issued shares 15.278 million
What is the % ownership between acquirers vs target’s shareholders?
- Structure the terms of the transaction
- Calculate offer value
- Determine consideration mix (cash vs stock)
- Choose for tax impact - Calculate transaction adjustments
- Balance sheet and income statement adjustments - Analyze pro forma impact
- analyze financial statements
- analyze tax consequences
What are the 3 phases of a merger consequences analysis? Describe the subphases.
It compares the deal exchange ratio and current exchange ratio over a specific period to historical exchange ratios.
Acquirer’s want a low exchange ratio because they are issuing fewer shares compared to higher exchange ratios.
What is exchange ratio analysis?
Why do acquirers want a low exchange ratio?
- $275 million
- $150 million
- $57.4 million
- $1.0749 and 0.0749 accretive
- 0% Target shareholders are non existant since this was financed 100% by debt. Target shareholders’ shares will cease to exist after the acquisition.
- 5.8x
- 2.8x
100% cash
Acquirer’s Information
EBITDA $135
Existing debt $200
Existing interest expense $12
Current share price $18
Total existing debt $200
Tax rate 40%
Interest on new debt 6%
NI $53.4
Diluted shares outstanding 53.4
EPS $1
Target Information
EBITDA $52.2
Existing Debt $50
Existing interest expense $4
Current share price $22
Total assets $370
Total liabilities $220
Existing Goodwill $25
NI $13.9
Diluted shares outstanding 10
EPS $1.39
Offer price/share $27.5
- What is the offer value?
- What is the Goodwill created?
- What is the pro forma NI, assuming no synergies or write ups?
- What is the pro forma EPS? What is the amount of accretion/dilution?
- What is the target shareholder ownership?
- What is the pro forma coverage ratio?
- What is the pro forma leverage ratio?
Dilution amount x diluted shares outstanding / (1-T)
How do you calculate the additional synergies needed to be EPS flat?
Basic shares + # of options in the money - shares repurchased under the modified treasury stock method + convertible debt shares + non vested RSUs
What is the diluted shares formula when calculating offer value of equity?
Goodwill is tested for impairment and thus potentially written down and expensed, lowering future NI.
How is Goodwill a future earnings risk?
The incremental interest expense / additional debt burden. Will the merged companies generate enough cash flow to sustain principal and interest payments to the lenders?
What are the concerns of using debt to finance a transaction?
Balance Sheet
You need to add that amount of write ups to the assets section.
Calculate and record deferred tax liability (due to future D/A or possible impairment charges)
Income Statement
Calculate depreciation expense using estimated useful lives. Make sure to appropriately split between depreciation and amortization.
When there are write ups to assets, what adjustments do you need to make on the balance sheet and income statement?
(Total Assets - Existing Goodwill) - Liabilities - Noncontrolling interest
Or
Identifilable Assets - Liabilities - Non-controlling interest
Identifiable Assets = Total Assets - Target’s Existing Goodwill
What is the formula for book value of Net Identifiable Assets?
$54,890
Offer price/share $54
Current share price $49
Basic shares outstanding 991
Options exercisable 62
Exercisable strike price $39
In-the-money options outstanding 86
Outstanding strike price $38
What is the offer value?
No.
It does not have specific rights and cannot be bought and sold.
Is Goodwill identifiable?
High P/E via stock
Low borrowing costs via debt
Companies with relatively high P/E ratios tend to finance acquisitions throught what?
Companies with low borrowing cost finance acquisitions through what?
Using prior acquisitions of companies very similar to the ones in the current deal.
What is a rough way to estimate synergies in a merger?
Accretion/dilution analysis
The analysis conducted derives whether or not the acquirer’s EPS will increase or decrease post-deal
Credit analysis answers the question of how much debt can a company take on without adversely affecting its credit rating. Essentially, what is its ability to take on debt and what are the effects to the balance sheet after taking on that debt.
What is merger consequences analysis also called? Why?
Credit analysis in a merger consequences analysis answer what question?
- How much can the company afford to pay?
- How are you going to finance the acquisition/What is the optimal cash vs stock blend to pay for the acquisition?
What are the 2 questions that merger consequences analysis, generally speaking, addresses?
- Accretive
- Dilutive
- The deal is ____ if the acquirer’s post deal EPS is greater than the pre-deal EPS.
- The deal is ____ is the post deal EPS is less than the pre deal EPS
Income statement and balance sheet
Which two statements do professionals analyze for merger impact?
Pre transaction anaylsis is used to identify its ability to finance the deal by issuing debt.
Post transaction analysis is used to identify leverage ratios and coverage ratios. It shows the impact of the financing to its balance sheet.
What is the purpose of analzying the pre transaction balance sheet and post transaction balance sheet?
The set of accounting rules that governs how an acquirer recognizes and records an M&A transaction on its balance sheet
What is purchase accounting?
Identification of the target company’s net identifiable assets
Net Identifiable assets = Identifiable assets - liabilities - Noncontrolling interest
Identifiable assets = Assets - Target’s existing goodwill
This is used in a merger analysis to eventually reach what Goodwill is. Goodwill = Purchase Price - Net Identifiable Assets - Write Ups.
This is dealing with the TARGET company.
Purchase accounting begins with what? Give the formula.
Assets-Liabilties
What is book value?
Adjusted to fair market value. Typically, they are written up, although it is possible for the fair market value to be written down.
Net Identifiable Assets are ____ before deriving Goodwill.
Increasing the depreciable value of the PP&E as well as creating a deferred tax liability
What is a side effect of writing up PP&E?
Paying for the control premium as well as benefitting from future synergies/strategic rationale.
What are the reasons for having a purchase price beyond the fair market value of net identifiable assets?
Yes.
Goodwill is NOT amortized, but it is tested for impairment.
Are finite life intangible assets amortized?
How is Goodwill adjusted?
- $275 million
- 1.5278
- 15.278 million
- $67.3 million
- 68.678 million
- $0.98 and dilutive
Acquirer Information
Current share price $18
Total existing debt $200
Tax rate 40%
Interest on new debt 6%
NI $53.4
Diluted shares outstanding 53.4
EPS $1
Target’s Information
Current share price $22
Total Assets $370
Total Liabilties $220
Existing Goodwill $25
NI $13.9
Diluted shares outstanding 10
EPS $1.39
Questions
- What is the offer value, assuming an offer price of $27.5?
- What is the exchange ratio assuming a 100% stock purchase?
- How many shares must be issued to the target’s shareholders?
- Assuming no synergies or write-ups, what is the pro forma NI?
- What would be the new shares outstanding?
- What is the pro forma EPS, and is the deal accretive or dilutive?
Target’s shareholders must receive 1.52 shares for every 1 share of the acquirer. Typically, the fractional shares are compensated for in cash.
What does an exchange ratio of 1.52 mean?
Acquirer’s NI + Target’s NI +/- Adjustments
Acquirer’s shares outstanding + New Shares Issued
New shares issued = Exchange ratio x target shares outstanding
What is the formula for the Pro Forma EPS?
After tax impact of:
Synergies
Interest expense on new acquisition of debt
Incremental depreciation of write ups
What are the most important adjustments to NI for a pro forma EPS?
The acquirer’s effective tax rate.
Which tax rate do you use?
- $9.9 million
($275 x 6%) x (1-40%)
- $1.075
- .075 accretion/share
- 5% accretion/share
100% cash purchase example
Acquirer’s information
Current share price $18
Total existing debt $200
Tax rate 40%
Interest on new debt 6%
NI $53.4
Diluted shares outstanding 53.4
EPS $1
Transaction expenses $3
Target’s information
Current share price $22
Total assets $370
Total liabilities $220
Existing Goodwill $25
NI $13.9
Diluted shares outstanding 10
EPS $1.39
Offer price/share $27.5
- What is the incremental after tax interest expense if the acquisition is funded solely by debt?
- What is the pro forma EPS?
- What is the accretion/dilution figure?
No. The EPS uses only the acquirer’s shares outstanding. THERE ARE NO NEW ISSUED SHARES IF IT IS SOLELY DEBT FINANCED, DUMMY.
Do you incorporate newly issued shares in the pro forma EPS calculation if the acquisition is 100% debt financed?
Yes.
Do you still use offer value as the purchase price in an all cash/debt transaction?
Acquirer’s debt + target’s debt + new debt issued
Acquirer’s interest expense + target’s interest expense + interest expense based on new debt issued
Acquirer’s EBITDA + Target’s EBITDA
What is the formula for pro forma debt?
What is the formula for pro forma interest expense?
What is the formula for pro forma EBITDA?
Compare the acquirer’s standalone P/E to the offer P/E
If the acquirer’s P/E is greater than the offer price P/E, then the deal will be accretive.
If the acquirer’s P/E is less than the offer price P/E, the deal will be dilutive.
This analysis assumes no write ups or synergies.
Describe the quick P/E analysis to determine accretive/dilutive transactions. What is important to note in this quick analysis?
- Dilutive.
Acquirer’s P/E 18x
Offer P/E multiple 19.8x
- $67.3 million
- 1.5278
- 15.278 million
100% stock transaction
Acquirer’s price/share $18
Acquirer’s EPS $1
Acquirer’s NI $53.4
Offer price/share $27.5
Target’s EPS $1.39
Target’s NI $13.9
Target’s outstanding shares 10 million
- Will this deal be accretive or dilutive?
- What is the pro forma NI?
- What would be the exchange ratio?
- What would be the new shares issued?
The reduction of redundant and overlapping expenses, thus leading to cost reductions.
Consider the after tax implications of synergies.
What usually constitutes the greatest synergies?
What is important to consider when calculating synergies?
$0.04
What is the dollar accretion for the below?
ABC Corporation
Pre tax cost of debt 6%
EPS $1
Net income $100 million
Tax rate 40%
XYZ Corporation
EPS $1
NI $10 million
Shares outstanding 10 million
If ABC buys XYZ using 100% cash (financed by new debt) for $16.67/share, what is the dollar amount of accretion for this transaction?
Don’t do the deal.
Pre-tax synergies needed to keep EPS flat is $25 million
The CEO of a company is contemplating acquiring another company. The CEO will only consider an accretive transaction. You run the merger analysis and find the deal is currently dilutive by $0.05 before the impact of synergies. Here are some other assumptions:
Pro forma shares 300 million
Tax rate 40%
The CEO also says he thinks he can reasonably achieve $20 million of pre-tax cost synergies. What should the CEO do- accept or deny the deal?
- Determine a valuation utilizing comparables, acquisiton comparables, and DCF
- Then, merger consequences analysis analyzes what a company can afford to pay and what the financial effects are of the transaction
Walk me through the steps taken before conducting merger consequences (accretion/dilution) analysis.
- $525 million
- $32.5 million (does not account for after tax int. exp)
- $187.2 million
- 2.8x
- 5.8x
Assume the $275 offer for 100% cash. Assume the acquirer has $200 million of existing debt, $12 million of existing interest expense, and $135 million of EBITDA. Assume the target has $50 million of existing debt, $4 million of existing interest expense, and $52.2 million of EBITDA. Assume 6% interest rate on new debt.
- What is pro forma debt?
- What is pro forma interest expense?
- What is pro forma EBITDA?
- What is the pro forma leverage ratio?
- What is the pro forma coverage ratio?
Reduce the amount of newly issued debt in the transaction.
If the pro forma leverage ratio is too high, what should occur to reach the leverage ratio acceptable to the acquirer?
Pro forma ownership for target
newly issued shares/pro forma shares
Pro forma ownership for acquirer
(1 - (newly issued shares/pro forma shares))
Additional things to consider:
Combinations of cash and stock
Incremental depreciation/amortization due to write ups
Impact of synergies
Incremenal interest expense due to newly issued debt
Contribution analysis aligning with pro forma ownership
Tax considerations
