Mergers & Acquisitions

Question 1

How do you calculate pro forma EPS?

Answer 1

[Acquirer’s Net Income + Target’s Net Income + “After-tax Incremental Adjustments”] divided by [ Acquirer’s Shares Outstanding + New Shares Issued]

Question 2

What are some incremental adjustments made when combining two companies?

Answer 2

1. ) After-tax interest expense from new debt financing
2. ) After-tax synergies
3. ) After-tax depreciation and amortization expense (from write ups)
4. ) Lost opportunity cost of cash balances if used to finance acquisition
5. ) “Saved” after-tax interest expense from liquidation of Target’s debt
6. ) “Saved” preferred stock dividend payment from liquidation or conversion of Target’s preferred stock

Question 3

What is Goodwill?

Answer 3

It is the excess purchase price over fair market value of net identifiable assets acquired

Question 4

What is net identifiable assets?

Answer 4

Shareholder’s equity minus target’s existing goodwill

Question 5

What happens to advisory fees, legal fees, and accounting fees?

Answer 5

Expensed as incurred on the income statement. This affects retained earnings on the balance sheet as well

Question 6

What is the exchange ratio?

Answer 6

Acquirer’s shares issued per Target share

Offer Price Per Share / Acquirer’s Share Price

Question 7

How do you calculate shares issued in the transaction?

Answer 7

Exchange ratio x # of target shares

Question 8

Relation of P/E ratio and % stock used in a merger / transaction?

Answer 8

P/E ratio will always determine accretion / dilution in 100% stock deals

Question 9

P/E ratio

Answer 9

How expensive a company’s earnings are

Question 10

How do you treat underwriting fees?

Answer 10

Underwriting fees are capitalized and amortized over the life of the debt issuance

This creates an incremental amortization expense which reduces PFNI over the term of the borrowing

Question 11

What is “Purchase Price Allocation”?

Answer 11

A sequence of steps to get from a pre-deal target balance sheet to a post-deal target balance sheet

1. ) Allocate the purchase price to the target’s net tangible book value, defined as assets, excluding goodwill, less liabilities
2. ) Assets and liabilities are marked up to fair market value
3. ) If purchase price is still higher than FMV of net assets, the remaining purchase price is allocated to goodwill

Question 12

What do you do with Goodwill on the target’s balance sheet?

Answer 12

Eliminate the goodwill from the asset side and strip the same amount out of the equity side

Question 13

Discuss deferred tax liabilities on deal day

Answer 13

DTL’s are the accrual that captures future tax differences from the write-up of certain assets

DTL Equation

DTL = (FV book basis - tax basis) x tax rate

Question 14

Discuss the steps in M&A modeling

Answer 14

1. Build the transaction assumptions section
2. Build the sources and uses section
3. Build the Write-Ups and PPA section
4. Build the pro-forma balance sheet, income statement, and cash flow statement

Question 15

How do you calculate fully diluted shares outstanding?

Answer 15

Take basic shares outstanding and options / convertible securities (10-k). Make sure to use shares outstanding and NOT exercisable as options usually vest upon a change of control. Assume that the proceeds from the exercise of the in-the-money options are used to repurchase shares at the current market price.

Then add the number of shares that would result from the conversion of ITM convertible securities

All of this is done for the target and acquirer

Question 16

What tax rate do you use for the target projections and the transaction?

Answer 16

Acquirer’s tax rate

Question 17

Issues with timing

Answer 17

Make sure the acquirer’s and target’s time periods are in sync