Mergers and Acquisitions

Question 1

What are some reasons that two companies would want to merge?

Answer 1

The main reason two companies would want to merge would be the synergies the companies would create by combining their operations. However, some other reasons could be to gain new market presence, gain brand recognition, grow in size, gain the rights to properties physical or intellectual that they couldn’t gain as quickly by creating or building in their own

Question 2

What are some reasons two companies would not want to merge?

Answer 2

synergies they are looking for would not occur

fees associated with going through a merger

Question 3

What do bankers do during a sell-side M&A deal?

Answer 3

in sell-side deal, the bank will market a company to potential buyers and then help both sides negotiate the deal and complete the sale process. normally bank meet with company and puts together documents to market the company to potential buyers and work with them through the process to maximise purchase price

Question 4

What do bankers do during a buy-side M&A deal?

Answer 4

In a buy -side deal, the bank will go out and search for potential companies for their client to acquire and negotiate the deal to obtain the lowest price possible.

1. research on a very lange number of potential acquisition targets
2. cut down list by meeting with clients and getting their feedback
3. decide which companies you’ll target and approach about being purchased
4. do due diligence on each of the targets with are open to acquisition and come up with target price for each
5. work with client to select final target and work to negotiate and structure the deal and announce the transaction

Question 5

What are synergies?

Answer 5

improvements that result from the combination of two companies, the idea is that the combined company can create a higher EPS then the two companies separate could
the concept of synergies is that the combination of two companies result in a company that is more valuable than the sum of the value of the two individual companies

Question 6

What is a fairness opinion?

Answer 6

a report evaluating the facts of an M&A transaction, normally prepared by an IB to examine the fairness of a given transaction

Question 7

Can you name two companies that you think should merge?

Answer 7

Peloton and Soul Cycle. Soul Cycle was going to file for an IPO, but withdrew because they don’t require public capital at this time to reach long-term growth and open more boutiques. The up and coming Peloton sell stationary bikes that stream classes, now they are selling treadmills too, and they want to expand to different location. I think both companies would benefit from merging, as Soul Cycle has a larger brand recognition and had already proven to be successful in geographic expansion but have not dominated the stay at home workout group that peloton has

Question 8

What is a stock swap?

Answer 8

A stock swap is when a company purchases another company and instead of giving the former owners cash they issue them new stocks of the new combined company. This is a sign that they believe in the potential success of the merger

Question 9

Why pay in stock versus cash?

Answer 9

If a company pays in cash, those receiving it will have to pay taxes on it. Also, if the owners of the company being acquired want to be part of the new company, they may prefer stock if they believe the new company will perform well and the stock will increase in value.

Question 10

What is the difference between shares outstanding and fully diluted shares?

Answer 10

shares outstanding is the actual number of common stock that have been issued as of the current date, fully diluted shares is the number of shares that would be outstanding if all “in the money” shares were exercised

Question 11

How do you calculate the number of fully diluted shares?

Answer 11

by using the treasury stock method, involves finding the number of current shares outstanding, adding the number of options and warrants that are currently “in the money” and then subtracting the number of shares that could be repurchased using the proceeds from exercising the options and warrants

Question 12

What is a cash offer?

Answer 12

a cash offer is the payment in cash for ownership of a corporation, for an acquisition

Question 13

Would I be able to purchase a company at its current stock price?

Answer 13

Normally, you cannot purchase a company at its current stock price because when you purchase a company or purchase a majority stake at a company you need to pay a control premium

Question 14

Why pay in stock versus cash?

Answer 14

Because when you pay in cash the ones receiving it normally have to pay taxes on it right away. Also, if the owners of the company being acquired want to be part of the new joint company, they may prefer stock if they believe the new company will perform well and the stock price will increase in value. Current market performance may also affect if the owners of the company want to be paid in cash or stock. If the market is highly volatile, or performing poorly, the company being acquired may prefer cash because of the stability it provides

Question 15

All else equal, how would one company prefer to pay for another?

Answer 15

In cash because cash is the cheapest source of capital, it would be the preferred way to purchase a company given that the purchaser has enough cash. If the purchasing company does not have cash or wants to keep cash would prefer other ways of financing. For instance, if a company feels that the stock price is overvalued, it would prefer to pay for the acquisition in stocks.
Preferred form of payment depends on the circumstances of the acquisition, the company and the market

Question 16

If you owned a small business and a larger company came to you offering an acquisition, how would you think about the offer and whether or not to take it?

Answer 16

Of course the higher the price the better. But would also have to take into consideration if Im getting paid in cash or stock. Cash is great because its tangible and you can spend it now, but you have to pay taxes on it. Stocks is good if I want to continue being involved in the company and if I believe the new company will perform well and that the stock will increase in value. Also, stock you only pay taxes when you sell it.

Question 17

What is a tender offer?

Answer 17

A tender offer occurs during a takeover. It happens when a company or individual offers to purchase the stock of the target company for a price usually higher than the current market price in an attempt to take control of the company without management approval
might involve:
-advertisement in newspapers to buy stocks of the target company above the market price in an attempt to gain ownership of over 50% of the stock and take ownership of the business

Question 18

If company A purchases company B, what will the combined company’s balance sheet look like?

Answer 18

the new balance sheet will be the sum of the two companies’ balance sheet plus the addition of “goodwill” which would be an intangible asset, to account for any premium paid on top of Company B’s actual assets

Question 19

What is the difference between goodwill and other intangible assets?

Answer 19

Goodwill and other intangible assets are similar because they are non-physical assets in a company’s balance sheet. The main difference between the two is that goodwill is only reduced in the event of a goodwill impairment or another acquisition, but other intangible assets are amortized, and since amortisation is an expense it reduces net income in the IS, and as the asset amortises its carrying amount on the balance sheet decreases

Question 20

What is divestiture?

Answer 20

A divestiture is a transaction when a company sells a certain business division. It works like a normal sell-side M&A deal but instead of the company looking to sell the entire company, it only looks to sell a certain part of the company. Bankers gather information about the div vision, then prepare a list of suitable buyers for that division or segment, and work with the client to pick the best acquirer and maximize the selling g price. The process is a little complicated since the bankers need to put all the information and financials for that division alone, which may not be as easy as accounting for the entire business

Question 21

What is the difference between an accretive merger and a dilutive merger, and how would you go about figuring out whether a merger is accretive or dilutive?

Answer 21

An accretive merger is one in which the acquiring company’s earnings per share will increase following the acquisition. A dilutive merger is when a company’s EPS will decrease following the merger. You can find out if a merger is accretive or dilutive by looking at the P/E ratios of the firms.
- If the acquiring firm has a higher EPS than the firm it is purchasing, it is accretive because the acquirer will pay less per dollar of earnings for the target company than where the target’s stock is currently trading at

Question 22

Accretive merger

Answer 22

if the acquiring firm’s earnings per share (EPS) increases after the deal goes through

Question 23

Dilutive merger

Answer 23

If the resulting deal causes the acquiring firm’s EPS to decline, the deal is considered to be dilutive
occurs because
1. negative or lower earnings contributions
2. additional shares are issued to pay for acquisition

Question 24

Reasons why EPS might go up after an M&A deal

Answer 24

• increased economies of scale as result of synergy
• target company’s capital or research and development tools may lead to future gains in productivity or revenue generation

Question 25

Mergers and acquisitions

Answer 25

• consolidation of companies or assets that can be done through many different transactions
  1. mergers
  2. acquisitions
  3. tender offers
  4. acquisition of assets
  5. consolidation

Question 26

Merger

Answer 26

two companies come together to form one company

Question 27

Acquisition

Answer 27

the acquiring company gets a majority stake in the acquired company, but the acquired company remains with its name or legal structure

Question 28

Consolidation

Answer 28

consolidation creates a new company, stockholders of both companies must approve the consolidation, and after the approval they receive shares in the new firm
For example, in 1998, Citicorp and Traveler’s Insurance Group announced a consolidation, which resulted in Citigroup

Question 29

acquisition of assets

Answer 29

one company acquires the assets of another company. The company whose assets are being acquired must obtain approval from its shareholders. The purchase of assets is typical during bankruptcy proceedings, where other companies bid for various assets of the bankrupt company, which is liquidated upon the final transfer of assets to the acquiring firm

Question 30

Company A is considering acquiring company B, company A’s P/E ratio is 50 times earnings, whereas Company B’s P/E ratio is 20 times earnings. After company A acquires company B, will company A’s earnings per share rise, fall, or stay the same?

Answer 30

Since the P/E of the firm doing the purchasing is higher than that of firm it is purchasing, the new company’s EPS will be higher, therefore creating an accretive merger

Question 31

Walk me through the basics of a merger model (an accreditation dilution model)

Answer 31

1. make an assumption about how much it costs to acquire the company and how the acquisition would be financed (cash, debt, or stock)
2. create a projection model of both the buyer and seller’s income statements from revenue down to net income
3. combine the income statements, you do this by adding together each of the individual line items
   - but you do need to make a few adjustments. If the acquisition was financed with debt, you have to add interest that would be paid on the new debt to the net interest expense line
   - if it was financed with cash, you need to subtract interest you would have earned on that cash (interest income) from the net interest line
   - if it was financed by issuing new shares, you must increase the share count
4. las step is to apply the buyer’s tax rate to pretax net income to get the net income of the combined company and then divide that number by the new number of shares outstanding to arrive at the new EPS and see if the transaction is accretive or dilutive

Question 32

What is the treasury stock method?

Answer 32

The treasury stock method is a way of calculating the number of fully diluted shares. It involves adding the number of “in the money” options and warrants to the number of common shares currently outstanding, and then assuming all the proceeds from exercising the options will go towards repurchasing stock at the current price

Question 33

Example of treasury stock method

Answer 33

1. begin with the company’s common shares outstanding, found in 10 K or 10Q. assume there are 1,000,000 shares outstanding
2. go to the 10k or 10q and find the options chart. the options that will be exercised are those with the weighted average exercise price below the current market price. assume there are 100,000 shares with weighted average exercise price of $5 and the stock is selling for $10
3. this means 100,000 new shares of stock will be issued, and the company will profit $500,000 from the sale of those shares, now there will be 1,100,000 shares
4. $500,000 profit will then be used to repurchase shares in the open market at $10 per share
5. the company will repurchase 50,000 shares, meaning there will be 1,050,000 shares after the exercise of the options

Question 34

If a company has 1,000 shares outstanding at $5 per share and also has 100 options outstanding at an exercise price of $2 per share, what is the company’s fully diluted equity value?

Answer 34

1,060

Question 35

are most mergers stock swaps or cash transaction and why?

Answer 35

This varies. In strong markets many mergers are stock swaps mainly because the prices of company stock are so high, but also because the current owners may desire stock in the new company as they anticipate further growth in a strong market

Question 36

You are advising a client in the potential sale of a company, who would you expect to pay more for the company: A competitor or an LBO fund?

Answer 36

If the competitor is a strategic buyer, you would expect the competitor to pay more for the company. A strategic buyer would get benefits, like synergies, and therefore higher cash flows from the purchase than would an LBO fund, which is normally a financial buyer

Question 37

What would be a real-life example of an LBO and what are the different pieces?

Answer 37

borrowing money to purchase an apartment to rent out. The down payment on the apartment is equivalent to the equity investment, while the mortgage loan is the debt or leverage in an LBO transaction. The interest payment on the mortgage would be interest payments on the debt, while the principal payments on the loan are made with the cash flows you receive from renting out the apartment which is similar to amortization of the debt. Finally, the sale of the property, hopefully for a gain, would be exiting the investment through either a sale or an IPO

Question 38

What are deferred tax liabilities and how are they created in an M&A transaction?

Answer 38

If an asset is written up, the company is experiencing a gain and a DTL is created because the new asset will have higher depreciation expense in the short term, which means the company will pay lower taxes. These taxes need to be paid back at some point, which is why a liability is created

Question 39

In a leverage buyout, what would be the ideal amount of leverage to put on a company?

Answer 39

in order to get the most return, the acquiring firm wants to finance the deal with the last amount of equity possible. However, they need to be careful to not put too much financial distress on the company by overloading them with debt

Question 40

What are the three types of mergers and what are the benefits of each?

Answer 40

horizontal, vertical and conglomerate

• horizontal merger is a merger with a competitor and ideally will result in synergies (peloton and soul cycle)
• vertical merger is a merger with a supplier or distributor and ideally will result in cost cutting (peloton and life fitness that makes gym equipment)
• conglomerate merger is a merger with a company in a completely unrelated business and is most likely done for market or product expansions or to diversify its product platform and reduce risk exposure (equinox buying lululemon)

Question 41

What is an exchange ratio and why would a company use it

Answer 41

an exchange ratio is a way of financing an acquisition by assigning a number of shares in the new company to be exchanged for each existing share in the original company. For example, Company A could acquire Company B and say “ we will give you 2 shares of the new, combined Company AB for each of your shares of Company B” rather than saying “ You will receive $XX of Company AB stock for each share of Company B”

Question 42

exchange ratio

Answer 42

way of doing an M&A transaction so that it is funded partially or fully with stock

Question 43

Benefits of using an exchange ratio

Answer 43

protect themselves if the stock price of Company A falls after the announcement of the transaction, the selling company would prefer a fixed dollar amount in stock if they believe the stock is going to fall in value

Question 44

How could a firm increase the returns on an LBO acquisition?

Answer 44

1. Increase the sale price when the firm monetizes its invest,ent
2. Negotiate a lower purchase price
3. Increase amount of leverage or debt on the deal. The higher the leverage, the higher the return. However, increasing the leverage puts more financial stress on the company being acquired and increases the bankruptcy risk

Question 45

How do you pick purchase multiples and exit multiples for an LBO?

Answer 45

• similar techniques when doing an M&A
• looking at precedent transactions and public company comparable
• when a PE firm is evaluating an investment it is looking to buy the company for the lowest possible multiple then improve the business through operational changes, and then sell it for a higher multiple