OE - Advanced M&A Flashcards
Take one of your old employers as a potential client and from a high-level strategic point of view, explain what type of company you would recommend it to acquire or merge with?
LF Stores. Revolve - has production in LA and store footprint.
What is the difference between a spin-off and a split-off?
In a spin-off, the parent company (ParentCo) distributed to its existing shareholders new shares in a subsidiary, thereby creating a separate legal entity with its own management team and board of directors. The distribution is conducted prorata, such that each existing shareholder receives stock of the subsidiary in the porportion to the amount of parent company stock already held. No cash changes hands, and the shareholders of the original parent company become the shareholders of the newly spun company (SpinCo).
In a split-off, the parent company offers its shareholders the opportunity to exchange their ParentCo shares for new shares of a subsidiary (SplitCo). This tender offer often includes a premium to encourage existing ParentCo shareholders to accept the offer. For example, ParentCo might offer its shareholders $11 worth of SplitCo stock in exchange for $10 of ParentCo stock (a 10% premium).
In an acquisition, what is a “squeeze-out threshold”?
The required proportion of the target company’s shares that the potential acquirer must own in order to effect a “squeeze out” of the target’s minority stockholders. A squeeze out means the acquirer can force the non-accepting minority to accept the offer. The squeeze out threshold varies by country. In the U.S. it varies by state, but the threshold in Delaware where many companies are headquartered is 90%.
Holding all else constant, would a buyer prefer an asset purchase or a stock purchase? Would would a seller prefer?
A seller almost always prefers a stock purchase to avoid double taxation and to get rid of all its liabilities. The buyer almost always prefers an asset deal so it can be more careful about what it acquire and to get the tax benefit from being able to deduct depreciation and amortization of asset write-ups for tax purposes.
What would the tax implications of selling this business (asset v. sale of stock)?
Asset purchase: Assets are recorded on the acquirer’s books at fair market value (FMV). Because this is usually higher than book, buyer gets a tax shield on the increased depreciation from the higher BV (called step-up basis). Since the assets change tax entities, buyer pays the difference in bases between the entities in taxes. Seller is taxed twice - once on the gain from the sale, again on the proceeds distribution to shareholders.
Stock sale: Seller usually gets more favorable tax treatment. The seller pays capital gains tax on the difference between purchase price and the basis (or TBV) of their stock. For the buyer, there is no step-up. The buyer assumes whatever tax basis the seller had before the transaction.
When would acquisition comps be lower than industry (trading) comps?
Acquisition comps tend to be higher than industry comps due to the control premium. However, precedent transactions are historical and may not reflect current industry conditions. Thus, if an industry is experiencing historical highs (and few, if any, transactions have occured recently) industry comps could be higher than precedent transactions.
Are there premiums in a merger of equals?
No. There is typically little or no premium paid in a merger of equals because it is a strategic transaction that is intended to produce a stronger combined entity for shareholders.
If Company X were to acquire Company Y, what would the merged balance sheet look like?
If Company X uses the purchase method to account for the acquisition, the assets of the acquired firm (Company Y) will be reported at their fair market value on Company X’s balance sheet. This allows Company X to establish a new cost basis for the acquired assets (Company X’s assets will continue to be reported at their book value.) The excess of the purchase price over the sum of the fair market value of all of the assets acquired will be reported as goodwill under assets. The balance sheet will obviously reflect any change in cash or liabilities resulting from the method by which Company X paid for Company Y. Asset purchase method does not lead to a creation of the deferred tax liability like stock purchase method.
Could you get DTLs or DTAs in an asset purchase?
No, because in an asset purchase the book basis of assets always matches the tax basis. They get created in a stock purchase because the book values of assets are written up or written down, but the tax values are not.
Discuss how you would handle currency issues in cross-border deals.
A number of ways to mitigate current fluctuation risk:
- Use multi-currency loans to mitigate currency exposures
- Use loan covenants set on a fixed exchange rate that allow for more consistent tracking of financial performance
- Enter into currency derivative contracts
Do you think Microsoft is a takeover target? Why?
It is an unlikely takeover target due to its size. Few corporations could afford such a takeover, and extracting sufficient synergies to make such a deal worthwhile would be challenging.
Company A has the following financial profile:
Share Price: $10 Diluted Shares Outstanding 100 Assume a Tax Rate of 50% Company Net Income: 50 Pre-Tax Cost of Debt: 10% Debt: 200
Company A then acquires company B for a 100% premium using 50% stock and 50% debt. Assume that Company B’s debt is refinanced at Company A’s cost of debt.
Company B has the following financial profile:
Share Price: $5 Diluted Shares Outstanding: 100 Assume a Tax Rate of 50% Company Net Income: 40 Pre-Tax Cost of Debt: 8% Debt: 500
How accretive or dilutive is the deal? How many new shares were issued? If the deal is dilutive, how much do we need in synergies to make the deal accretion neutral?
The equity purchase price is $5/share x 100 shares x 100% premium = $1000
50% debt means we issue $500 in new debt, at a 5% after-tax cost of debt this lowers proforma NI by $25.
50% equity means we issue $500/10 = 50 new shares.
$500 in Company B’s existing debt is being refinanced in the Deal:
First calculate how much we add back to Company B’s N.I. as $500 x 4% = 20
Then calculate how much new interest expense we have for the pro-forma company as $500 x 5% = $25
Proforma NI = [Company A NI + Company B NI + synergies - new interest expense on debt + net effect of debt refinancing on interest expense]
Proforma NI = [$50 + $40 +0 - $25 +(20-25)] = [50+40-25-5] = $60
Proforma EPS = $60/(100+50) = $.40 / share
Accretion / Dilution = proforma EPS / Company A EPS = $.40/$0.50 -1 = -20% - the deal is dilutive without synergies
Post tax synergies needed = (Company A EPS - Pro-forma EPS) x pro-forma shares outstanding = ($0.50 - $0.40) x 150 = $15
Note that Pre-tax synergies needed are = $15/50% tax rate = $30
With $15 in post-tax synergies the pro-forma N.I. = [$50 + $40 + 15 - 25 - 5] = $75
This makes pro-forma EPS = $75/150 = $0.50/share = Company A’s standalone EPS
