Picasso - M&A Questions Flashcards
Walk me through an accretion/dilution analysis.
Goal of the analysis: does the transaction make sense financially given the expected synergies, new economics, and cost of acquisition?
(“Quick and Dirty Merger Analysis”)
- Project financials out 1-2 years for buyer and target
- Calculate expected pre-tax synergies from a merger
- Consideration used. New cash balance and capital structure - make your PF I/S and B/S adjustments
- New D&A, new interest, lost interest income
- Compare the PF EPS (accounting for shares issued if any) to standalone EPS. If it’s greater, then the txn is accretive
Shares = acq shares + shares issued to acquire
If you merge two companies, what does the pro-forma income statement look like? Discuss whether you can just add each line item for the proforma company. Please start from the top.
- Sum everything above the line
- Account for any revenue / cost synergies, economies of scale, cross selling abilities, etc. (fixed costs have more potential for synergies)
- Excess D&A
3a. . New interest expense - New tax rate if you operate in new jurisdictions; NOLs assumed may lower
- NI
What is a merger model?
Determine if the merger makes sense from an accretive /dilutive analysis
What is a stock swap?
Issue stock in the buyer to the target’s shareholders
Are most mergers stock swaps or cash transactions? Why?
Cash?
- Cash is king. Easily quantifiable. Value of consideration does not depend on PF performance
However in hot stock markets, markets are hot and sellers believe in the continued growth
Which method would a company prefer to use when acquiring another company: cash, stock or debt?
Depends on the cost of each.
- Cash = Lost interest income. Also you have less cash on the balance sheet which may hurt credit rating or market value
- Stock = P/E?
- Debt = incremental cost of debt? Can you refinance your whole cap stack?
With unlimited resources, cash! Cheapest
What is a merger?
Merger of two companies similar in size, forming a new entity
What is an acquisition?
One company acquires the other, and the target’s original brand may dissolve and redundant employees laid off.
What factors can lead to the dilution of EPS in an acquisition?
- Operating performance
- Cost of debt
- Synergies do not materialize
At the onset
- PE of target greater than buyer
- write up of D&A and amort
If a company with a low P/E acquires a company with a high P/E in an all stock deal, will the deal likely be accretive or dilutive?
Dilutive. Buyer has a higher cost of equity than the target’s earnings yield
What is goodwill and how is it calculated?
Excess Value from the purchase that cannot be allocated to intangibles or existing net assets. Accounting plug!
Consideration
less: FV NIA (Eq. less existing goodwill plus write ups)
plus: any DTLs recognized
= New Goodwill
What are the three types of mergers and what are the benefits of each?
- Horizontal
- Take out competitors. Econ of scale - Vertical
- Reduce bargaining power of suppliers or customers. Higher valuation from an end to end provider - Conglomerate
- Diversification, market expansion
What major factors drive mergers and acquisitions?
- Financial sense
- Synergies
- Depressed valuations
- Exit underperforming segment / enter attractive industry
- Diversification
- Complemenatary product mix
- Control distribution channel, supply chain, etc.
- Ego. Pressure to expand and put capital to work
- Acquire technology or clients
- Opp to consolidate industry
- Brand
What are a few reasons why two companies would not want to merge?
- Culture
- Not merging for the right reasons
- Aggresive reliance on synergies
- IB and advisor fees
- Cost of debt capital
- Macro / external / regulatory (DOJ) reasons
- Customers may not carry over
Explain the concept of synergies and provide some examples.
1+1=3
Revenue and cost synergies
Revenue = cross sell products, more bargaining power and can raise prices , complementary markets and distribution channels
Cost = bargaining power with suppliers reducing COGS, redundant overhead (SG&A), redundant fixed assets, leases, office spaces, IT infrastructure
However, you will have costs to realize these synergies
- Integrating IT and ERP
- Training
How do you calculate fully diluted shares?
Current shares O/S + shares from in the money converts + TSM method for options
If our calculation is for a minority interest based valuation methodology (i.e. comparable companies) we will use only options exercisable.
If our calculation will be used for a control based valuation methodology (i.e. precedent transactions) or M&A analysis, use all of the options outstanding.
If the exercise price of an option is greater than the share price (or purchase price) then the options are out-of-the-money and have no dilutive effect.
What is the concept underlying the Treasury Stock Method?
Use proceeds from exercise of options to repurchase shares in the market, reducing impact of dilution
What is the difference between shares outstanding and fully diluted shares?
FDS includes additional shares issued from options and converts
You are advising a client on the potential sale of the company. Who would you expect to pay more for the company: a competitor or a LBO fund?
Competitor. Longer hold time. Synergies. Emotional purchase. Ego.
LBO charges a higher cost of equity capital
How is new goodwill calculated?
Consideration less FV of NIA
When looking at an acquisition of a company, do you pay more attention to enterprise value or equity value?
Both are extremely important.
- Enterprise value is more important because it’s a change of control event. You need to pay off/assume debt and provide consideration to equity holders to tender their shares
- Equity value is important because shareholders will require a premium = offer price
Why do most mergers and acquisitions fail?
- Synergies do not pan out
- Optimistic mgmt forecasts
- Does not make financial sense
- Customers do not carry over
- Culture
Why would an acquiring company pay in stock rather than cash?
- High stock price, wants to keep cash on BS, debt is expensive
Target prefers - Defer capital gains to target, Target may prefer to have equity in PF company
Let’s make the following assumptions for our Merger Model:
100% stock-financed acquisition
Zero Premium Paid
Zero Transaction Synergies
Acquiror: $3.25 EPS, P/E 11.0x, Shares 1,000
Target: $3.75 EPS, P/E 13.0x, Shares 300
Buyer
- NI = 3.25*1000=3250
- Share price = 11*3.25=32.5+3.25=35.75
- Market cap = 35.75*1,000=35,750
Target
- NI = 3.75*300=1,125
- Share price = 3.75*13=37.5+11.25=48.75
- Market cap = 48.75300 = 1.25300=375 –> 15,000-375=14,625
- Shares issued by buyer = 14,625/35.75=409
Combined NI = 3250+1125=4,375
PF Shares = 409+1000=1,409
EPS = 3.10 (vs 3.25 standalone)
Dilutive
Why would you use options outstanding over options exercisable to calculate transaction price in an M&A transaction?
Change of control event = options immediately vest
- Options in the money considering the purchase price will convert and have a dilutive effect
Options exercisable only include options that have vested and are exercisable
A company purchases another company with a 10x PE ratio using 10% debt. Is it accretive or dilutive?
Accretive
Earnings yield of the target is 10%
After tax cost of debt is (assuming 40% tax) 6%
If you owned a small business and were approached by a larger company about an acquisition, how would you think about the offer and how would you make a decision about what to do?
- Do I want to sell my company?
- Lose executive control? Stay on board? Negotiate pay? Equity in new company?
- Personal balance sheet = want liquidity? Retire and buy a new house? - Purchase price
- Consideration
- Tax considerations
- Cash today
- Equity in new company (stock)
Give some examples of when you might see a negative book value of equity.
- Net loss
- Dividend recap - large dividend
- Share repurchases at a high price
- Large write down
What happens if a company overpays for a target company?
- Aside from Operating performance, goodwill is impaired (if recognized in transaction)
Which are more important, revenue or cost synergies?
Generally, cost synergies are.
- Easier to know which costs are redundant / can be avoided than to know how customers will respond to new products, new brands, how competitors will respond, etc.
How much debt could a company issue in a merger or acquisition?
- Depends on the yield of the company
- Credit markets
- Current capitalization
- PF cash flows and asset value as credit support
How do you determine the purchase price for the target company in an acquisition?
Valution
- DCF, comps, precedents
- If public, pay a premium over the share price
What are some common anti-takeover tactics?
- Poison Pill: give shareholders the right purchase more shares at a discount in the event of a hostile takeover
- Pac Man - try to acquire the buyer
- Golden Parachute - set up a lucrative severance for current management to make the txn very expensive
- Issue new debt to increase debt burden
- Find a white night
If Company A purchases Company B, what does the combined balance sheet look like?
Add them together, and then make adjustments for:
- Cash adj
- New debt, debt refi’d
- PF Goodwill
- Wipe out SHE
- DTL
- Write ups
Would you be able to make an offer to buy a company at its current stock price?
No, unless the shareholders have large blocks and the stock is not traded frequently.
- Control premium
- 52 week high?
- Optimistism
Is there anything else “intangible” besides goodwill/intangibles that could also impact the combined company?
In process R&D
Customer distro lists
Write up of current intangibles
What are some factors to consider when evaluating a target?
- Financial sense (valuation, transaction structure)
- Financial wherewithall
- Cultures
- Industry
- Synergies
- PF debt
- ** regulatory concerns
Company A values B at $400M, but B wants $430M. Company A could use stock to pay the additional $30M. Under what circumstances might Company A agree to the additional $30M?
- Still accretive. Synergies?
- Use debt to reap benefits of DTS
Company A trades at a P/E of 20. Company B trades at a P/E of 10. Both are considering acquiring Company C, which trades at a P/E of 15. For which of the two acquiring companies would the deal be dilutive. For which would it be accretive? Explain why for each.
A: earnings = 5%
B = earnings = 10%
C = earnings = 6.66%
Dilutive for B, cost of equity vs earnings yield
You buy an investment for $100 million, and then you sell it for $100 million.
Dividends and cash flow
Earnout
Sell for shares in a new company and their stock goes up
Spin off vs Split off
Spin off = SH get shares in sub and parent
Split off = SH can pick between shares in either or
