Price + Purchase Methods Flashcards
How do you determine the purchase price for the target company in an acquisition?
use same valuation methods as normal, more so for private sellers
If seller is public company, pay more attention to premium paid over the current share price to make sure it’s sufficient to win shareholder approval
All else being equal, which method would a company prefer to use when acquiring another company – cash, stock, or debt?
Almost always cash:
- cash is cheaper than debt as interest foregone <debt interest usually
- cash cheaper than stock as most companies have P/E multiples in 10-20x range, which = a 5-10% cost of stock
- cash less risky than debt as no chance buyer may fail to raise sufficient funds from investors or buyer default
- cash less risky than stock as buyer’s share price could drop hugely
Cash ‘almost always’ less expensive than debt or stock, why not always
With debt always, as why would a cash pay more on cash deposited than charge for borrowers.
With stock similar, as only not the case if buyer has extremely high P/E multiple, e.g. 100x -> 1% might be lower than the after tax cost of cash - extremely uncommon.
If a company were capable of paying 100% in cash for another company, why would it choose NOT to do so?
Might be saving its cash for something else, or just as backup safety.
- or stock may be trading at an all-time high
How much debt could a company issue in a merger or acquisition?
Look at comparable companies and precedent transactions to determine this.
- use combined company’s EBITDA figure and find EBITDA ratio of companies you’re looking at, and apply that to the company’s own EBITDA figure to get a rough idea of how much debt it could raise
When would a company be MOST likely to issue stock to acquire another company?
- stock trading at an all time high, or just very high
- seller almost as large as buyer, so can’t raise enough debt or use enough cash outright to acquire
Let’s say that a buyer doesn’t have enough cash available to acquire the seller. How could it decide between raising debt, issuing stock, or some combination of those?
Key factors:
- relative cost of debt and stock
- existing debt
- shareholder dilution
- expansion plans may need debt/cash in the future
Let’s say that Company A buys Company B using 100% debt. Company B has a P / E multiple of 10x and Company A has a P / E multiple of 15x. What interest rate is required on the debt to make the deal dilutive
Company A cost of stock = 6.7%
Company B yield = 10%
After tax cost of debt must be above 10% for the acquisition cost to exceed Company B’s yield.
0.1/(1-0.4) = 16.7%, so above roughly 17%, which is rare, so deal almost certainly accretive
Company A has a P / E of 10x, which is higher than the P / E of Company B. The interest rate on debt is 5%. If Company A acquires Company B and they both have 40% tax rates, should Company A use debt or stock for the most accretion?
- company A cost of debt =. 5% x (1-0.4) = 3%
- company A cost of stock = 10%
- company B yield os greater than 10% since P/E is lower
Thus deal will be accretive regardless as yield greater than debt and stock. - however, company A will achieve far more accretion if it uses 100% debt as the cost of debt much lower than the cost of stock
Company A: Enterprise Value of 100, Market Cap of 80, EBITDA of 10, Net Income of 4.
Company B: Enterprise Value of 40, Market Cap of 40, EBITDA of 8, Net Income of 2.
A - EV/EBITDA.= 10x, P/E = 20x
B - EV/EBITDA = 5x, P/E = 20x
Now, Company A decides to acquire Company B using 100% cash. What are the combined EBITDA and P / E multiples?
- A had 60 of debt, 40 of cash
Add market caps of both companies together and then adjust for the cash, debt and stock used
- combines market cap = 120, A had 20 more debt than cash and B equal.
- cash is all gone to acquire B, B dent and cash cancel out
So combined enterprise value = 180.
- add EBITDA and net income to get combined figures
- Combined EV/ EBITDA = 10x
- Combined P/E = 120/6 = 20x
What was the point of this scenario and these questions? What does it tell you about valuation multiples and M&A activity?
Main take is the combined P/E multiple may be much different depending on the purchase method
- EV/EBITDA multiple is NOT affected, ad EBITDA excludes interest income and expense, and enterprise value will always be the same irregardless of method used
Why would a strategic acquirer typically be willing to pay more for a company than a private equity firm would?
Strategic acquirer can realise revenue and cost synergies that the private equity firm can’t, unless it combines the company with a complementary portfolio company, so synergies cancel out higher price.
