Qs for 1 & 2 Flashcards
Walk me through a merger model?
- project financial statements of both
- calculate puchase price
- calculate mix of stock debt equity
- create sources & uses schedule and purchase price allocation schedule to estmate true cost of acq, funding and after effects
- combine BS- reflect cash debt stock used, goodwill, write ups/ downs
- combine IS- incl foregone interest on cash, interest paid on new debt, synergies
- calculate combined NI (combined pretax income x (1-buyers tax rate)
- calculate combined eps = buyers existing share count + new shares
- calculate accretion/ dilution= combined EPS/buyer standalone EPS
When is a deal accretive?
when pretax income from seller (sellers yield in not % form) > cost of acquisition (wca not weighted lol) (foregone interest from cash, interest to be paid on new debt, new stock issued)
When is a deal dilutive?
when pretax income from seller (sellers yield not in % form) < cost of acquisition (wca not weighted lol) (foregone interest from cash, interest to be paid on new debt, new stock issued)
What does Weighted Cost of Acquisition really mean?
How much the seller has given up in %terms in foregone interest from cash, interest to be paid on new debt, new stock issued for the deal to go forward.
What is a detailed formula for weighted cost of acquisition?
Foregone Interest Rate on Cash * (1 – Buyer’s Tax Rate) * % Cash + Interest Rate on Debt * (1 – Buyer’s Tax Rate) * % Debt + 1 / (Buyer’s P / E Multiple) * % Stock
What does the buyer lose in an acquisition?
foregone interest from cash, interest to be paid on new debt, costs new stock
How does EPS capture full impact of deal?
- foregone interest on cash
- interest paid new debt
- new shares issued
Why not use EBITDA or UCFC over EPS?
- more accurately approx cash flow and core biz value
but - don’t reflect deal’s full impact b/c exclude net interest and effect of new shares
How to calculate purchase price for a public co?
- calc seller’s current share price
- add a premium
- check this figure by looking at precedent transactions’, DCF etc.
- check the premium by precedent transactions’ premiums
How to calc purchase price for a private co?
valuation methods
b/c no easy to determine share price- link to EBITDA/ EBIT Rev
Pros of using cash to fund deal?
- cheapest
- earn little interest income on it so don’t lose much by using
- fast, easy
Cons of using cash?
- limits buyers flexibility if it needs the cash for smth else soon
Pros of using debt?
- cheaper than stock but more expensive than cash
Cons of using debt?
- more time to close deal b/c need to market new debt to investors
- additional debt makes future debt issuances more difficult and expensive
Cons of stock
- dilutes buyer existing investors
Pros of stock?
- prevents buyer from paying additional cash expense for deal
How much cash can a co issue to fund a deal?
- use all but minimum cash
How much debt can a co issue to fund a deal?
can raise debt to a level where Debit/EBITDA and EBITDA/Interest ratios are in line w peer companies
How much stock can co issue to fund a deal?
- no limit, but only to a level where deal is accretive
Why in calculating COE here we use inverse P/E? why not risk free rate, beta and equity risk premium?
Different uses
- b/c COE for M&A is about EPS impact
- CAPM is based on annualized returns
When might it be cheaper to use equity to fund deal?
If trading at a high enough PE multiple
When is EPS accretion/ dilution not impt?
- buyer private
- buyer has -ve EPS
- buyer far bigger than seller eg. 10 to 100x
When EPS accretion/ dilution doesn’t matter, how do you gauge success of deal?
- qualitative merits
- IRR vs DR
- seller + synergies vs equity purchase price
- contribution analysis
- value creation analysis
M vs A- methods of acquisition?
100% or majority stock deals more common in mergers
b/c similarly sized cos don’t use cash/ debt to acquire each other
Main problems w merger models?
- NI and CF are diff, so EPS deals might be bad from a CF perspective
- don’t capture true risk in M&A eg. bad integration, shareholder revolt
- don’t consider what if buyer/ seller share price significantly before deal closes
What is the typical premium?
20 to 30%
In general, which is more accretive- all cash deals or all stock deals?
all cash
What incentives are offered to seller when u wanna buy, besides premium?
eg. employment contracts, significant management roles for seller, bonuses
What is due diligence?
- process to uncover risks, issues, opps in target/ deal
- examine official statements, execs, financial projection
- substantiate all claims that are material to transaction
what’s an example of a revenue synergy?
cross selling
Why would a co pay cash/ stock/ both when acquiring co?
- greater the stock issuance, greater ownership acquirer has given up (dilution) -> might not be happy if stock is currently undervalued
- cash transaction: acquiring shareholders take all the risk that the expected synergy value in acq premium won’t materialize
- stock: this risk is spread and shared w acquired shareholders as well
depends on how accretive transaction will be b/c diff mixes impact accretion
- cash deal: additional earnings (saving cash) vs cost of additional debt (using cash)
- stock deal: additional earnings (saving cash) vs dilution (using stock)
