Qs for 1 & 2

Question 1

Walk me through a merger model?

Answer 1

• 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

Question 2

When is a deal accretive?

Answer 2

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)

Question 3

When is a deal dilutive?

Answer 3

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)

Question 4

What does Weighted Cost of Acquisition really mean?

Answer 4

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.

Question 5

What is a detailed formula for weighted cost of acquisition?

Answer 5

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

Question 6

What does the buyer lose in an acquisition?

Answer 6

foregone interest from cash, interest to be paid on new debt, costs new stock

Question 7

How does EPS capture full impact of deal?

Answer 7

• foregone interest on cash
• interest paid new debt
• new shares issued

Question 8

Why not use EBITDA or UCFC over EPS?

Answer 8

• 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

Question 9

How to calculate purchase price for a public co?

Answer 9

• 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

Question 10

How to calc purchase price for a private co?

Answer 10

valuation methods
b/c no easy to determine share price- link to EBITDA/ EBIT Rev

Question 11

Pros of using cash to fund deal?

Answer 11

• cheapest
• earn little interest income on it so don’t lose much by using
• fast, easy

Question 12

Cons of using cash?

Answer 12

• limits buyers flexibility if it needs the cash for smth else soon

Question 13

Pros of using debt?

Answer 13

• cheaper than stock but more expensive than cash

Question 14

Cons of using debt?

Answer 14

• more time to close deal b/c need to market new debt to investors
• additional debt makes future debt issuances more difficult and expensive

Question 15

Cons of stock

Answer 15

• dilutes buyer existing investors

Question 16

Pros of stock?

Answer 16

• prevents buyer from paying additional cash expense for deal

Question 17

How much cash can a co issue to fund a deal?

Answer 17

• use all but minimum cash

Question 18

How much debt can a co issue to fund a deal?

Answer 18

can raise debt to a level where Debit/EBITDA and EBITDA/Interest ratios are in line w peer companies

Question 19

How much stock can co issue to fund a deal?

Answer 19

• no limit, but only to a level where deal is accretive

Question 20

Why in calculating COE here we use inverse P/E? why not risk free rate, beta and equity risk premium?

Answer 20

Different uses
- b/c COE for M&A is about EPS impact
- CAPM is based on annualized returns

Question 21

When might it be cheaper to use equity to fund deal?

Answer 21

If trading at a high enough PE multiple

Question 22

When is EPS accretion/ dilution not impt?

Answer 22

• buyer private
• buyer has -ve EPS
• buyer far bigger than seller eg. 10 to 100x

Question 23

When EPS accretion/ dilution doesn’t matter, how do you gauge success of deal?

Answer 23

• qualitative merits
• IRR vs DR
• seller + synergies vs equity purchase price
• contribution analysis
• value creation analysis

Question 24

M vs A- methods of acquisition?

Answer 24

100% or majority stock deals more common in mergers
b/c similarly sized cos don’t use cash/ debt to acquire each other

Question 25

Main problems w merger models?

Answer 25

• 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

Question 26

What is the typical premium?

Answer 26

20 to 30%

Question 27

In general, which is more accretive- all cash deals or all stock deals?

Answer 27

all cash

Question 28

What incentives are offered to seller when u wanna buy, besides premium?

Answer 28

eg. employment contracts, significant management roles for seller, bonuses

Question 29

What is due diligence?

Answer 29

• process to uncover risks, issues, opps in target/ deal
• examine official statements, execs, financial projection
• substantiate all claims that are material to transaction

Question 30

what’s an example of a revenue synergy?

Answer 30

cross selling

Question 31

Why would a co pay cash/ stock/ both when acquiring co?

Answer 31

• 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)