Special Cases

Question 1

Normally we create Goodwill because we pay more for a company than
what its Shareholders’ Equity says it’s worth. But what if the opposite happens? What if we paid $1000 in Cash for a company, but its Assets were worth $2000 and its Liabilities were worth $800?

Answer 1

First try reverse any write ups to assets to get back to positive goodwill.
IS: 200 gain pre tax, 120 gain post tax
CFS: net income up 120, - 200, so cash down 80, -1000 CFI, so cash down 1080
BS: cash down 1080, assets up 2000, liabilities 800, net income 120, so balance.

Question 2

What if SE is negative

Answer 2

Nothing different, still wipe it out, allocate Purchase Price, and create goodwill

Question 3

How would an accretion / dilution model be different for a private seller

Answer 3

Same mechanics, but likely to be asset purchase transaction structure
- private sellers dont have EPS, so only project down to Net Income on seller’s IS
- accretion/ dilution analysis not needed if private buyer as they dont have EPS

Question 4

Explain what a contribution analysis is and why we might look at it in a merger model.

Answer 4

Compares how much revenue, EBITDA, pre-tax income, cash etc buyer and seller contributing to estimate what the ownership of the combined company should be
- if ones sliding more revs, should own more na?
Most common to look at this with merger of equals scenarios.

Question 5

How would I calculate “break-even synergies” in an M&A deal and what does the number mean?

Answer 5

Set EPS accretion/ dilution to 0 and then back-solve in Excel to get the required synergies to make the deal neutral to EPS
- important to get an idea of whether or not a deal works maths wise, and a high number of break-even synergies tells you need a LOT of cost or revenue synergies to make it work

Question 6

Normally in an accretion / dilution model you care most about combining both companies’ Income Statements and Balance Sheets. But let’s say I want to combine all 3 financial statements – how would I do this?

Answer 6

1. Combine BS first, wipe out seller’s SE
2. Make necessary adjustments
3. Project combined balance sheet
4. Combine and project the income statement
5. Then project the CFS and link everything together
   Only look at combined IS and CFS immediately after the acquisition and into future years.

Question 7

Can you explain what “Pro Forma” numbers are in a merger model?

Answer 7

Pro forma numbers exclude non-cash acquisition effects

Question 8

If you’re looking at a reverse merger (i.e. a private company acquires a public company), how would the merger model be different?

Answer 8

Mechanically the same.
- difference is that accretion / dilution is not meaningful if it’s a private company as it doesn’t have an EPS number, so place more weight on a contribution analysis or IRR of acquisition.