Structure Terms Flashcards
Phase 1 Transaction
Step 1 - Determine the Offer Value
Need to calculate two things - the offer price and the target’s diluted shares outstanding
What is the offer price
Price per share the Acquirer offers the Target in exchange for ownership…based on public comparables, acquisition comparables and DCF
Offer premium
Offer premium = (Offer price / Target customer share price) - 1
Why will acquirer be willing to pay a premium?
Control and Synergies - 1) Control - has salable value and substantial. Gain say in target’s business decision making and previous owners are relinquishing control over the business to you…requiring a premium. 2) Synergies - shareholders demand a premium knowing that there will be financial benefit because of the synergies of the acquisition - economies of scale, consolidating redundant technologies, accounting systems, back office operations and revenue synergies…translating into higher cash flows and profits…and therefore want a piece
Merger of Equals
When the combined entity is owned about equally by Acquirer and Target - no control premium
Risk is a ?
Cost
Control Premium amounts
Generally between 20 - 40% over the Target’s stock price
Offer Value
Offer Value = Offer price per share X Target’s Diluted Shares Outstanding. Diluted shares outstanding can be found via basic share count of common shares plus dilutive securities. The Offer Value is the total consideration offered to the Target shareholders in exchange for their stock equivalent to equity value, however offer value factors in control premium, and the equity value represents the standalone value of the company’s stock.
Offer Value vs Transaction Value
Offer value essentially equivalent to equity value…Transaction value is equivalent to Enterprise value => both are all-inclusive as it factors in all forms of capital to include equity, debt, non-controlling interest, and preferred stock. It measures the size of the entire transaction including the offer value paid to Target’s shareholders along with the assumed liabilities of other capital holders (debt, preferred stock and non-controlling interest)
Determine Consideration Mix - Stock
Acquirer issues stock by issuing new shares of its own stock in exchange for shares of Target. Acquirer matches the value of the offer price with its own shares…Target price is $100 and Acquirer shares are worth $50…Acquirer would issues two of its own shares to Target. Unlike debt, there is no interest expense, and therefore no reduction to earnings and no additional balance sheet risk. However it does dilute the ownership of the acquiring company. Issuing shares can have a more dilutive effect to earnings than using debt.
Impact of Stock considerations
Depending on how much stock is issued, the Target shareholder can wield significant influence in the merged company, becoming an issue if their are significant clashes between Acquirer management and shareholders. Stock deals are tax deferred until ultimate disposition of those shares
Determine Consideration Mix - Cash
Typically the Acquirer will go to the capital markets to borrow debt and uses the proceeds to finance the transaction. Key concern is additional interest expense, reduces earning and shareholder returns and increases balance sheet risk. If the amount of debt borrowed and the accompanying interest expenses too high, the Acquirer may not be able to meeting financial obligations to debt holders leading to default and bankruptcy.
Determine Consideration Mix - Cash & Stock
Mix of two in order to maximize benefit and minimize cons of both.
Impact of Cash deal
Cash represents an immediate and full exit. No upside or downside risk after the merger event. Acquirer will need to borrow the amount promised to Target…and a cash consideration is generally taxed upon distribution to the shareholder.
Two types of Transaction Structures
1) Asset Purchase; and 2) Stock Purchase
When make adjustments, then are generally done on the…?
1) Balance Sheet; and 2) Income Statement
Balance Sheet adjustments…
1) Debt Financing: How much debt (principle payments and interest expense) can the Acquirer take on. 2) Goodwill - New Asset (Purchase accounting)
Income Statement adjustments…
Moves us from Acquirer’s standalone EPS to its pro forma EPS. Adjust for the following after-tax adjustments Benefits 1) Target’s Net Income; and 2) After-Tax Synergies. Costs 1) After-Tax Interest on New Debt; and 2) New Shares Issued.
Benefit - Target Net Income
Gathered from equity research analysts (deal in prelim stages) or Management estimates (deal is further along)…both need to be scrutinized thoroughly - Mgmt will try to inflate to increase the valuation but also understands the inner workings of the business.
Benefit - Revenue Synergies
1) Revenue; and 2) Cost. Revenue - most revenue synergies fail to materialize…they look great on paper…However some do like when a good product is acquired and pushed through strong distribution network. Sometimes excluded because they are illusory
Benefit - Cost Synergies
Analyzing cost structure of the business and eliminating redundant operations, consolidating assets, downsizing personnel, streamlining internal processes, and pursuing other restructuring strategies that generate cash flow. Changes required to achieve these synergies often generate restructuring costs upfront. Example closing a facility may have disposal costs and severance pay for the employees…these are generally non-recurrent and are often excluded when calculating pro forma
Costs
If the Acquirer is paying for 1) Target’s earnings; 2) Merger synergies…Then think of Acquirer’s costs as 3) the interest on acquisition debt; 4) new shares issues; and 5) one-time merger restructuring costs if they happen to be substantial.
Cost of Burrowing requires a credit analysis that depends on the following…
1) the amount of debt being raised as compared to the pro forma cash flows of the combined company; 2) Acquirer and Target’s credit ratings; 3) the size of the Acquirer; 4) the possible cyclicality of the business…All of this is taken from the investment bank debt capital markets desk. Drives the merger’s impact on pro forma EPS through the numerator when cash-financed
New Shares Issued
New shares do not reduce earnings, but they do increase the total number of shares outstanding and thereby reduce the returns to shareholders. Drives the merger’s impact on pro forma EPS through the denominator when stock-financed. The number of new shares the Acquirer must issue, in turn, depends on 1) the percentage of the consideration that’s being financed with stock; and 2) the value of Acquirer’s shares relative to the value of Target’s shares. The higher the price of the Acquirer shares compared to the Target shares, the less that will need to be offered and the less dilutive the deal.
What determines the cost of using stock consideration
The Acquirer’s valuation, relative to the offer value, determines the cost of using stock consideration
Which tax rate to use
If the Acquirer is significantly larger than the Target, use the Acquirer’s. If the Target is larger, use a blended average of the two.
Accretive
Pro Forma EPS > Standalone EPS
Dilutive
Pro Forma EPS < Standalone EPS
Breakeven or EPS Neutral
Pro Forma EPS equal to Standalone EPS
Leverage ratio of combined entity (Income Statement Metric)
EBITDA / Interest Expense => determines whether the company will generate enough operating cash flow to meet is regular interest obligations. The higher the ratio, the better.
Leverage ratio of combined entity (Balance Sheet Metric)
Debt / EBITDA => determines whether the combined company can meet the principal obligations. The higher the ratio, the more risky the deal.
Credit Ratings
Do not cross credit boundaries…could downgrade the company making it more costly to borrow money and hinder the ability to raise capital in the future. Depends on size of the company, operations and the robustness of the macro-economy and prevailing industry conditions.
Goodwill Considerations
Goodwill is an asset, albeit it is an intangible one. It captures the economic benefit of a merger (synergies). If the synergies do not materialize, the company could face a write-down because of impaired goodwill. This would negatively affect the income statement, reduce earnings, and flow through retained earnings to reduce stockholder’s equity. It indicates lower expected profits in the future and that the Acquirer overpaid for the Target. A write-down could cause a company to lower its working capital, causing it to break potential loan covenants. Write downs also lower taxable income.
Tax Consequences
1) Target - based on type of deal…transactions with significant percentage of stock will be tax-deferred (at least 40% stock consideration)…all cash will be taxed. 2) Purchase accounting, goodwill and potential write ups which result in deferred tax liabilities. 3) Transaction structure - depends on whether it is a stock purchase or an asset purchase. This will affect both the Acquirer and the Target
