WSP - MA Flashcards
Walk me through a simple M&A model
An M&A model takes two companies and combines them into one entity. First, assumptions need to be made about the purchase price and any other uses of funds such as refinancing target debt and paying transaction and financing fees). Then, assumptions about the sources of funds need to be made – will the acquirer pay for the acquisition using cash, take on additional debt or issue equity. Once those basic assumptions are in place, the acquirer’s balance sheet is adjusted to reflect the consolidation of the target.
Certain line items – like working capital can simply be lumped together. Others need a little more analysis – for example, a major adjustment to the combined target and acquirer balance sheet involves the calculation of incremental goodwill created in the transaction, which involves making assumptions about asset write ups, and deferred taxes created or eliminated.
Lastly, deal-related borrowing and pay-down, cash used in the transaction, and the elimination of target equity all need to be reflected.
In addition, the income statements are combined to determine the combined (“pro forma”) accretion/dilution in EPS. This can be done as a bottom’s up analysis – starting from the buyer’s and seller’s standalone EPS and adjusting to reflect incremental interest expense, additional acquirer shares that must be issued, synergies, and incremental depreciation and amortization due to asset write ups.
Alternatively, the accretion dilution can be a top down, whereby the two income statements are combined starting with revenue and working its way down to expenses, while making the deal related adjustments.
Is it better to finance a deal via debt or via stock?
The answer depends on several factors.
From the buyer’s perspective, when the buyer’s PE ratio is significantly higher than the target’s, a stock transaction will be accretive which is an important consideration for buyers and may tilt the decision towards stock. When considering debt, the buyer’s access to debt financing and cost of debt (interest rates) will influence the buyer’s willingness to finance a transaction with debt. In addition, the buyer will analyze the deal’s impact to its existing capital structure, credit rating and credit stats.
From the seller’s perspective, a seller will generally prefer cash (i.e. debt financing) over a stock sale unless tax deferment is a priority for the seller. A stock sale is usually most palatable to the seller in a transaction that more closely resembles a merger of equals and when the buyer is a public company, where its stock is viewed as a relatively stable form of consideration.
