M&A Modeling Exam
Financial reasons one company might acquire another? - ANSWER Economies of
scale
Geographic expansion
Gain Market Share
Seller is Undervalued
Acquire Customers or Distribution Channels
Tax Reductions
Product Expension/Diversification
"Fuzzy" reasons for M&A? - ANSWER IP/Patent/Key Tech
Defensive Acquisition
Acqui-Hire (hiring good teams)
Intangibles
Office politicis, ego, pride
Advantages/Disadvantages of Cash - ANSWER Advantages: typically cheapest
method (interest earned on cash is typically low). Seller gets cash immediately so
don't have to deal with financing.
Disadvantages: Seller gets taxed immediately and seller can't take advantage of
potential upside of buyer stock
Advantages/Disadvantages Debt - ANSWER Advant.:Cheaper than stock and
seller gets cash immediately
Disadvant.: Increased debt for company, financing can be expensive and time
consuming, Seller still gets taxed immediately, no upside of buyer stock for seller
Advantages/Disadvantages Stock - ANSWER Advant.: Can be cheaper if buyer has
high stock price and P/E multiple, can be faster then debt financing, seller gets to
participate in potential upside of buyer's stock price, seller isn't taxed until stock is
sold
Disadvant.: More risk for seller since buyer share price could change, there may be
lock-up periods for the stock and the seller might have to hold it for a long time
before selling, fixed shares vs. fixed value could make a big impact on seller if the
buyer's share price changes a lot.
Two ways of determining Cost of Equity in Merger Model? - ANSWER 1. Buyer Net
Income/Buyer Equity Value
2. the reciprocal of the Buyer's P/E multiple
Different than WACC because you are looking at Cost of Equity in terms of its impact
on the company's EPS, not the company's overall discount rate.
,Weighted Cost of Acquisition Equation? - ANSWER = % Cash Used*After-Tax Cost
of Cash + %Debt Used*After-Tax Cost of Debt + %Stock Used*After-Tax Cost of
Stock
Seller's "Yield" Equation - ANSWER Net Income/Purchase Equity Price
The Yield is how much Net Income you get for each $1 spent on Company B's stock.
When is a deal accretive/dilutive/neutral based on Weighted Cost of Acquisition &
Seller's Yield? - ANSWER WCA < Yield: Accretive
WCA = Yield: Neutral
WCA > Yield: Dilutive
When company A is paying less than what Company B is yielding then the deal is
accretive.
When is a deal accretive/dilutive/neutral in a 100% stock deal? - ANSWER Buyer
P/E > Seller P/E at Purchase Price: Accretive
Buyer P/E = Seller's P/E at Purchase Price: Neutral
Buyer P/E < Seller's P/E at Purchase Price: Dilutive
When the Buyer is paying less than what the Seller is yielding, EPS will be boosted
How do you calculate Forgone Interest on Cash? - ANSWER Cash used* interest
rate
What tax rate should you use when calculating combined Net Income? - ANSWER
the buyer's because the seller becomes a subsidiary after it is purchased.
How do you calculate Accretion/Dilution? - ANSWER Subtract the Standalone EPS
from the Combined EPS and divide it by the Combined to get a %.
You can also subtract Standalone from Combined to get a $ value
Why might EPS not always be a meaningful metric? - ANSWER If company is
private they may not care and if acquirer has negative Net Income they it also may
not care.
Issues with merger models? - ANSWER - Net Income and cash flow are very
different so something based on EPS might look great, but based on cash flow look
horrible
- Merger models don't capture risk of M&A deals; All cash deals would need massive
differences in Seller's EPS being above buyer's to be dilutive
, - Merger models don't reflect qualitative factors like cultural fit, the ability of
management to work together, etc., but they are critical for the deal to work.
Main factors that impact "Purchase Price" above buying a target's shares? -
ANSWER 1. Treatment of the Seller's Existing Debt
2. Treatment of Seller's Existing Cash
3. Transaction Fees, Unfunded Pensions, and Other Items
What happens to Purchase Price when a Buyers pays off all of Seller's debt as
opposed to replacing their Debt with new Debt? - ANSWER Repays:
Seller projected Interest Expense (and principal repayments) go away & Buyer's
projected Interest Income decreases because of Cash decreasing.
The debt repayment causes an increase in purchase price.
Replacing Debt:
Seller's projected Interest Expense remains, but might have different interest rate on
new debt. Buyer's projected Interest Income remains because Cash does not
change.
In most cases, Buyer will use this option, may impact interest but does not increase
what buyer "really pays"
How do you determine a maximum purchase price for a company? - ANSWER
Many ways but one is all available cash (total - minimum balance) plus amount of
Debt that will take you to Debt EBITDA ration reasonable limit, plus the maximum
amount of stock that can be issued without the deal becoming dilutive.
Combined Equity Value Equation? - ANSWER Buyer's Equity Value + Value of any
stock issued in deal
Combined Enterprise Value Equation? - ANSWER Combined Equity Value + Debt -
Cash (and other non-core business Assets) of combined company including Cash
and Debt used to fund the deal.
OR
= Acquirer's Current Enterprise Value + Seller's Purchase Enterprise Value
What happens to combined Enterprise Value-Based multiples with different payment
structures? - ANSWER Purchase Methods do not impact them and neither are
metrics like Revenue, EBIT, or EBITDA
What happens to combined Equity Value-Based multiples with different payment
structures? - ANSWER Purchase methods will change because Combined Equity
Value changes based on the amount of Stock used and the Combined Net Income
changes based on the amount of Cash and Debt used and the interest on them.
7 steps to create a merger model? - ANSWER 1. Project the Financial Statements
of the Buyer and Seller
Financial reasons one company might acquire another? - ANSWER Economies of
scale
Geographic expansion
Gain Market Share
Seller is Undervalued
Acquire Customers or Distribution Channels
Tax Reductions
Product Expension/Diversification
"Fuzzy" reasons for M&A? - ANSWER IP/Patent/Key Tech
Defensive Acquisition
Acqui-Hire (hiring good teams)
Intangibles
Office politicis, ego, pride
Advantages/Disadvantages of Cash - ANSWER Advantages: typically cheapest
method (interest earned on cash is typically low). Seller gets cash immediately so
don't have to deal with financing.
Disadvantages: Seller gets taxed immediately and seller can't take advantage of
potential upside of buyer stock
Advantages/Disadvantages Debt - ANSWER Advant.:Cheaper than stock and
seller gets cash immediately
Disadvant.: Increased debt for company, financing can be expensive and time
consuming, Seller still gets taxed immediately, no upside of buyer stock for seller
Advantages/Disadvantages Stock - ANSWER Advant.: Can be cheaper if buyer has
high stock price and P/E multiple, can be faster then debt financing, seller gets to
participate in potential upside of buyer's stock price, seller isn't taxed until stock is
sold
Disadvant.: More risk for seller since buyer share price could change, there may be
lock-up periods for the stock and the seller might have to hold it for a long time
before selling, fixed shares vs. fixed value could make a big impact on seller if the
buyer's share price changes a lot.
Two ways of determining Cost of Equity in Merger Model? - ANSWER 1. Buyer Net
Income/Buyer Equity Value
2. the reciprocal of the Buyer's P/E multiple
Different than WACC because you are looking at Cost of Equity in terms of its impact
on the company's EPS, not the company's overall discount rate.
,Weighted Cost of Acquisition Equation? - ANSWER = % Cash Used*After-Tax Cost
of Cash + %Debt Used*After-Tax Cost of Debt + %Stock Used*After-Tax Cost of
Stock
Seller's "Yield" Equation - ANSWER Net Income/Purchase Equity Price
The Yield is how much Net Income you get for each $1 spent on Company B's stock.
When is a deal accretive/dilutive/neutral based on Weighted Cost of Acquisition &
Seller's Yield? - ANSWER WCA < Yield: Accretive
WCA = Yield: Neutral
WCA > Yield: Dilutive
When company A is paying less than what Company B is yielding then the deal is
accretive.
When is a deal accretive/dilutive/neutral in a 100% stock deal? - ANSWER Buyer
P/E > Seller P/E at Purchase Price: Accretive
Buyer P/E = Seller's P/E at Purchase Price: Neutral
Buyer P/E < Seller's P/E at Purchase Price: Dilutive
When the Buyer is paying less than what the Seller is yielding, EPS will be boosted
How do you calculate Forgone Interest on Cash? - ANSWER Cash used* interest
rate
What tax rate should you use when calculating combined Net Income? - ANSWER
the buyer's because the seller becomes a subsidiary after it is purchased.
How do you calculate Accretion/Dilution? - ANSWER Subtract the Standalone EPS
from the Combined EPS and divide it by the Combined to get a %.
You can also subtract Standalone from Combined to get a $ value
Why might EPS not always be a meaningful metric? - ANSWER If company is
private they may not care and if acquirer has negative Net Income they it also may
not care.
Issues with merger models? - ANSWER - Net Income and cash flow are very
different so something based on EPS might look great, but based on cash flow look
horrible
- Merger models don't capture risk of M&A deals; All cash deals would need massive
differences in Seller's EPS being above buyer's to be dilutive
, - Merger models don't reflect qualitative factors like cultural fit, the ability of
management to work together, etc., but they are critical for the deal to work.
Main factors that impact "Purchase Price" above buying a target's shares? -
ANSWER 1. Treatment of the Seller's Existing Debt
2. Treatment of Seller's Existing Cash
3. Transaction Fees, Unfunded Pensions, and Other Items
What happens to Purchase Price when a Buyers pays off all of Seller's debt as
opposed to replacing their Debt with new Debt? - ANSWER Repays:
Seller projected Interest Expense (and principal repayments) go away & Buyer's
projected Interest Income decreases because of Cash decreasing.
The debt repayment causes an increase in purchase price.
Replacing Debt:
Seller's projected Interest Expense remains, but might have different interest rate on
new debt. Buyer's projected Interest Income remains because Cash does not
change.
In most cases, Buyer will use this option, may impact interest but does not increase
what buyer "really pays"
How do you determine a maximum purchase price for a company? - ANSWER
Many ways but one is all available cash (total - minimum balance) plus amount of
Debt that will take you to Debt EBITDA ration reasonable limit, plus the maximum
amount of stock that can be issued without the deal becoming dilutive.
Combined Equity Value Equation? - ANSWER Buyer's Equity Value + Value of any
stock issued in deal
Combined Enterprise Value Equation? - ANSWER Combined Equity Value + Debt -
Cash (and other non-core business Assets) of combined company including Cash
and Debt used to fund the deal.
OR
= Acquirer's Current Enterprise Value + Seller's Purchase Enterprise Value
What happens to combined Enterprise Value-Based multiples with different payment
structures? - ANSWER Purchase Methods do not impact them and neither are
metrics like Revenue, EBIT, or EBITDA
What happens to combined Equity Value-Based multiples with different payment
structures? - ANSWER Purchase methods will change because Combined Equity
Value changes based on the amount of Stock used and the Combined Net Income
changes based on the amount of Cash and Debt used and the interest on them.
7 steps to create a merger model? - ANSWER 1. Project the Financial Statements
of the Buyer and Seller
