M&A Deals and Merger Models Review
Questions and Correct Answers
Financial reasons one company might acquire another? ✅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? ✅IP/Patent/Key Tech
Defensive Acquisition
Acqui-Hire (hiring good teams)
Intangibles
Office politicis, ego, pride
Advantages/Disadvantages of Cash ✅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 ✅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 ✅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? ✅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? ✅= % 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 ✅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? ✅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? ✅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? ✅Cash used* interest rate
What tax rate should you use when calculating combined Net Income? ✅the buyer's
because the seller becomes a subsidiary after it is purchased.
How do you calculate Accretion/Dilution? ✅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? ✅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? ✅- 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? ✅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? ✅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? ✅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? ✅Buyer's Equity Value + Value of any stock issued
in deal
Combined Enterprise Value Equation? ✅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? ✅Purchase Methods do not impact them and neither are metrics like
Revenue, EBIT, or EBITDA
Questions and Correct Answers
Financial reasons one company might acquire another? ✅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? ✅IP/Patent/Key Tech
Defensive Acquisition
Acqui-Hire (hiring good teams)
Intangibles
Office politicis, ego, pride
Advantages/Disadvantages of Cash ✅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 ✅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 ✅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? ✅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? ✅= % 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 ✅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? ✅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? ✅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? ✅Cash used* interest rate
What tax rate should you use when calculating combined Net Income? ✅the buyer's
because the seller becomes a subsidiary after it is purchased.
How do you calculate Accretion/Dilution? ✅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? ✅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? ✅- 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? ✅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? ✅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? ✅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? ✅Buyer's Equity Value + Value of any stock issued
in deal
Combined Enterprise Value Equation? ✅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? ✅Purchase Methods do not impact them and neither are metrics like
Revenue, EBIT, or EBITDA
