M&A, Merger Models: Concepts and Overview CORRECT 100%
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Module
M&A, Merger Models
Institution
M&A, Merger Models
1. Why would one company want to buy another company? - ANSWER One company will want to buy another company if it believes it will be better off after the acquisition takes place. For example:
• The Seller's asking price is less than its Implied Value, i.e. the Present Value of its future cas...
M&A, Merger Models: Concepts and Overview CORRECT 100%
1. Why would one company want to buy another company? - ANSWER One
company will want to buy another company if it believes it will be better off after
the acquisition takes place. For example:
• The Seller's asking price is less than its Implied Value, i.e. the Present Value of its
future cash flows.
• The Buyer's expected IRR from the acquisition exceeds its WACC. Buyers often
acquire Sellers to save money via consolidation and economies of scale, to grow
geographically or gain market share, to acquire new customers or distribution
channels, and to expand their products.
- Deals are also motivated by competition, office politics, and ego.
2. How can you analyze an M&A deal and determine whether or not it makes
sense? - ANSWER - The qualitative analysis depends on the factors above: Could
the deal help the company expand geographies, products, or customer bases, give
it more intellectual property, or improve its team?
- The quantitative analysis might include a valuation of the Seller to see if it's
undervalued, as well as a comparison of the expected IRR to the Buyer's WACC.
- Finally, EPS accretion/dilution is very important in most deals because few
Buyers want to execute dilutive deals; investors focus tremendously on near-term
EPS, so dilutive deals tend to make companies' stock prices decline.
, 3. Walk me through a merger model (accretion/dilution analysis). - ANSWER - In a
merger model, you start by projecting the financial statements of the Buyer and
Seller. Then, you estimate the Purchase Price and the mix of Cash, Debt, and Stock
used to fund the deal. You create a Sources & Uses schedule and Purchase Price
Allocation schedule to estimate the true cost of the acquisition and its effects.
- Then, you combine the Balance Sheets of the Buyer and Seller, reflecting the
Cash, Debt, and Stock used, new Goodwill created, and any write-ups. You then
combine the Income Statements, reflecting the Foregone Interest on Cash,
Interest on Debt, and synergies. If Debt or Cash changes over time, your Interest
figures should also change.
- Combined Net Income = Combined Pre-Tax Income * (1 - Buyer's Tax Rate)
- Combined EPS = Combined Net Income / (Buyer's Existing Share Count + New
Shares Issued in the Deal)
- You calculate the accretion/dilution = (Combined EPS / Buyer's standalone EPS) -
1.
4. Why might an M&A deal be accretive or dilutive? - ANSWER A deal is accretive
if the extra Pre-Tax Income from a Seller > the cost of the acquisition in the form
of Foregone Interest on Cash, Interest Paid on New Debt, and New Shares Issued.
- Ex) if the Seller contributes $100 in Pre-Tax Income, but the deal costs the Buyer
only $70 in Interest Expense, and it doesn't issue any new shares, the deal will be
accretive because the Buyer's Earnings per Share (EPS) will increase.
A deal will be dilutive if the opposite happens.
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