M&A Exam Questions and Correct
Answers
If a company trades at a forward PE of 20.0x, and acquires a company trading at a
forward PE of 13.0x. Assuming the deal is 100% stock-for-stock, and a 20% premium is
being offered, will the deal be accretive in year 1? ✅Yes: stock for stock deals where
the acquirer's PE is higher than target's are always accretive. Don't get tricked - a 20%
premium just brings the target's PE to 13 + (13 x 20%) = 15.6 PE, still below the
acquirer's.
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 paydown, 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.
What are some reasons that a company might acquire another company? ✅Reasons
to acquire another company include: Accelerate time to market with new products and
channels, Remove competition (buying a competitor is called horizontal integration),
Achieve supply chain efficiencies (buying a supplier or customer is called vertical
integration)
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.
What are synergies? Why are they important in a deal? What are some examples of
synergies? ✅Synergies are cost savings or incremental revenues arising from an
acquisition. They are important because if any acquirer believes synergies can be
realized, it would be willing to pay higher premiums. Examples of synergies are cost
savings from eliminating overlapping workforces, closing redundant facilities, lower
costs due to scale, cross selling opportunities, etc.
What does accretion/dilution analysis tell you about the attractiveness of a transaction?
✅From a valuation perspective, an accretive deal is not necessarily indicative of value
creation for the acquirer and vice versa for dilutive deals. However, significant accretion
or dilution is often perceived by buyers (and public company buyers in particular) as an
indication of potential investor reaction to the transaction. Specifically, dilutive deals are
feared by buyers to lead to decline in their share price after announcement. This fear is
rooted in the notion that investors will apply the pre-deal PE ratio to the now-lower pro
forma EPS. These concerns, while quite valid when viewed through the prism of buyers'
short-term concerns about meeting EPS targets, or not actually relevant to whether a
deal actually creates long term value for the acquiring company's shareholders, which is
a function of intrinsic value of the newly combined company.
How do you calculate offer value? ✅The offer value in the context of M&A refers to the
equity purchase price being offered by the buyer to acquire the seller. Like equity value,
offer value is calculating by multiplying fully diluted shares outstanding (including
options and convertible securities) times the offer price per share.
How do you calculate transaction value? ✅Transaction value in the M&A context refers
to the target's implied enterprise value given the offer vale. As such, the transaction
value equals the target offer value plus the target's net debt.
Why should companies acquired by a strategic acquirer expect to fetch higher
premiums than those selling to private equity buyers? ✅Strategic buyers may be able
to benefit from synergies, which enable them to offer a higher price.
What are the most common balance sheet adjustments in an M&A model? ✅In an
M&A analysis, some acquirer and target balance sheet line items can simply be lumped
together. However, there are some line items that need to be adjusted to reflect both
deal-related accounting and funding adjustments.
On the accounting side:
-Goodwill: Eliminate pre-deal target goodwill and create new goodwill from the deal
