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? - ANSWER Yes: stock for stock deals where the acquirer's PE is higher than tar...
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? - ANSWER 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. - ANSWER 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? - ANSWER 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? - ANSWER 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? -
ANSWER 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? - ANSWER
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? - ANSWER 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? - ANSWER 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? - ANSWER Strategic buyers may be able to benefit from synergies,
which enable them to offer a higher price.
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