M&A

Question 1

Reasons for M&A?

Answer 1

• Diversification
• Horizontal Expansion (related businesses)
• Vertical Expansion (along value chain)
• Synergies
• Economies of Scale
• Acquisition of new technologies
• LBO
• Target undervalued
• Irrational reasons (Imperialism,…)

Question 2

What drives M&A activity?

Answer 2

• Synergies
• Need to acquire new tech
• Grow share in market/remove competitor
• Buying supplier or distributor to increase pricing power
• Improve financial metrics

Question 3

Sort valuations from highest to lowest valuation:

Answer 3

• Precedent transactions (company pays control premium)
• DCF (frequently optimistic; sensitive terminal value)
• Market Comps
• Market Valuation (just equity, no premiums)

Question 4

Ways to value a company:

Answer 4

• Comparables/Multiples
• Market Valuation/Capitalization
• DCF

Question 5

Why would company issue equity rather than debt?

Answer 5

• If share price is inflated, they can raise more money
• If CF from coming investments to immediately produce profit, they can finance themselves longer term
• Adjust cap structure or pay down debt
• If owners want to sell portion

Question 6

Reasons for sale of company?

Answer 6

• Not core business anymore
• Restructuring after over indebtedness
• Elimination of negative synergies
• Sale of family run business without offspring
• Split of conglomerates
• End of an LBO
• Antitrust forces split of company

Question 7

What are EOS?

Answer 7

With larger size, fixed costs get distributed across more “individual parts” of business. Transform business better through larger size.

Question 8

More horizontal or vertical mergers?

Answer 8

Horizontal a lot more; trend in business to focus on what you can do best; stick to own qualities

Question 9

3 opportunities to sell company

Answer 9

• Trade Sale (sell to strategic investor)
• IPO
• Spin-Off

Question 10

Which types of processes are there in M&A?

Answer 10

• Friendly takeover
• Hostile takeover
• Merger of equals

Question 11

What’s a Pitch Book?

Answer 11

PowerPoint presentation designed to win new business. The pitch is typically an explanation of why the bank in question is best suited to lead the transaction and why they should be engaged by the client.

Question 12

What is included in a Pitch Book?

Answer 12

• Title page: Logos, date, title
• Table of Contents
• Executive Summary: Reason for pitch and call to action
• Team & Bank Intro: introduce people at meeting
• Market Overview: Charts and graphs
• Marketing Strategy
• Equity Story
• Valuation: Comps/Prec. Transaction/DCF on Football Field
• Transaction Strategy: IPO/acquisition/sale; primary/secondary
• Structure of Banking Syndicate: Global Coordinator(s), Joint Bookrunner, Co-Leads
• Timeline
• Summary: Why relevant; how market environment suitable; why valuation is achievable
• Appendix: Mostly backup information on potential questions

Question 13

Main points of Sell-Side process

Answer 13

• Identify universe of potential buyers
• Valuation of company
• Preparation of auction process or direct bilateral discussion with buyer, if high potential of actual transaction
• Advisory of seller about potential alternatives (IPO, Spin-Off,…)
• Preparation of Marketing Materials (Equity Story, Teaser, Info Memo, Management Presentation)
• Help on preparation of Vendor Due Diligence
• Discussion of final due diligence with remaining potential buyers
• Signing of Sales & Purchase Agreements

Question 14

Main points of Buy-Side process

Answer 14

• Search for potential acquisition target
• Help on strategic review
• First communications with targets and preparation of LOI (letter of intent)
• Valuation of company
• Due diligence on basis of Vendor Due Diligence
• Risk analysis on potential other bidders
• Preparation of submission of first bid
• If successful and still intent to buy: Preparation of detailed due diligence
• Working out financing
• Discussion and signing of Sales & Purchasing Agreement with final bid

Question 15

What is a Vendor Due Diligence?

Answer 15

Less detailed due diligence from target for all potential buyers to start from when working on their own (much more detailed) due diligence. Risks of a VDD are bias, conflicts of interest, etc.

Question 16

Important documents of M&A process?

Answer 16

• NDA: to receive more detailed information upon assurance of no further distribution
• Teaser: short information overview to attract attention from potential buyer
• Information Memorandum: detailed company info (50-100 pages)
• Management Presentation: ~100 slides about management
• Process Letter: Sent from sell-side IB to all potential buyers to explain process structure and timeline
• Letter of Intent (LOI): document signed by both parties; not legally binding; about agreements on M&A deal to efficiently continue discussion
• Term Sheet: Another name for LOI
• Sales & Purch. Agreement (SPA): final agreement on basis of LOI; legally binding

Question 17

How do you evaluate if M&A deal makes sense or not?

Answer 17

Very complex and encompasses a lot of factors but the three most important considerations are:

• Strategy: Long-term benefits? EOS? New Technologies?
• Shareholder Value: Is Shareholder Value optimized? I.e. NPV>0
• Finances: Capital structure; EPS; Risks

Question 18

What are the main chapters in an SPA?

Answer 18

• Preamble: Short Overview of included parties
• (Definition of Terms): Explaining words etc.
• Target: What is bought? Share Deal or Asset Deal?
• Closing Conditions: What are the prerequisites for successful transaction
• Covenants: Which duties does the seller take on between Signing and Closing?
• Transaction price: EV
• Transaction price adjustments: Via EV-Equity Bridge adjusting for some metrics
• Representations & Warranties of Seller: Assuring correctness of info like VDD
• Representations & Warranties of Buyer: Assuring correctness of buyer’s materials
• Indemnification: Assurance of seller being responsible for damage happening after transaction

Question 19

What are examples of revenue and cost synergies?

Answer 19

Revenue:

• Higher prices as a result of better bargaining power
• Cross-Selling of products
• Easier expansion into newer markets

Cost:

• Usage of fewer plants (only one headquarter, etc.)
• EOS in acquisition of new inventory
• Consolidation of employees

Question 20

Does a consolidation or diversification have more EOS?

Answer 20

Consolidation, as it is more similar by definition and therefore more opportunity to use same resources.

Question 21

Are Cost- or Revenue-Synergies more important?

Answer 21

Cost, as they are much more quantifiable and plannable

Question 22

How do you determine if a transaction is an asset or share deal?

Answer 22

A share deal is when a company’s stock is bought. An asset deal is when all assets are bought and integrated in buyer company. Which one makes more sense is depending on situation. Things to consider:
Share Deal:
- After takeover, entire ownership is automatically transferred
- Therefore, object of transaction is easily identified
- If real estate is included in the juristic shell, no RETT (RE transfer tax) has to be paid
- Detailed DD necessary because not only all assets but also all liabilities are bought
- No changes for employees
- Extensive regulatory approvals necessary (Management, Shareholders, Board etc.)
Asset Deal:
- Process more complex as every single asset is acquired and not company as a whole
- Buyer can choose assets that he wants and leave others out
- Real estate is taxed as assets change owner
- Certain liabilities are not necessarily transferred (but rather rare in practice as buyer can’t just leave liabilities back)
- Employees also make transition. It is not possible to leave them back in old company
- Generally, less approvals necessary as “only” plants and equipment are sold instead of company itself

Question 23

Are there more asset or share deals?

Answer 23

Share Deals by a lot. Asset Deals are mostly happening in distressed and insolvency situations. Share Deal is simpler as a clearly defined object is sold.

Question 24

When will a company prefer to pay in cash (Cash Deal) and when in stock (Share Deal)?

Answer 24

• Cash Deal requires enough cash on BS or possibility to acquire
• Valuation of target and own company. If own company is overvalued, it might be worth doing a Share Deal. If target is undervalued, it is worth doing a Cash Deal as you could realize all gains from difference to FMV which you otherwise would have to share with shareholders.

Question 25

What are pros and cons of Share- and Cash-based Deals?

Answer 25

- Share deals are much more complex than just paying cash - Share deals very influential on whether deal is accretive or dilutive - Share deal good if own stock is overvalued (more money) but these profits also have to be shared with shareholders

Question 26

FMV of a company is at €2.3b. Buyer decides to buy €2.4m. What could be reasons for this?

Answer 26

FMV not objectively measurable. Buyer could have a lot of synergy possibilities with target

Question 27

What’s the difference between signing and closing in an M&A process?

Answer 27

Signing is when SPA is signed. Transaction is thereby approved by both parties and legally binding. M&A process however isn’t finished yet and company only goes from seller to buyer after closing. Closing happens after all “Conditions Precedent” are fulfilled. CPs are the things that both parties still have to do (payment of acq. price; cartel things etc.)

Question 28

Which risks occur for a buyer of a company between signing and closing and how can they be mitigated?

Answer 28

After signing, deal is legally binding and acquisition price is set. Seller however retains company until closing and could put the company at risk during this time. Usually, seller is obligated to only do “usual business” between signing and closing.

Question 29

Should dilutive deals never be done?

Answer 29

No. The decision is much more complex than that considering strategic value and future accretion.

Question 30

What is a big weakness of EPS in evaluating an M&A deal?

Answer 30

EPS is a highly condensed number, depending on many factors. Earnings Growth is important. Dilutive deal can become Accretive if Earnings Growth is strong enough. Furthermore, EPS is driven by accounting standards which are manipulable.

Question 31

Company A is valued at P/E of 10x and buys Company B in an all-Stock Deal. B is valued at 15x P/E. Is the deal accretive or dilutive?

Answer 31

Because it’s an all-share deal, it is dilutive. Company A pays more per unit of earnings than it is worth and therefore dilutes existing shareholders.

Question 32

Company A buys Company B and pays in Cash. Both companies are of the same size and value. A is valued at 15x P/E and B is valued at 17x P/E. Is this deal dilutive?

Answer 32

Not necessarily. In an all-share deal it would be dilutive. Since it’s a cash deal, we have to find out where cash is coming from and what interest we potentially have to pay for it. In all-cash deal, the number of stocks stays the same, however, Earnings change drastically (increase because of new company; decrease because of potential interest payments).

Question 33

Company A has 10m stocks @€10 and wants to buy Company B that has 20m stocks @€3. A has earnings of €12m, while B has earnings of €1.2m. A can buy B with 50% stock and 50% cash from new debt @4%. Taxes are 30%. How are EPS before and after the deal?

Answer 33

Before: €1.2 (€12/10) After: Use Formula: EPS= (Earnings_B + Earnings_T - New Interest*(1-Tax)) / (#Shares_B + Share Price_T/SharePrice_B * #Shares_T * % of share deal) In this case: EPS = (12 + 1.2 – 30 * 4% * (1 – 30%)) / (10 + 3/10 * 20 * 50%) = 12.36/13 = €0.95 The deal is dilutive.

Question 34

How do you get a Break-Even Price for an All-Share Deal, which assures EPS that remain at pre-transaction value?

Answer 34

EPS_BE = #Shares_B * Eearnings_T * Shareprice_B / (#Shares_T * Earnings_B)

Question 35

A company announces a very accretive deal. The next day the market opens and the share price plummets. Why?

Answer 35

Usually if majority of market participants don’t see that much value in transaction. Destruction of Shareholder value and EPS accretion are not a contradiction. EPS is just a snapshot, while share price is effect of a longer-term development. Reasons: - Deal is now accretive but dilutive in future - Strategic thoughts behind acquisition are not reasonable - Acquisition leads to more damage than good in long-term competition in market - Management has paid too much for today’s EPS accretion and thereby reduced shareholder value

Question 36

How would you find out how much debt a company can take on to buy another company?

Answer 36

No right answer but usually look at Leverage (Net Debt/EBITDA). Below 2.5x it is solidly financed. Between 2.5x and 3.5x it is still investment grade. Above 3.5x and 4.0x it gets riskier very quickly (PE LBOs etc.). IB analyzes according to peer group about how much leverage it can still take on and how much cash-flow it has to pay interest. Thereby it can analyze how much debt the company can still take on (“Firepower Analysis”).

Question 37

What is a Firepower Analysis?

Answer 37

To find out how much more debt a company can take on (usually regarding a transaction). Note that the newly acquired investment increases EBITDA and therefore again reduces leverage (ND/EBITDA), which allows even more debt (calculate using Goal-Seek in Excel).

Question 38

Is it better to be bought from a strategist or PE from a Management perspective?

Answer 38

No right answer but some considerations: - After acquisition by strategist, previous management either transitions to mother company or gets laid off - PE investor sometimes lays off part of management - Management is usually incentivized by performance bonuses in LBO

Question 39

What is a Fairness Opinion?

Answer 39

Objective opinion by third-party investment bank; often consulted by board of target company.

Question 40

In a fairness opinion would you put in the price that is reasonable from the perspective of the target to approve that the bidder’s price is fair?

Answer 40

No, never. Fairness opinion is there to evaluate fairness of a certain bid but not a target price. Offering a target price would lead to potentially lower offers if this threshold is publicized.

Question 41

Who pays more for a company, a strategist or PE?

Answer 41

Usually a strategist, as it can realize synergies and use new technologies as well as expand into new markets. PE LBO only cares about performance and usually doesn’t use any synergies etc. since the company stays the same.

Question 42

Which possibilities does a company have to avoid takeover?

Answer 42

- Poison Pill: generally everything that stops buyer; e.g. special subscription rights for existing investors that dilute ownership of buyer after transaction; transferring subsidiaries into foundation so that it can’t be sold off easily anymore - Greenmail Payments: If investor has significant shares in company, management can offer to buy back shares (at premium) to stop takeover; potentially only short-term - Golden Parachute: Management usually has multi-year contracts and they receive payments for contracts that are stopped earlier (“Severance Payments”). In a Golden Parachute, these payments are so high that the buyer doesn’t want to take over company anymore - White Knight: Instead of being taken over by attacker, look for “white knight” that does friendly takeover or buys blocking minority - Dual-Class Shares: one class of shares with lots of voting rights and other with few or none. These “less powerful” shares are open to public investors while “Golden Stock” is retained by Management etc. - Staggered Boards: Board can’t be exchanged immediately but only a few people can switch positions every year - Super-Majority Provisions: raises necessary approval for transaction from 50% or 2/3 to e.g. 80% which makes takeover much harder as more voting rights are needed - Pacman-Defense: Initiate takeover of buyer by seller - Media Campaigns

Question 43

What’s the difference between Goodwill and Other Intangibles?

Answer 43

Mainly that Other Intangibles are amortized over a set period of time and Goodwill is only amortized in case of an impairment.

Question 44

What are the three types of mergers?

Answer 44

- Horizontal (with competitor) - Vertical (supplier or distributor) - Conglomerate (completely unrelated)

Question 45

Walk me through the impact of an asset write-down on the financial statements

Answer 45

The write down is regarded as a loss so goes through IS and reduces taxable income and may create a DTA (DTA = write-down * tax rate). On the CFS the write-down is added back. On BS you have the asset written down, the new DTA and the change in cash that you have. Everything should balance with RE on the liabilities side.