Walk me through a sell-side M&A process.
- Plan the process and create the marketing materials
- Contact the initial set of buyers.
- Set up management meetings and presentations.
- Solicit initial and subsequent bids from buyers.
- Conduct final negotiations, arrange financing and close the deal.
Walk me through a basic merger model.
Merger model is used to analyze the financial profiles of two companies, the purchase price and how the purchase is made, and determines whether the buyer’s EPS increases or decreases.
- Make assumptions about the acquisition: price and mix of consideration.
- Determine the valuations and shares outstanding of both both parties, and project an I/S for each.
- Combine the two I/S, adding up Revenue and OpEx, adjusting for foregone interest on cash and interest paid on debt in the combined EBT.
- Apply buyer’s tax rate to get combined NI, then divide by new share count to get PF EPS.
What’s the difference between a merger and an acquisition?
Largely semantics:
- Acquisition: buyer is much larger
- Merger: both are of similar size
Why would a company want to acquire another company?
- Gain market share by buying a competitor
- Achieve faster growth
- Buyer thinks seller is undervalued
- Buyer wants to acq. seller’s customers and up-sell / cross-sell
- Buyer thinks seller has a competitive advantage that it can enhance its business with (i.e., tech, IP)
- Possible synergies will make the deal accretive
Why would an acquisition be dilutive?
Dilutive means the additional amount of NI acq. from the target does not offset the buyer’s foregone interest on cash, add’l interest paid on debt and the effects of issuing add’l shares.
Acquisition effects - i.e., amort. of intangibles - can also make dilutive.
Is there a rule of thumb for calculating whether an acquisition will be accretive or dilutive?
IFF deal is cash and debt - compare sum of foregone interest on cash and interest on debt with seller’s pre-tax income.
If it’s an all-stock deal, compare P/E.
If all three, no quick rule.
A company with a higher P/E acquires one with a lower P/E - accretive or dilutive?
TRICK - can’t tell unless it’s all-stock. Doesn’t matter if all-cash or all-debt, since no new stock.
Generally, buying more earnings for less is good and is likely to be accretive, but can’t know.
What’s the rule of thumb for assessing whether an M&A deal will be accretive or dilutive?
ALL-STOCK - if buyer’s P/E is higher than seller’s, accretive; otherwise dilutive.
What are the complete effects of an acquisition?
- Foregone Interest on Cash - buyer loses the interest it would’ve otherwise earned, if it pays in cash
- Add’l Interest on Debt - if buyer uses debt, more interest
- Add’l Shares Outstanding - if buyer uses stock, must issue new
- Combined F/S - must PF F/S for the acquisition
- Creation of Goodwill & Other Intangibles - represent premium to fair value
If a company could pay 100% in cash for another company, why wouldn’t it?
Possibilities:
- Saving cash for something else / rainy day fund
- Stock trading high and eager to use
Why would a strategic acquirer typically be willing to pay more for a company than a PE firm?
May be able to realize revenue and cost synergies that the sponsor cannot, absent combination with a complementary portfolio company.
Why do Goodwill & Other Intangibles get created in an acquisition?
They represent the premium paid over the FMV of net identifiable assets. Alternatively, customer relationships, brand and IP.
What’s the difference between Goodwill and Other Intangible Assets?
Goodwill - stays the same and isn’t amortized. Only change if impairment or another acq.
Other - amortized over several years, which affect the I/S.
Is there anything else “intangible” besides Goodwill & Other Intangibles that could also impact the combined company?
Could have a Purchased In-Process R&D Write-off and a Deferred Revenue Write-off.
What are synergies, and can you provide a few examples?
Cases where the sum is greater than the parts.
- Revenue synergies - combined co. can cross-sell or up-sell products, or expand into new markets
- Cost synergies - combined co. can reduce redundant headcount, buildings or otherwise.
How are synergies used in merger models?
Revenue synergies - add to PF revenues and assume a margin for EBIT[DA].
Cost synergies - reduce PF COGS, OpEx or SG&A.
Are revenue or cost synergies more important?
Revenue are much harder to predict, whereas cost synergies are easier to see.
All else equal, what is a company’s preferred M&A consideration?
If a buyer had unlimited resources, CASH:
- “Cheaper” since foregone interest < interest on debt
- Less risky than debt - if you have it, you have it
- Cheaper than stock (Ke > Kd > cash)
- Less risky than stock, which is volatile
How much debt could a company issue in an M&A?
- From comps, pull median leverage multiple.
- Apply that multiple to PF EBITDA.
OR, look at debt comps.
How do you determine the Purchase Price for the target in an acquisition?
Using the big 3 valuation methods. If target is public, need a sufficient premium (15%-30%).
Let’s say a company overpays for another company - what typically happens afterwards?
Lots of Goodwill & Other Intangibles would be created. If the acq. goes poorly, buyer may realize a large impairment charge down the line.
A buyer pays $100M for the seller in an all-stock deal, but a day later the market decides it’s only worth $50M. What happens?
Buyer’s share price would fall pro rata for the $50M loss in value.
Why do most M&As fail?
- Integration risk
- Execution risk (synergies)
- Poor motivations (i.e., CEO ego, SH pressure)
What role does a merger model play in deal negotiations?
As a sanity check - not as the basis for action.
