100% stock transaction Acquirer's price/share $18 Acquirer's EPS $1 Acquirer's NI $53.4 Offer price/share $27.5 Target's EPS $1.39 Target's NI $13.9 Target's outstanding shares 10 million 1. Will this deal be accretive or dilutive? 2. What is the pro forma NI? 3. What would be the exchange ratio? 4. What would be the new shares issued?

1. Dilutive. Acquirer's P/E 18x Offer P/E multiple 19.8x 2. $67.3 million 3. 1.5278 4. 15.278 million

Merger Modeling Comprehensive Flashcards by Adam Gravitt

Even if a merger occured through equity issuance, how could the resultant company’s debt be impacted?

The resultant company takes on debt of the acquiree. Thus, it increases its debt load.

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What are transaction expenses, and when are they expensed?

Expenses for consultants, accountants, and investment bankers. They are expensed as incurred. They are not recurring, thus they need to be adjusted for appropriate for pro forma analysis.

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What are the 2 questions that merger consequences analysis, generally speaking, addresses?

How much can the company afford to pay?
How are you going to finance the acquisition/What is the optimal cash vs stock blend to pay for the acquisition?

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If a deal is financed with cash, can a company tap into its balance sheet to use its own cash instead of using 100% debt? If so, what must the company consider?

Yes. But, it must consider the opportunity cost of interest income.

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In regards to taxes, how are stock contributions different from cash contributions?

Stock contributions are typically tax deffered until the stock is sold, while cash contributions are typically taxed immediately.

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What is the diluted shares formula when calculating offer value of equity?

Basic shares + # of options in the money - shares repurchased under the modified treasury stock method + convertible debt shares + non vested RSUs

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Are finite life intangible assets amortized?

How is Goodwill adjusted?

Yes.

Goodwill is NOT amortized, but it is tested for impairment.

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Why is a DTL created with an asset write up?

Due to GAAP taxes being lower than tax book taxes

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What is the difference between offer value and transaction value?

Offer value is almost equatable to Equity value

Transaction value is like enterprise value, which includes offer value plus the assumed liabilities. It measures the size of the transaction.

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What are the reasons for having a purchase price beyond the fair market value of net identifiable assets?

Paying for the control premium as well as benefitting from future synergies/strategic rationale.

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What are the 3 phases of a merger consequences analysis? Describe the subphases.

Structure the terms of the transaction
- Calculate offer value
- Determine consideration mix (cash vs stock)
- Choose for tax impact
Calculate transaction adjustments
- Balance sheet and income statement adjustments
Analyze pro forma impact
- analyze financial statements
- analyze tax consequences

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What is exchange ratio analysis?

Why do acquirers want a low exchange ratio?

It compares the deal exchange ratio and current exchange ratio over a specific period to historical exchange ratios.

Acquirer’s want a low exchange ratio because they are issuing fewer shares compared to higher exchange ratios.

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100% stock transaction

Acquirer’s price/share $18

Acquirer’s EPS $1

Acquirer’s NI $53.4

Offer price/share $27.5

Target’s EPS $1.39

Target’s NI $13.9

Target’s outstanding shares 10 million

Will this deal be accretive or dilutive?
What is the pro forma NI?
What would be the exchange ratio?
What would be the new shares issued?

Dilutive.

Acquirer’s P/E 18x

Offer P/E multiple 19.8x

$67.3 million
1.5278
15.278 million

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At what price does the acquirer use to repurchase shares using proceeds for options?

Offer price

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What is a concern of issuing stock to finance a transaction?

Diluting ownership. Will the target’s shareholders that are the recipients of the new shares have more ownership than the acquirer’s want?

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Offer price/share $54

Current share price $49

Basic shares outstanding 991

Options exercisable 62

Exercisable strike price $39

In-the-money options outstanding 86

Outstanding strike price $38

What is the offer value?

$54,890

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What is the offer value?

Which methods are used to derive offer value?

Offer price x target’s diluted shares outstanding

Offer value is derived using public and acquisition comparables analysis and DCF anaylsis

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Merger modeling aka accretion/dilution analyis tells us what a company could/should pay?

It tells what a company COULD pay in order to achieve a certain result.

What a company should pay is derived from public comparables, acquistion comparables, and discounted cash flow analysis.

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100% cash purchase example

Acquirer’s information

Current share price $18

Total existing debt $200

Tax rate 40%

Interest on new debt 6%

NI $53.4

Diluted shares outstanding 53.4

EPS $1

Transaction expenses $3

Target’s information

Current share price $22

Total assets $370

Total liabilities $220

Existing Goodwill $25

NI $13.9

Diluted shares outstanding 10

EPS $1.39

Offer price/share $27.5

What is the incremental after tax interest expense if the acquisition is funded solely by debt?
What is the pro forma EPS?
What is the accretion/dilution figure?

$9.9 million

($275 x 6%) x (1-40%)

$1.075
.075 accretion/share
5% accretion/share

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What is contribution analysis?

What is pro forma ownership anaylsis?

Why is it important to compare ownership and contribution analysis?

It assigns % of acquirer and target to specif metrics such as EBITDA, NI, Sales, etc

Pro forma ownership analysis assigns ownership %s based on the acquirer’s stock and newly issued stock.

Contribution to NI, EBITDA, etc should closely match the ownership anaylsis, thus that is why it is important to compare them.

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Review P/E of cash

1 / (interest rate % x (1-T))

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What are the three main synergies resulting from M&A?

Cost reductions, revenue enhancements, CapEx savings

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What is a side effect of writing up PP&E?

Increasing the depreciable value of the PP&E as well as creating a deferred tax liability

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What is a tender offer?

The buyer appeals directly to the target’s shareholders to offer cash in exchange for their shares

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Describe the quick P/E analysis to determine accretive/dilutive transactions. What is important to note in this quick analysis?

\*\*Make sure to clarify that it is a 100% or high stock transaction Compare the acquirer's standalone P/E to the offer P/E If the acquirer's P/E is greater than the offer price P/E, then the deal will be accretive. If the acquirer's P/E is less than the offer price P/E, the deal will be dilutive. This analysis assumes no write ups or synergies.

What usually constitutes the greatest synergies? What is important to consider when calculating synergies?

The reduction of redundant and overlapping expenses, thus leading to cost reductions. Consider the after tax implications of synergies.

Synergies offset what in regards to an acquisition's price?

Synergies offset a higher premium paid for an acquisition. Also, it offsets the potential incremental interest expense and depreciation/amortization.

What are the thresholds for leverage and coverage ratios for investment grade companies?

Leverage ratios, no greater than 2.5x - 3.0x Coverage ratios, no less than 5.5x - 6.0x

What pro forma ratios do you analyze to determine credit risk? What are the consequences of taking on too much debt?

Total Debt / EBITDA EBITDA / Interest expense Companies could receive credit downgrades, thus reducing their ability to issue debt at lower rates in the future

Pg. 109 of Merger Modeling

Purchase accounting begins with what? Give the formula.

Identification of the target company's net identifiable assets Net Identifiable assets = Identifiable assets - liabilities - Noncontrolling interest Identifiable assets = Assets - Target's existing goodwill This is used in a merger analysis to eventually reach what Goodwill is. Goodwill = Purchase Price - Net Identifiable Assets - Write Ups + DTL. This is dealing with the TARGET company.

If the pro forma leverage ratio is too high, what should occur to reach the leverage ratio acceptable to the acquirer?

Reduce the amount of newly issued debt in the transaction.

What are 3 tax noteworthy points in a merger?

1. Impact to target's shareholders 2. Creation of deffered tax liabilities due to purchase accounting and write ups 3. Stock vs asset purchase

Which two statements do professionals analyze for merger impact?

Income statement and balance sheet

What dilutes the EPS figure in an acquisition using cash and stock?

interest on new debt, increase in depreciable value, and new stock issues.

What is a rough way to estimate synergies in a merger?

Using prior acquisitions of companies very similar to the ones in the current deal.

Assume the $275 offer for 100% cash. Assume the acquirer has $200 million of existing debt, $12 million of existing interest expense, and $135 million of EBITDA. Assume the target has $50 million of existing debt, $4 million of existing interest expense, and $52.2 million of EBITDA. Assume 6% interest rate on new debt. 1. What is pro forma debt? 2. What is pro forma interest expense? 3. What is pro forma EBITDA? 4. What is the pro forma leverage ratio? 5. What is the pro forma coverage ratio?

1. $525 million 2. $32.5 million (does not account for after tax int. exp) 3. $187.2 million 4. 2.8x 5. 5.8x

Do you incorporate newly issued shares in the pro forma EPS calculation if the acquisition is 100% debt financed?

Trick question- there are no newly issued shares if it's 100% debt financed

How do you calculate the additional pre tax synergies needed to be EPS flat?

Dilution amount x diluted shares outstanding / (1-T)

**100% cash** **_Acquirer's Information_** EBITDA $135 Existing debt $200 Existing interest expense $12 Current share price $18 Total existing debt $200 Tax rate 40% Interest on new debt 6% NI $53.4 Diluted shares outstanding 53.4 EPS $1 **_Target Information_** EBITDA $52.2 Existing Debt $50 Existing interest expense $4 Current share price $22 Total assets $370 Total liabilities $220 Existing Goodwill $25 NI $13.9 Diluted shares outstanding 10 EPS $1.39 Offer price/share $27.5 1. What is the offer value? 2. What is the Goodwill created? 3. What is the pro forma NI, assuming no synergies or write ups? 4. What is the pro forma EPS? What is the amount of accretion/dilution? 5. What is the target shareholder ownership? 6. What is the pro forma coverage ratio? 7. What is the pro forma leverage ratio?

1. $275 million 2. $150 million 3. $57.4 million 4. $1.0749 and 0.0749 accretive 5. 0% Target shareholders are non existant since this was financed 100% by debt. Target shareholders' shares will cease to exist after the acquisition. 6. 5.8x 7. 2.8x

1. The deal is ____ if the acquirer's post deal EPS is greater than the pre-deal EPS. 2. The deal is ____ is the post deal EPS is less than the pre deal EPS

1. Accretive 2. Dilutive

What is the dollar accretion for the below? **_ABC Corporation_** Pre tax cost of debt 6% EPS $1 Net income $100 million Tax rate 40% **_XYZ Corporation_** EPS $1 NI $10 million Shares outstanding 10 million If ABC buys XYZ using 100% cash (financed by new debt) for $16.67/share, what is the dollar amount of accretion for this transaction?

$0.04

When there are write ups to assets, what adjustments do you need to make on the balance sheet and income statement?

**_Balance Sheet_** Add the amount of write ups to assetsn. Calculate and record deferred tax liability (due to future D/A or possible impairment charges) **_Income Statement_** Calculate depreciation expense using estimated useful lives. Make sure to appropriately split between depreciation and amortization.

What is the offer P/E multiple? When should relative P/E analysis be used to analyze accretion/dilution?

Offer price per share / Target's standalone EPS Relative P/E anaylsis should be used in a high % stock consideration transaction

Do you use outstanding or exercisable options when calculating diluted shares?

Outstanding and in-the-money

Walk me through the steps taken before conducting merger consequences (accretion/dilution) analysis.

1. Determine a valuation utilizing comparables, acquisiton comparables, and DCF 2. Then, merger consequences analysis analyzes what a company can afford to pay and what the financial effects are of the transaction

**100% Stock Purchase** **_Acquirer Information_** Current share price $18 Total existing debt $200 Tax rate 40% Interest on new debt 6% NI $53.4 Diluted shares outstanding 53.4 EPS $1 **_Target's Information_** Current share price $22 Total Assets $370 Total Liabilties $220 Existing Goodwill $25 NI $13.9 Diluted shares outstanding 10 EPS $1.39 **_Questions_** 1. What is the offer value, assuming an offer price of $27.5? 2. What is the exchange ratio assuming a 100% stock purchase? 3. How many shares must be issued to the target's shareholders? 4. Assuming no synergies or write-ups, what is the pro forma NI? 5. What would be the new shares outstanding? 6. What is the pro forma EPS, and is the deal accretive or dilutive?

1. $275 million 2. 1.5278 3. 15.278 million 4. $67.3 million 5. 68.678 million 6. $0.98 and dilutive

What are the most important adjustments to NI for a pro forma EPS?

After tax impact of: Synergies Interest expense on new acquisition of debt Incremental depreciation of write ups New shares issued (not affected by taxes)

What is the formula for Goodwill in M&A?

Purchase price - fair value of net identifable assets Assets are adjusted to fair market value, typically written up, thus causing incremental depreciation etc. More precise way: Purchase price - book value of net identifiable assets = purchase price allocation Purchase price allocation - write ups + resulting deferred tax liability = Goodwill

Companies with relatively high P/E ratios tend to finance acquisitions throught what? Companies with low borrowing cost finance acquisitions through what?

High P/E via stock Low borrowing costs via debt

Is Goodwill identifiable?

No. It does not have specific rights and cannot be bought and sold.

What is the historical control premium?

20% to 40%

Acquirer's shares 53.4 million Newly issued shares 15.278 million What is the % ownership between acquirers vs target's shareholders?

22% target's shareholders 78% acquirer's shareholders

**50% stock 50% debt** **Acquirer Information** Current price/share $18 Total existing debt $200 EBITDA $135 million Existing interest expense $12 million Tax rate 40% Interest on new debt 6% NI $53.4 Diluted shares outstanding 53.4 EPS $1 **Target Information** Current price/share $22 Total existing debt $50 million EBITDA $52.2 Existing interest expense $4 Total assets $370 Total liabilities $220 Existing Goodwill $25 NI $13.9 Diluted shares outstanding 10 EPS $1.39 Offer price/share $27.5 1. What is the offer value? 2. Show the split between debt raised and equity issuance 3. What is the resulting Goodwill? 4. What is the exchange ratio? 5. What is the number of newly issued shares? 6. What is the incremental after tax interest expense? 7. What is the pro forma NI? 8. What is the pro forma shares outstanding? 9. What is the pro forma EPS? 10. What is the accretion/dilution amount? 11. What is the after tax cushion to be EPS flat? 12. What is the pro forma coverage ratio? 13. What is the pro forma leverage ratio? 14. What is the target shareholder %

1. $275 million 2. $137.5 million debt raised $137.5 equity issuance 3. $150 million 4. 0.7639 5. 7.639 million 6. $4.95 million 7. $62.35 8. 61.039 9. 1.021 10. 0.0214 or 2.14% accretion 11. $1.31 million 12. 7.7x 13. 2.1x 14. 12.5%

How is Goodwill a future earnings risk?

Goodwill is tested for impairment and thus potentially written down and expensed, lowering future NI.

What are the concerns of using debt to finance a transaction?

The incremental interest expense / additional debt burden. Will the merged companies generate enough cash flow to sustain principal and interest payments to the lenders?

The CEO of a company is contemplating acquiring another company. The CEO will only consider an accretive transaction. You run the merger analysis and find the deal is currently dilutive by $0.05 before the impact of synergies. Here are some other assumptions: Pro forma shares 300 million Tax rate 40% The CEO also says he thinks he can reasonably achieve $20 million of pre-tax cost synergies. What should the CEO do- accept or deny the deal?

Don't do the deal. Pre-tax synergies needed to keep EPS flat is $25 million

Why do you analyze the pre-transaction balance sheet? Why do you analyze the post-transaction balance sheet?

Pre transaction anaylsis is used to identify its ability to finance the deal by issuing debt. Post transaction analysis is used to identify leverage ratios and coverage ratios. It shows the impact of the financing to its balance sheet.

What are the two types of transaction structures for tax purposes?

Asset purchases and stock purchases

Net Identifiable Assets are ____ before deriving Goodwill.

Adjusted to fair market value. Typically, they are written up, although it is possible for the fair market value to be written down.

What is merger consequences analysis also called? Why? Credit analysis in a merger consequences analysis answer what question?

Accretion/dilution analysis The analysis conducted derives whether or not the acquirer's EPS will increase or decrease post-deal Credit analysis answers the question of how much debt can a company take on without adversely affecting its credit rating. Essentially, what is its ability to take on debt and what are the effects to the balance sheet after taking on that debt.

Which tax rate do you use?

The acquirer's effective tax rate.

What is the formula for the Pro Forma EPS?

_Acquirer's NI + Target's NI +/- Adjustments_ Acquirer's shares outstanding + New Shares Issued New shares issued = Exchange ratio x target shares outstanding

What is the formula for book value of Net Identifiable Assets?

(Total Assets - Existing Goodwill) - Liabilities - Noncontrolling interest Or Identifilable Assets - Liabilities - Non-controlling interest Identifiable Assets = Total Assets - Target's Existing Goodwill

What does an exchange ratio of 1.52 mean?

Acquirer issues 1.52 shares to every 1 shareholder of the target company.

What is book value of equity formula?

Assets-Liabilties

What is the formula for pro forma debt? What is the formula for pro forma interest expense? What is the formula for pro forma EBITDA?

Acquirer's debt + target's debt + new debt issued Acquirer's interest expense + target's interest expense + interest expense based on new debt issued Acquirer's EBITDA + Target's EBITDA

When conducting premium analysis, you want to use what stock price?

The offer price and the unaffected stock price. The unaffected stock price is the stock price before any news of an acquisition was released and thus increasing the stock price.

Additional things to consider: Combinations of cash and stock Incremental depreciation/amortization due to write ups Impact of synergies Incremenal interest expense due to newly issued debt Contribution analysis aligning with pro forma ownership Tax considerations

**_Pro forma ownership for target_** newly issued shares/pro forma shares **_Pro forma ownership for acquirer_** (1 - (newly issued shares/pro forma shares))

Merger Modeling Comprehensive Flashcards

(69 cards)