financial modeling using excel mergers and acquisitions

Financial Modeling Using Excel

Mergers and Acquisitions

INSPIRON

Typewritten Text

www.yerite.co.in

INSPIRON

Typewritten Text

M&A

2

Source: www.ft.com

Agenda

• Meaning and categories of M&A

• Merger motivations

• Forms of payment

• Hostile Vs Friendly offer

• Estimating value

3

Mergers & Acquisitions defined

• Mergers & acquisitions:

– Refer to the aspect of corporate finance dealing with purchase, sale or combination of two business entities

that can add strategic value to a company in a given industry and grow rapidly without having to grow

organically.

Mergers Acquisitions

Refer to the acquirer absorbing the entire

target company. Refer to the acquirer buying only a part of

target company

Involve purchase of controlling stock Involve purchase of assets or a distinct

business segment (eg. subsidiary)

Both the acquirer and target lose their

respective identities after merger (eg.

Glaxo Smithkline)

The acquirer and/or target retain their

identity after merger. (Mahindra Satyam)

It is generally friendly in nature It can be a hostile take-over

4

Transaction Structure - Amalgamation into an Existing Company

Co. 1

S1

Co. 2

S2

Transfer

Assets &

Liabilities

Issue

shares

Co. 2

S2S1

• Co. 1: Amalgamating Company; Ceases

to Exist

• Co. 2: Amalgamated Company

• Co. 2 receives all of Co. 1’s assets and

liabilities

• S1: Shareholders of Co. 1 receive shares

in Co. 2 and maybe other benefits like

debentures, cash

• Co. 2 will now have S1 and S2 as its

shareholders

• Case in Example – Merger of Reliance

Petroleum into Reliance Industries

Limited

5

Categories of M&A - Horizontal Integration

• Two firms in the same industry combine

• Typically the competitors

• Motivation: To achieve

– Industry consolidation to exploit economies of scale, size and /

or scope

– Entry into a new geography

– Enhance product / services portfolio

• Examples

– P&G acquiring Gillette

– Acquisition of equity stake in IBP by IOCL

– Bharat Forge’s acquisition of CDP (Germany)

– S&P’s stake in CRISIL

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 1

Which Industries / Sectors will typically see Horizontal Integration? Why???

6

Categories of M&A - Vertical Integration

Vertical Integration

Internalization of crucial forward

or backward activities

Forward Integration

Buying your customer

Backward Integration

Buying your supplier

• Two firms across the vertically integrated industries combine


– Control of aforward or backward activity in supply chain

– Secure Raw Materials

• Examples

– Indian Rayon’s acquisition of Madura Garments

– IBM’s acquisition of Daksh

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 1

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 2

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 3

Raw

Mate

ria

l

Su

pp

lier

Pro

du

cer

/

Man

ufa

ctu

rer

Cu

sto

mers

of

fin

ish

ed

go

od

s

Su

pp

ly C

hain

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 1

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 2

Firm 1 Firm 2

Firm 3 Firm 4

Firm 5

Industry 3

Raw

Mate

ria

l

Su

pp

lier

Pro

du

cer

/

Man

ufa

ctu

rer

Cu

sto

mers

of

fin

ish

ed

go

od

s

Su

pp

ly C

hain

7

Categories of M&A - Conglomerate

• Combination of two firms in uncorrelated business


– Diversification by combining uncorrelated assets and income streams

– To reduce business risks

• Examples

– L&T’s attempted acquisition of Satyam

8

Agenda






9

Merger Motivations

10

Motivations according to Industry life cycle

Industry stage Characteristics Motivations Type of M&A

Pioneer • Uncertainty of product acceptance

• High capital requirements, low margins

• Access to larger/mature firm’s capital

• Gain management expertise

• Horizontal

• Conglomerate

Rapid growth • High profit margins

• Increasing revenues and profits

• Less competition

• Access to capital

• Capacity expansion

• Horizontal

• Conglomerate

Mature growth • Increasing competition

• Less scope for supernormal growth

• Operational efficiencies

• Synergies (economies of scale/scope)

• Horizontal

• Vertical

Stabilization • Reduced growth potential due to high

competition

• Capacity constraints

• Economies of scale

• Management efficiency

• Horizontal

Decline • Change in consumer tastes

• Excess capacity/declining margins

• Operational efficiencies

• New growth opportunities

• survival

• Horizontal

• Vertical

• Conglomerate

Size

Time

11

Agenda






12

Form of acquisition

Metric Asset purchase Stock purchase

Payment to party Made directly to target’s

shareholders in exchange for

their shares

Made directly to the company

Approval Majority shareholder

approval required

Unless asset sale is a

substantial portion, no

shareholder approval necessary

Taxes No tax expense incurred by

company, but shareholders

pay capital gains tax

Target company has to pay

capital gains tax

Liabilities of target Acquiring firm assumes

target’s liabilities

Usually the liabilities are avoided

by acquirer in the transaction.

13

Methods of payment

Metric Stock offering Cash offering

Meaning Target’s shareholders receive

proportion of acquirer’s common stock

in exchange for their target’s holding

Acquirer pays an agreed

amount of cash for target

company stock

Risk in the merged

entity

• Part of the risk (and reward) is

borne by target’s shareholders.

• Lower confidence in synergies by

acquirer.

• Risk is entirely borne by

acquirer

• Higher confidence in

synergies

Relative valuations Stock offer is a signal that acquirer’s

shares may be overvalued

Capital structure

impact

Decreases leverage as issuance of

new stock dilutes ownership for

existing shareholders

Increases leverage,

especially if acquirer

borrows money to pay

target’s shareholders.

14

Agenda






15

Friendly Vs Hostile offer

• Friendly offer:

– Refer to the acquisition of a target company that is willing to be taken over.

– Usually, the target will accommodate overtures and provide access to confidential information to facilitate the

scoping and due diligence processes.

– Normally the process is started voluntarily by target company, but can be intiated by friendly overture by

acquirer seeking better information to value target.

• Both parties have opportunity to structure deal to their mutual satisfaction:

– Taxation Issues (stock offer instead of cash offer)

– Asset purchase rather than stock purchase

– Earn outs

Friendly Acquisition

Information

memorandum

Approach

target

Sign letter

of intent

Final sale

agreement

Confidentiality

agreement

Main due

diligence Ratified

16

Friendly Vs Hostile offer (Cont…)

• Hostile offer:

– A takeover in which the target has no desire to be acquired and actively rebuffs the acquirer and refuses to

provide any confidential information.

– The acquirer usually has already accumulated an interest in the target (15% of the outstanding shares) and

this preemptive investment indicates the strength of resolve of the acquirer.

• Acquirer’s tactics:

– Bear hug: acquirer submits merger proposal directly to target’s board of directors

– Tender offer: acquirer offers to buy shares directly from target’s shareholders

– Proxy battle: acquirer seeks control over target by having target’s shareholders approve a new board of

directors chosen by acquirer. If successful, the new board may then replace target’s management and

execute a friendly merger.

Hostile Acquisition

Beachhead: slowly acquire

toehold by open market

purchase of target’s shares

Make a tender offer to bring

ownership percentage to the

desired level.

File statement with SEBI

without attracting attention

Acquire 15% stock through

open market purchase over

longer period

17

Understanding M&A Process - Typical Steps & Timelines

1 2 3 4 5 6 7 8 9 10 11

Preliminary Preparation and

Shortlisting of Buyers

Signing of Non Disclosure Agreement

Dispatch of Info Pack to selected Buyers

Management Meetings, discussion on Info Pack and Business Model

Receipt of Preliminary Bid

Shortlist 2-3 Potential Buyers

Buyer Due Diligence,

Data room

Shortlist Final Buyer and

provide exclusivity

Confirmatory due diligence

and Final Negotiations

Finalize transaction

documents

Closure

Fortnights

Activity

Key external point

Key decision point

Phase I Phase II Phase III

Receipt of Final Bid

18

• Teaser

• Confidentiality Agreement / Non Disclosure Agreement

• Information Memorandum

• Business Model, Valuation - Methodology

• Synergies

• Building synergies into the model

• Preliminary bid – Non Binding Offer

• Due Diligence

• Term Sheet

• Final Bid – Binding Offer

• Negotiations: How do valuations change?

• Deal Closure

Understanding M&A Process - Typical Terms

19

Agenda






20

Estimating Value

Types of valuation DCF Comparable companies Comparable transactions

Advantages • Easy to make

modifications in cash flow

forecasts

• Based on forecasts of

future conditions than on

current data

• Easy to customize

• Data of comparable

firms readily available

• Relies on market data

than on assumptions

of variables

• No takeover premium

necessary since actual

valuations are considered

• Estimates are based on

recent prices

• Avoid any potential lawsuit

for mispricing deal

Disadvantages • Difficult to apply during

negative cash flows

• Heavy reliance on

assumptions like discount

rate, and on terminal cash

flow

• Implicitly assumes

comparables are

accurately valued

• Difficult to incorporate

synergies into analysis

• Estimation of takeover

premium may not be

accurate

• Implicitly assumes accurate

valuation for comparables

• Lack of sufficient number of

comparable transactions

• Does not incorporate

merger synergies in

analysis

21

Evaluating a merger bid

• Post merger valuation for an acquirer:

• Gains accrued to Target:

• Gains accrued to acquirer:

• In case of stock offer,

CSVVV TAAT

• VAT=Value post merger

• VA=Value of acquirer

• VT= Value of target

• S=synergies

• C=Costs

TTT VPGain • PT=price paid by

acquirer (includes

premium)

)( TTA VPSGain

)( ATT PNP

• N=number of shares

22

Mergers & Acquisitions Analysis

• The typical M&A deal involves an acquirer company taking over (or merging with) a target company

• There are a variety of the reasons for you to analyze an M&A transaction:

– Your bank has a BUY-SIDE mandate (i.e. you are advising the acquirer)

– Your bank has a SELL-SIDE mandate (i.e. you are advising the target)

– Your bank has hired to provide a FAIRNESS OPINION to the Board of the acquirer or target

– You are working on a counter-bid (e.g. “white knight“ scenario)

– You are looking for potential M&A deals to pitch to clients

– You need to know more about a specific transaction

23

Merger Analysis – Model Map

24

Acquirer ModelTarget Model DEAL TERM

Target

Ownership

COMBO Full Model-Target Ownership

-EPS accretion/dilution

-Pre-Tax Synergies to Break-Even

-P/E to maintain Share Price

-Pro-forma EV/EBITDA

-Pro-forma Credit Ratios

-Pro-forma Incremental Debt

-Pro-forma Net Income

-Pro-forma WASO

-Pro-forma EPS

-Pro-forma EBITDA

Analysis at

Various Prices

Scenario Analysis

for Financing Cases

Contribution

Analysis

MERGER MODEL

After-Tax

Merger Cost

Merger Analysis- Steps

Inputs

1. Market Data

2. Share Information

3. Balance Sheet Information

4. Income Statement Information

5. Valuation Summary

6. Deal Assumptions

7. Sources and Uses Table

8. Combo Shares

9. Goodwill

10. Combo Balance Sheet

11. Combo EPS

25

Outputs

1. Deal summary

2. Simple Sensitivity Tables

3. 2D Sensitivity Tables

4. Contribution Analysis

5. Analysis at Various Prices

Target Ownership

26

Share Information

Treasury Stock Method

Market Data-Company Names

-Tickers

-Unaffected Shares Prices

-Prices Dates

-Offer PremiumBasic Share

Information

Diluted Share

Information

From Latest Published

Financial Statements

Target Ownership

Target Price should exclude any run-up ahead of deal date

Offer Price

= Share Price *(1+ Premium)

Target Ownership: Market Data

27

Target Ownership

Share Information

Treasury Stock Method


-Tickers


-Prices Dates


Information

Diluted Share

Information



Offer Price


Target Ownership: Basic Equity

28

Share Information

Treasury Stock

Method


-Tickers


-Prices Dates


Information

Diluted Share

Information



Target Ownership

Offer Price


gOutstandin SharesBasic*PriceOffer

BasicionConsideratEquity

Target Ownership: Treasury Stock Method

• The diluted number of shares incorporates the potential

conversion into shares of all existing “dilutive” instruments (e.g.

options, warrants, restricted stock units, convertibles etc.)

• Only include instruments which are in the money (i.e. the

instruments which are profitable for the holder to convert)

• For options, use the Treasury Stock Method

– Assumes any proceeds from the conversion of the options are

used to repurchase shares in the market

29

Share Information

Treasury Stock

Method


-Tickers


-Prices Dates


Information

Diluted Share

Information



Target Ownership

Offer Price


Target Ownership: Treasury Stock Method Example

• Example:

Total outstanding shares: 1000 Strike Price: 5

Number of options: 100 Market Price / Offer Price: 12

Cash from options 100*5 = 500

Shares 500/12 = 42

Net new shares 100-42 = 58

30

PriceMarket

PriceStrikePriceMarket*OptionsofNoShares Newfor formulaShortcut

Treat Restricted Stock Units and Stock Grants like options with zero Strike Price(X)

For Target, use the Acquisition Price not the Market Price

Market Price of the Acquirer

Target Ownership

31

ofAcquirerSharesDilutedIssuedSharesNew

IssuedSharesNewOwnershipTarget

Basic Shares

OutstandingNo of Options

Outstanding

Strike Price

Of Options

Market Price of

the Acquirer

Financing The Deal

• Using the Acquirer’s Existing Cash

– Excess cash is typically a low-yielding asset, and making an acquisition is potential way to increase the

Acquirer’s return on capital employed

– Your analysis needs to consider the lost interest income or cash

• Issuing Debt

– New debt increases leverage and interest expenses decreases net income

– Structure: Senior vs junior; Cash vs PIK; Covenants

– Tax considerations

• Issuing Shares

– Dilutes existing shareholders

– In certain countries, existing shareholders have pre-emptive rights. Do you need to structure a Rights Issue?

32

After-tax Merger Cost

33

Incremental After-Tax

Interest Expense

Loss of

Interest Income

Amortization of

Capitalized Financing Fee

Incremental Pre-Tax

Interest Expense

Marginal Tax

Rate (MTR)

Pretax Interest

Expense on New Debt

Merger Cost

Financing Fee

Current Pretax

Interest Expense

on Retired Debt

New Debt

Required

Existing Target

Debt Retired

Cost

Of Debt

Current Pre-Tax

Interest Rate

Marginal

Tax Rate

Life of Debt

Target + Acquirer’s

Cash Used

Cost

of Cash

Goodwill Calculation

34

Purchase

Price

EQUITY

PURCHASE

PRICE

Advisory

Fees

Fair Value of

Net Assets

Acquired

PP&E

Step-up

Book Value of

Equity Bought

New IntangiblesNet of

the

related

Deferred

Tax

Liabilities

GOODWILL

Equity Purchase Price

Book Value of Equity

Deal Assumptions

• Make a list of all the deal- related assumptions

• Financing Mix split only relates to the Equity purchased (the advisory fees are always financed with

cash)

• The net assets of the target need to be adjusted to their fair value at the time of the deal.

• In our example, we have:

– Identifiable intangible assets, which are going to be amortized

– Revaluation of PP&E, which is going to be depreciated

• Interest on Acquisition Debt pretax: make a preliminary assumption. You will adjust it once you

know the leverage of the combo post- deal

• Interest on Acquirer’s Cash pretax: if the acquirer uses an existing cash balance to finance the deal,

it will lose some interests income. Estimate cash interest rate on cash based on the information you

have on the acquirer.

• Yearly synergies pretax: This is a preliminary assumptions on the cost synergies generated by the

deal, based on your views and/or what has been publicly announced

35

Use the acquirer’s marginal tax rate to calculate the interest rates post-tax

Deal Assumptions

• Most deals generate some Cost and/or Revenue synergies

– In our examples we assume SG&A synergies

• Use the synergies announced and/or your views on the deal

• Sanity-check:

– Synergies as % of total SG&A:

• what is the % reduction in costs?

– Synergies as a % of Sales

• what is the increase in profit margins?

• Benchmark your assumptions against information from previous deals

36

Combo EPS Calculation

• Investors (current and Potential) are interested in the impact of the deal on the earnings of the Acquirer

• They will calculate the projected EPS for the Combo and will compare it with the projected EPS of the

acquirer stand-alone

• Several factors impact on the Combo EPS

– Acquirer Net Income

– Target Net Income

– Interest Expense on Acquisition Debt (post-tax)

– Lost interest on Acquirer’s Cash as part of funding (post-tax)

– Synergies(post- tax)

– Extra depreciation and amortization (post-tax)

– Number of new shares issued

• Investors usually calculate a Cash EPS, ignoring the impact of non-cash changes , such as the extra

depreciation and amortization generated by fair value adjustments

37

Combo Full Model: Pro-Forma EPS

38

Pro-forma

EPS

Combo Full Model

Pre-Tax

Synergies to

EPS Breakeven

EV/EBITDA

to Maintain

Share Price

Pro-forma

EBITDA

EPS

Accretion/DilutionP/E to maintain

Share Price

Pro-forma

Net IncomeWASO IssuedSharesNewSharesDilutedsAcquirer'

CostSynergyTaxAfterNINI TargetAcquirer

Relative P/Es

• We can run a back-of-the-envelope EPS accretion/dilution analysis using a relative P/Es comparison.

• We do not even need to calculate the Combo EPS!!

• We need:

39

Forecast EPS DilutedAcquirer

Price ShareAcquirer P/EAcquirer

Debt ofCost Tax -Post

1 P/ECash

Forecast EPS DilutedTarget

PriceOffer P/En Acquisitio

Relative P/Es – Stock Deals

• In an All-Stock deal

– Acquirer finances deal by issuing new shares

– The new shares are the currency used to purchase Target’s earnings

• If Acquirer P/E > Target P/E , deal is likely to be ACCRETIVE

– Target earnings are cheaper than Acquirer earnings

– Financing cost is lower than the expected return

• If Acquirer P/E > Target P/E , deal is likely to be DILUTIVE

– Acquirer earnings are cheaper than Target earnings

– Financing cost is higher than the expected return

40

Contribution Analysis

• Analyzes each party’s contribution to Combo financials

– Sales

– EBITDA

– Net Income

• The relative contribution to earnings is important when negotiating the deal

• The relative growth rates are an important factor

• In all-stock deals, the relative ownership post deal is benchmarked against the relative contribution to earnings

• In all-stock deals, the relative ownership post deal is benchmarked against the relative contribution to earnings

• The Net Income contribution is usually less significant, as it is dependent on the pre-deal capital structures

41

Analyzing the deal

• A Merger analysis allows you to assess:

• Offer Price Range

– Depending on the maximum premium that can be paid

– What is the maximum premium that the Acquirer can offer before the deal becomes dilutive?

– What synergies do you need to avoid dilution? Does the amount look realistically achievable?

• Financing Mix ( Stock vs Debt)

– Stock: What is the maximum amount of shares that the Acquirer can issue, while still retaining control of the

Combo?

– Debt: The debt capacity is capped by a maximum leverage level. Interest coverage should also be

considered.

42

Thank You

43

financial modeling using excel mergers and acquisitions

Documents