Greenhill Technicals

What can lead to EPS dilution in M&A?

• target has negative net income

• target has higher PE ratio (if all stock)

• no synergies

• increased interest expense due to debt to finance M&A

Difference between acquisition and merger?

Acquisition is when buyer is much larger and merger is when the companies are of similar size

Why would a company want to acquire another?

• target is under valued

• synergies (cost and revenue)

• gain market share by buying competitor

• ability to cross/up sell to other customers

What does acquisition being dillutive actually mean?

• If the net income from the target does not offset the forgone interest on cash, added interest expense of debt, and effect of issuing new shares

• EPS decreases

What are the complete effects of an acquisition?

• forgone interest on cash: buyer loses interest it could have made on cash used in M&A

• more debt expense: buyer pays additional debt expense if using debt

• more shares outstanding: must issue additional shares if using stock

• combined financial statements: seller’s financials are added to buyer’s

• creation of goodwill: represent premium paid over fair market value

Why might a company use cash/debt/stock?

• Cash: large cash balance, cash is cheapest, stock is undervalued, avoid shareholder dilution

• Debt: cheaper than equity, avoid dilution, provide tax benefit

• Stock: stock is overvalued, preserve/low cash, don’t want more debt

Why is a strategic acquirer willing to pay more for a company than a financial buyer?

Strategics can realize cost and revenue synergies that PE can’t realize unless it combines the company with one of its port cos

Why are goodwill and other intangible assets created in an acquisition?

• Represents the value over the fair market value of the seller that the buyer has paid for

  • From synergies, reputation

• Other intangibles represent customer relationships, trade markets, licenses, tech, and IP

What is the difference in treatment between goodwill and other intangible assets?

• Goodwill stays the same over time and is not amortized, can be impaired if you realize the value is less that what you thought/has decreased in value; recorded as non cash expense on IS and added back on CFS

• Other intangibles are amortized over several years/finite life and show up on income statement

Examples of revenue and cost synergies?

• Revenue: cross and up sell to seller’s customers, expand into new geographical areas

• Cost synergies: consolidate buildings and factories, consolidate marketing/HR/admin

How are synergies used in merger models?

• Revenue: added to combined revenue and then assume a certain margin on the rev

• Cost: reduce the combined COGS/Op Ex

All else being equal, what is the preferred method of acquisition?

• Cash:

  • the cheapest option; typically cheaper than debt and doesn’t contribute to dilution

  • less risky; no added expense by using cash unlike w/ debt

What types of sensitivities would you look at in a merger model?

• Purchase price, % of stock/debt/cash, revenue synergies, cost synergies

Difference between DTA & DTL?

• DTA is future tax benefit, pay more in taxes now; if book exp > tax exp; asset down

• DTL is future tax liability, pay less in taxes now; if book exp < tax exp; asset write up

What are the 4 types of M&A synergies?

• Revenue

• Cost

• Tax (accumulate NOLs or relocate HQ)

• Financing/leverage (refinance debt w/ lower int rate, more purchasing power w/ suppliers)

What are NOLs and how are they used?

• NOLs are when a company records a loss and are able to use that loss to offset future taxable income.

• When NOLs are created, they are recorded as a DTA on the BS to represent future tax savings

If Company A (PE 10x) acquires Company B (PE 6x) what should their combined PE ratio be?

It should be somewhere between 6 and 10x. If they are the same size, might be around the middle, but if A is significantly larger than B, A will have more weighting and swing the ratio closer to 10.

Company A (PE 10x) acquires Company B (PE 6x). If A is twice the size of B instead of the same size, what would it make the deal more accretive or dilutive?

It would make the deal more dilutive since B is what’s making the deal accretive with the low PE. If A is even larger, it will have more weight with its higher PE and make the deal more dilutive.

Difference between syndicated loan market and private credit?

• Syndicated loan: banks underwrite and then give pieces of the loan to a large group of investor (more liquid, cheaper, more dependent on market conditions)

• Private credit: private credit fund holds the loan and lends directly to the company (less liquid, more expensive, more certain since only 1 party)

Conditions for strong IPO market?

• Low market volatility, positive market outlook, strong investor risk appetite, stable economic conditions

How a change in interest rates would impact a company’s financial statements and valuation?

• Statements: higher interest expense, lower pre tax income, less paid in taxes, lower NI

• Valuation: higher rates = lower valuation

  • higher cost of debt (interest rate)

  • higher risk free rate (10 yr treasury) → higher cost of equity

  • higher WACC

• If investors can earn more from risk free rate, willing to pay less for dollar of earnings

Difference between operating and finance lease?

• Operating lease: renting asset, lease expense under operating expenses

• Financing lease(as if you bought asset with debt): ownership of asset, D&A and interest expense