Definition of Terms Used in Mergers and Overview
- Slides: 82
Definition of Terms Used in Mergers and Overview Merger and Acquisition Modelling November 20 1
Merger and Acquisition Background • A few terms that will be used throughout the course. • Mergers and Acquisitions are valuation and capital budgeting problems, but: • The value of synergies and management strategy in M&A are difficult to quantify with financial models • Costs and benefits of a merger can be measured in various different ways (DCF Valuation, Equity IRR, EPS changes, credit quality, NPV) • Accounting, tax, and regulatory issues can be complex in modeling (goodwill, tax step-ups, re-financing) • Methods of quantifying the costs and benefits of M&A with financial model • Merger or consolidation; performance of combined company in terms of EPS and credit quality (as well as DCF of target company) • Acquisition; model the rate of return earned assuming that the company will be re-sold after a holding period and evaluate EPS effects (as well as DCF of target company) Merger and Acquisition Modelling November 20 2
Merger Terms • Synergy • Increase in revenue and/or decrease in expense and/or decrease in capital expenditure that occurs because two companies operate as one. • Premium • Increase in target share price from before the merger to after the merger • Dilution/Accretion • Effect of merger or acquisition on earnings per share or some other measure – accretion is increase from merger and decrease is dilution. Merger and Acquisition Modelling November 20 3
Premium • . Merger and Acquisition Modelling November 20 4
Example of Synergy Estimate • . Merger and Acquisition Modelling November 20 5
Negative Synergies and Costs to Achieve Merger and Acquisition Modelling November 20 6
Synergy and Premium NRG Price: $22/Share 264 million shares NRG Market Cap: $5, 810 Million Premium: $2. 1 Billion 37% of $5, 810 Million After Tax Synergies $1 bill - $1. 8 billion Less: Costs 360 Net Synergies $720 – 1, 440 million Merger and Acquisition Modelling November 20 7
Example of Accretion/Dilution Analysis Merger and Acquisition Modelling November 20 8
Earnings Analysis Should Include Constraint of Credit Rating • . Merger and Acquisition Modelling November 20 9
Merger Terms • Purchase Accounting • Purchase accounting is normally used in M&A. Assets and liabilities are measured at fair value rather than original cost and the common equity of the company is eliminated. Alternative method is pooling of interests. • Goodwill • Asset arising from purchase accounting that arises from the difference between equity that was on the balance sheet and equity that is paid for the company. • Minority Interest • The share of the company (assets and income) that is not owned by shareholders of the corporation. Merger and Acquisition Modelling November 20 10
Merger Terms • Consideration: • How the payment is made for the equity value of the target company. This can be share exchange, cash, preferred stock, option or other creative forms of financing. • Uses and Sources of Funds in Acquisition • Uses of funds include consideration and fees and may include repayment of existing debt. Sources are debt, equity (public offering or share exchange), surplus cash of target etc. Sources can also include the sale of business units. • Purchase Price Allocation: • In an stock purchase, can elect to have the transaction treated as an asset purchase implying a step-up in value Merger and Acquisition Modelling November 20 11
Merger Terms – Example What the equity holders of the target receive Merger and Acquisition Modelling Amount paid for the equity of the target Includes debt of the target November 20 12
Example of Sources and Uses and Credit Constraints Merger and Acquisition Modelling November 20 13
Merger Terms • Exchange Ratio and Share Exchange • The number of shares received for the new merged firm that will be received for existing shares of the target. The starting point for evaluation should be the relative share prices before the merger. • Transaction Multiples • Financial ratios such as the price to earnings ratio, the market to book ratio and the enterprise value to EBITDA ratio that are computed from the amount paid for other transactions. Transaction multiples contrast with public company multiples. • Transaction Value • Enterprise value (equity value plus net debt (market value) plus the transaction fees Merger and Acquisition Modelling November 20 14
Floating Collar To evaluate the band in exchange ratio, could adjust the sources and uses of funds statement When the acquirer share price increases, then the exchange ratio declines When the acquirer share price declines, the exchange ratio increases Merger and Acquisition Modelling November 20 15
Definitions of Success • Accounting • Earnings Accretion is Success • Earnings Dilution is Failure • Economics • Net present value of free cash flow • Net Present Value of Synergies > Premium is Success • Net Present Value of Synergies <= Premium is Failure • Finance • Compute the Equity IRR with Exit Multiples over Holding Period • Stock Price Increases Relative to Comparable Companies Merger and Acquisition Modelling November 20 16
Alternative Methods of Analysis • There alternative methods for analysis of an acquisition, all of which have advantages and disadvantages: • Discounted Cash Flow • Compute DCF of Target on Standalone Basis • Add after-tax PV of Synergies • Acquisition Model • Compute Equity Cash Flow with Actual Financing Structure • Evaluate Equity IRR and Variation in Equity IRR • Integrated Merger Model • Compute the Effect of Acquisition on EPS and Other Ratios • Evaluate Credit Ratios and EPS Changes Merger and Acquisition Modelling November 20 17
Alternative Valuation - DCF Merger and Acquisition Modelling November 20 18
Use of Multiples in M&A Valuation • . Merger and Acquisition Modelling November 20 19
Evaluation of EV/EBITDA Ratio • . Merger and Acquisition Modelling November 20 20
Accretion Objective Mergers Premium received by target company and added benefits if continue interest in the new company EPS Accretion from the perspective of acquiring company Merger and Acquisition Modelling November 20 21
Analysis in M&A Merger and Acquisition Modelling November 20 22
Objectives of Model Overview Section • Provide a general understanding of M&A models as background for subsequent sections • Read through actual models to gain general familiarity with transaction • Understand why and sheets and modules are added in models • Find key components of common to M&A models • How M&A models can be used to evaluate the benefits and costs of a transaction with alternative structures. • M&A Accounting • M&A Financing • M&A Synergies • Target Valuation • Model Assumptions Merger and Acquisition Modelling November 20 23
Merger and Acquisition Accounting Merger and Acquisition Modelling November 20 24
Accounting for Acquisitions (Majority Stake) • Purchase Accounting • Assets of acquired firm must be reported at fair market value • Goodwill is created – difference between purchase price and estimated fair market value of net assets • Goodwill no longer has to be amortized – assets are essentially marked-to-market annually and goodwill is adjusted and treated as an expense if the market value of the assets has decreased • Pooling of interests • Pooling accounting is meant to reflect situations in which there is no ownership change, but the uniting of business interests Merger and Acquisition Modelling November 20 25
Accounting for Acquisitions (Alternative Stakes) • Consolidation • When the investor controls more than 50% of the voting shares • Line by line consolidation of financial statements • Eliminate inter-company transactions • Minority interest • Equity Method • Investor holds between 20% and 50% of a company • Investment stated at net asset value • Dividends received treated as adjustment to investment • Earnings recorded as percent of companies earnings • Fair Value Method • Investor holds less than 20% • Dividends treated as income Merger and Acquisition Modelling November 20 26
Purchase Accounting • Cash and Accounts Receivable • Generally valued at carrying values prior to the acquisition • Marketable Securities • Net realizable value • Inventories • Replacement cost; eliminate LIFO reserves • Property plant and equipment • Booked at fair market value • Accounts payable and accrued expenses • Carrying values prior to acquisition • Debt • Value at current interest rates • Intangible Assets (Customer listes etc. ) Merger and Acquisition Modelling November 20 27
Treatment of Goodwill • Goodwill -- The intangible assets of the acquired firm arising from the acquiring firm paying more for them than their book value. • Formerly, goodwill could not be amortized for more than 40 years for “financial accounting purposes. ” and goodwill charges are generally deductible for “tax purposes” over 15 years. • Now Goodwill is amortized only when determined that there has been a permanent “impairment” (Thus, firm has some discretion in when it is recognized as an expense) • Impairment of goodwill is not tax deductible (for tax purposes, can still amortize goodwill) • Kitchen Sink Quarter: Digging through their vaults, dredging anything that looked shaky, and writing it off – getting it over with. Merger and Acquisition Modelling November 20 28
Steps in Goodwill Calculation to Compute Goodwill • Step 1: • Purchase Price of Equity less Book Value of Target • Step 2: • Add Transaction Cost (Like increase in the purchase price that is capitalized) • Step 3: • Deduct asset write-ups (Like increase in the book value of equity of the target) • Step 4: • Add liability write-ups (Like reduction in the book value of equity of the target) Merger and Acquisition Modelling November 20 29
Steps in Purchase Allocation and Write-Up • Begin with Purchase Price – Enterprise Value • Equity Consideration • Plus: Existing Debt and Fees • Less: Surplus Cash Used • Subtract • Existing Net working Capital (Other than surplus cash) • Net Other Assets and Other Liabilities • Existing Value of Fixed Assets • Goodwill (Value as Zero) • Equals • Asset Write-up Merger and Acquisition Modelling November 20 30
Goodwill and Purchase Price Allocation • Goodwill • Purchase Price • GW = Equity Purchase price – Book Value of Target + Fees Allowed – Asset Write-ups + Liability Write-ups • Purchase price is the amount of the fixed assets plus the net goodwill (analogous to the enterprise value) • Using Abbreviations • GW = Eq. Price – BVeq + Fees – Write-up • PP = Eq. Price + Debt + Fees = Existing Assets + Write-up + Goodwill + Net WC • Or since BVeq = Existing Assets – Debt + Net WC • GW = Eq. Price – Existing Assets + Ex Debt – Net WC - Write-up Merger and Acquisition Modelling • GW = PP - Existing Assets - Write -up - Net WC November 20 31
Transaction Fees–Summary Merger and Acquisition Modelling November 20 32
Goodwill versus Intangible Assets – Tyco Example • If intangible assets are created, then subsequent earnings are affected. Consider the example of Tyco: • By minimizing or marking down the value of intangible assets and maximizing or marking-up, goodwill, Tyco can inflate its earnings. The earnings lift comes because Tyco can treat the goodwill differently from real assets, which under accounting rules lose value over time. • In addition, if Tyco sells the assets it has marked down at the time of the acquisition, it can make a larger profit. • Over the last three years, Tyco has spent about $30 billion on acquisitions and created the same amount of goodwill. Merger and Acquisition Modelling November 20 33
Goodwill Calculation Example • Compute goodwill and goodwill amortization as a function of purchase price of the target company. Book value of equity plus net asset write-ups Separately add deferred taxes and fees Merger and Acquisition Modelling November 20 34
Example of Purchase Price Allocation • This example shows how the balance sheet is reconciled with valuation of assets at market values and use of goodwill. Merger and Acquisition Modelling November 20 35
Example of Purchase Price Allocation Begin with Consideration for the equity and then add the debt assumed to derive purchase price. Net purchase price is the consideration paid (including fees) plus the net debt Allocate the purchase price to fixed assets and net working capital. The remainder is goodwill Merger and Acquisition Modelling November 20 36
Bargain Purchase and Negative Goodwill • Negative goodwill is allocated to reduce the pro-rata values assigned to purchased assets excluding cash, financial assets, accounts receivable, inventories and other assets held for sale. • If all of the negative goodwill cannot be absorbed, then record income. Merger and Acquisition Modelling November 20 37
Restructuring Charges in Business Combinations Restructuring charges • Costs associated with the exit or disposal of activities. • Fall into three main classes: 1. One-time benefits provided to employees being involuntarily terminated. 2. Costs of terminating contracts. 3. Costs of moving employees or consolidating operations. Merger and Acquisition Modelling November 20 38
Restructuring Charges in Business Combinations (continued) If restructuring costs provide future benefits to the combined company– • They are not recognized as a liability on the transaction date. • Instead, they are recognized as expenses in the future periods when they are incurred. • The fair value of target’s preexisting restructuring liabilities recognized by the acquirer at the acquisition date and included as part of the target’s total liabilities for the calculation of transaction goodwill. Merger and Acquisition Modelling November 20 39
Introductory Case Exercise Merger and Acquisition Modelling November 20 40
Case Exercise • Given two standalone models • Determine the combined ratios • Assume two private companies • Assume no synergies in initial case • Use template model with titles Merger and Acquisition Modelling November 20 41
Analysis with Consolidation Analysis • Alternative synergies • Alternative purchase prices • Alternative debt and equity issues • Alternative asset write-up and write-down policies • Alternative dividend policy Merger and Acquisition Modelling November 20 42
How M&A Models are Put Together • An M&A Model Accepts • Corporate models from both companies (with financial statements) • Purchase price for target company • Financing of purchase • Transaction costs and synergies • M&A Model Outputs • Financial performance of new company (EPS and financial ratios) • Credit quality of new company (credit quality ratios of new company) Merger and Acquisition Modelling November 20 43
Inputs, Outputs and Valuation in Standalone Corporate Models • Inputs to Derive Free Cash Flow • Capital Expenditures • Revenues • Expenses • Debtors and Creditors • Tax Rates • Plant Life • Calculations are simple: Revenues – Expenses – Working Capital Movement, net of tax • Inputs to Derive Net Cash Flow • Debt to Capital • Interest Rates • Debt Repayment • Dividends • Net cash flow is: Operating Cash – Interest – Debt Repayment – Dividends • The basic structure of corporate models are easy to understand without being a modelling expert • The balance sheet must balance – by far the most effective check on calculations Merger and Acquisition Modelling November 20 44
Goodwill Calculation • Goodwill is computed as the amount paid for equity less the equity book value. • Goodwill is lowered from asset write-ups (increases in book value) and eliminations of deferred tax (reductions in liabilities). • Goodwill is increased from asset write-downs, deferred tax asset elimination and transaction fees that are effectively a reduction in purchase price. Merger and Acquisition Modelling November 20 45
Pro-forma Balance Sheet • Purpose: establish the initial balance sheet for modeling. Existing book equity of the target company should be eliminated. All of the other adjustments including goodwill, debt and equity issues and retirements and asset write-ups are from the sources and uses and the goodwill analysis. Merger and Acquisition Modelling November 20 46
Reasons for Mergers and Acquisitions Merger and Acquisition Modelling November 20 47
Basic Merger Points • The market for corporate control is efficient • Easy deals that add value are difficult to find • Most successful deals are from highly disciplined deal making such as General Electric • Better deals come from: This implies that you should compute the ROIC and understand differences • Believable and unique synergies • Lower price premiums • Smaller companies in related businesses (not diversification) • ROIC and Related Industry • Better run acquirers (higher ROI relative to the industry average) • Same Industry – asset base is similar so you would expect the same ROIC Merger and Acquisition Modelling November 20 48
Example of Merger Analysis -- J. P. Morgan • The elements of J. P. Morgan's analyses included: • Assessing the potential value creation as a result of the merger; • Assessing the sharing of the combined pro forma entity given the historical and forecast contributions of each company, and the sharing of the potential value creation; • Testing the results on pro-forma Exxon earnings per share for the potential accretion/dilution of earnings for the next 3 years; and, • Checking the premium to be paid by Exxon in the merger against market precedent. Merger and Acquisition Modelling November 20 49
Successful M&A • Characteristics of successful M&A transactions: • Focus on quickly improving operating performance (revenue synergies are difficult to achieve; cost synergies are more believable) • Extract investment within five years • Created incentives for top management • Concentrate on cash flow rather than earnings • Personal wealth involved in the deal • Value investing (low P/E) rather than glamour investing (high multiples) • Paying with cash has had more success than issuing shares through share exchange • M&A as a way to use excess cash has not been successful Merger and Acquisition Modelling November 20 50
Studies of Merger Benefits • Value to target is significant • Value to buyer is subject to debate • General conclusion of many studies is that economic profit is about zero, with high variance. • Problems with studies • Event studies • Surveys • Return on Investment • George Stigler: Rational people don’t do stupid things repeatedly. This disputes the notion that M&A continually destroys value. Merger and Acquisition Modelling November 20 51
Merger Failures • Here are my top 10 most common, preventable merger failure modes. One is enough to spell doom, but the more the merrier the train wreck: • 1. Flawed corporate strategy for either or both companies 2. One company sugarcoats the truth, the other buys a Power. Point pitch 3. Sub-optimum integration strategy for the situation 4. Cultural misfit, loss of key employees after retention agreements are up 5. Acquiring company's management team inexperienced at M&A 6. Flawed assumptions in synergies calculation 7. Ineffective corporate governance, plain and simple 8. Two desperate companies merge to form one big desperate company 9. CEO of one or both companies sells board and shareholders a bill of goods 10. An impulse buy or panic sell gets shoved down the board's throat Merger and Acquisition Modelling November 20 52
Theoretical Reasons for Mergers and Acquisitions • Theoretical explanations for M&A activity outcomes: • Synergy theory – expects that there is really “something out there” which enables the merged entity to create shareholders value • Managerialism theory – claims that these combinations are driven by empire building not by shareholders wealth objective • Managerial hubris – managers make unconscious mistakes being overconfident about transportability of their successfulness • Comparable acquisitions – legal issue; shareholders of target are protected by the law, while acquirer’s shareholders are not Merger and Acquisition Modelling November 20 53
Strategic Reasons for Mergers and Acquisitions • Increased market power • Capitalizing on core competencies • Overcome entry barriers • Bypass cost of new product development: • Increased speed to market • Increased diversification • Avoiding excessive competition Merger and Acquisition Modelling November 20 54
Reasons for Acquisitions Continued • Increased Market Power • Acquisition intended to reduce the competitive balance of the industry • Example: British Petroleum’s acquisition of U. S. Amoco • Sportmart and Sports. Authority • Overcome Barriers to Entry • Acquisitions overcome costly barriers to entry which may make “start -ups” economically unattractive • Example: Belgian-Dutch Fortis’ acquisition of American Banker’s Insurance Group • Lower Cost and Risk of New Product Development • Buying established businesses reduces risk of start-up ventures • Example: Watson Pharmaceuticals’ acquisition of Thera. Tech Merger and Acquisition Modelling November 20 55
Questionable Reasons for Acquisitions • Diversification • Investors can diversify for themselves at lower cost and more efficiently through capital markets • Stockholder wealth may actually decrease after the merger because the reduction in risk in effect transfers wealth from the stockholders to the bondholders • Securing access to inputs or sales of outputs • This may be valid, but presumes there are inefficient or uncompetitive markets • Creating the appearance of growth • Increased EPS Merger and Acquisition Modelling November 20 56
Reasons for Acquisitions Problems in Achieving Success Increased market power Integration difficulties Overcome entry barriers Inadequate evaluation of target Cost of new product development Large or extraordinary debt Increased speed to market Inability to achieve synergy Lower risk compared to developing new products Too much diversification Increased diversification Managers overly focused on acquisitions Avoid excessive competition Too large Merger and Acquisition Modelling November 20 57
M&A Intermediaries • Business brokers • Accountants • Lawyers • Consultants • Business valuation firms • Commercial banks • Investment banks Merger and Acquisition Modelling November 20 58
Reason for Acquisition Activity: Investment Banker and Legal Fees in Mergers • Exxon Mobil • We estimate that merger-related fees and expenses, consisting primarily of SEC filing fees, fees and expenses of investment bankers, attorneys and accountants, and financial printing and other related charges, will be approximately $90 million. We estimate that costs of approximately $2. 0 billion will be incurred for severance and other integration-related expenses, including the elimination of duplicate facilities and excess capacity, operational realignment and related workforce reductions. • Chevron Texaco • We estimate that merger-related fees and expenses, consisting primarily of SEC filing fees, fees and expenses of investment bankers, attorneys and accountants, and financial printing and other related charges, will total approximately $150 million. Merger and Acquisition Modelling November 20 59
Example of Merger Financial and Economic Objectives Each objective should be quantified with a financial model Merger and Acquisition Modelling November 20 60
General Themes of Course Merger and Acquisition Modelling November 20 61
Value In M&A Comes from Economic Profit • An investor can invest in risk free securities and earn the risk free rate of interest. If a strategy is to be effective, you must make profit over and above opportunity cost -- you must make economic profit and be able to grow the profit. If you are in a very competitive industry and a price taker, you can earn economic profit through cost efficiency. In a less competitive industry, you can try to differentiate your product, and keep up barriers to entry. • The P/E and other valuation ratios are driven by the rate of return earned above the cost of capital and the ability to grow real profits (valuation from ROIC and growth); • Net present value is computed as the value of cash flow relative to the opportunity cost of capital; • The return on invested capital should be gauged against the weighted average cost of capital. Merger and Acquisition Modelling November 20 62
Valuation is Very Important, But You are Fooling Yourself if You Think it is Precise • Valuation may be the most important skill for a business professional and there a number of different techniques that can be used to measure value ranging from discounted free cash flow to earnings multiples to discounted earnings. However: • None of the valuation methods gives you a precise value number from a practical perspective and none of the approaches is perfect from a theoretical perspective. • You can come up with vastly different valuations if you apply different discount rates or different terminal value methods. • You should acknowledge that there is a range in values and evaluate the downside risk and upside potential in value with different assumptions. • If you use DCF, measure risk directly through scenario, sensitivity and break-even analysis rather than focusing on the discount rate in the base case. Merger and Acquisition Modelling November 20 63
Assess Costs and Benefits of M&A with Financial Models • Because of the difficulty in valuation, it is often more effective to assess strategies through measuring the effect of the strategy on financial measures such as earnings per share, return on invested capital and other financial ratios rather than attempting to gauge the value impacts. • Measure the earnings per share and credit quality before and after the merger using similar economic assumptions for the target and the acquirer; • Measure the effects of different purchase price premiums financing strategies, share price dilution, purchase price and transactions costs; • Measure the impact of the financing constraints through evaluating prospective credit ratings and debt capacity. Merger and Acquisition Modelling November 20 64
Relevance of Free Cash Flow • In theory, value comes from free cash flow that is independent of the financing of the firm. Equity and debt are the claims on that free cash flow. Even if theory is not completely practical for valuation, it does have a number of relevance in M&A; • Debt capacity in a leveraged buyout comes from the level and the volatility in free cash flow • Valuation of synergies and strategies from free cash flow using the WACC; • Creation of structured debt issues from a free cash flow; • Use of free cash flow to determine debt capacity in LBO. Merger and Acquisition Modelling November 20 65
Corporate Model Functions in M&A • The corporate model serves many functions in an M&A transaction: • The model is the data collection point – for example if an item from due diligence is important in the transaction it should be included in the corporate model. • The corporate model provided in the offering memo can be the basis of negotiation. • The corporate model is used to make presentations to creditors in raising debt for the transaction. Merger and Acquisition Modelling November 20 66
To be Most Effective in Negotiating M&A Transactions, You Need to Understand Value • To develop strategies that result in outcomes and compromises that are perceived as being advantageous to both parties, you need to understand the perspective of the other party in the negotiation. Specifically, you need to understand how the other side perceives value. What is the valuation method used, what assumptions does the other side make, what item of value is most important. • Contract negotiation, M&A, financing fees. • Develop financial projections for the other side, compute IRR for the other side. • Know the value of financial instruments from different perspectives Merger and Acquisition Modelling November 20 67
Reference Slides Merger and Acquisition Modelling November 20 68
Transaction Type – Stocks versus Assets • Type of transaction depends on tax considerations, legal requirements, and the ability to attain shareholder approval. • In reality virtually all transactions are acquisitions by one company, even though some are called mergers after the fact. • Leveraged transactions are similar to other transactions except that a high level of debt is used to finance the transaction: • High level of debt makes the transaction more complex with covenants, cash flow waterfalls and other restrictions. Merger and Acquisition Modelling November 20 69
Stock Offer • Fixed exchange ratio. • # of acquirer shares to be exchanged for each target share is set at the time of the offer. • Floating exchange ratio. • Value to be paid is agreed upon at the time of offer, ratio floats until closing. • Collar. • Upper and lower limits on shares to be offered (floating). • Upper and lower limits on price to be paid (fixed). • Walk-away. • Target can walk from fixed if acquirer’s stock falls too low. • Acquirer can walk from floating if it’s stock falls too low. Merger and Acquisition Modelling November 20 70
M&A Terms - Merger • Definition: A transaction where the purchasing company buys all of the assets and assumes all the liabilities of the target company. Both prior companies cease to exist and the new company combines both. • Modeling: Model mergers with exchange ratios and/or with integrated model. • Approval: 50% or more of the shareholders of each firm. • Tax: No write-up of assets; no taxable gain for target shareholders, surviving firm can use net operating loss. In the old days, the accounting would use pooling of interests. • Other: Assume contracts, no minority shareholders remain Merger and Acquisition Modelling November 20 71
Merger Terms – Acquisition -- Purchase of Stock • Stock Purchase Acquisition – The distinction is more important for legal and tax purposes • Definition: A transaction where one firm buys all or the majority of the stock of another (target) company. • Tax: Avoids tax for the target on a corporate basis (it is as if targets company just changed shareholders). • Cannot write-up or step-up assets for tax purposes. • Can use the NOL • Acquirer is main shareholder; can have minority interest • Contracts remain in place, accept undisclosed liabilities • Modeling: Model acquisitions with capital expenditure addition to corporate model along with an equity issue. Merger and Acquisition Modelling November 20 72
Merger Terms – Acquisition -- Asset Purchase • Asset Purchase Acquisition • Financing: Generally cash transactions • Approval: Sale of division does not require approval; sale of 50% or more of assets usually requires approval • Taxes: Treated as an asset sale for tax purposes • Target company is subject to taxes at the corporate level; buyer can stepup and amortize goodwill for taxes • Taxes paid by the target company and personal taxes on capital gains result in double taxation –Amortize goodwill over 15 years for tax –Not allowed to use NOL of target • May avoid some contractual liabilities if only purchase the assets Merger and Acquisition Modelling November 20 73
M&A Objectives • …acquisitions that complement existing products and services, enhance the Company's product lines and/or expand its customer base. The Company begins formulating exit plans as part of the acquisition approval process. The company determines what it is willing to pay for an acquisition, partially based on its expectation that it can cost effectively integrate the products and services of an acquired company into Tyco's existing infrastructure and improve earnings by removing costs in areas where there are duplicate sales, administrative or other facilities and functions. In addition, the Company utilizes existing infrastructure (e. g. , established sales force, distribution channels, customer relations, etc. ) of acquired companies to cost effectively introduce products to new geographic areas. The Company also targets companies that are perceived to be experiencing depressed financial performance. All of these factors contribute to acquisition prices in excess of the fair value of identifiable net assets acquired and the resultant goodwill. Merger and Acquisition Modelling November 20 74
Example of Goodwill and Purchase Price Allocation • Actual Example of Goodwill and Fair Value adjustments – note the asset and liability categories that had the largest impact Merger and Acquisition Modelling November 20 75
Other Terms • Pre-emptive Bid • Target destroys the credibility of the offeror before making a bid • Bear Hug • Target makes bid for Offereor before Offeror makes bid for target • Pac Man • Target makes bid for Offeror after Offeror makes bid for target Merger and Acquisition Modelling November 20 76
Types of Mergers • From Perspective of Buyers • Horizontal • Vertical – upstream or downstream • Conglomerate/Diversification • Financial • Private versus Public • Public – fixed pricing, many rules, high documentation Merger and Acquisition Modelling November 20 77
Terms • Perfuming the pig • Stuffing the distribution channels • Over-optimistic projections • Disguising head count • Treating recurring costs and one-off • Under-funding capital expenditures and SG&A • Due Diligence • Buyer conducts an investigation of the business • Can result in calling off a deal • Can result in adjustments to price • Also employed by banks in IPO Merger and Acquisition Modelling November 20 78
Earnings Exchange Analysis Merger and Acquisition Modelling November 20 79
EV/EBITDA Adjsutments Merger and Acquisition Modelling November 20 80
• . Merger and Acquisition Modelling November 20 81
Synergy Questions • . Merger and Acquisition Modelling November 20 82
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