Merger Model: Assessment Centre Case Study (24:14)

Step 1: Read and interpret the instructions… and understand where to cut corners!

Requirements: Need to be able to change the purchase price and % debt and stock used… but cash and the foregone interest on cash are unnecessary, which simplifies things.

Also, they’ve given us incomplete information in a few spots and we need to go through and calculate some figures for Company A and Company B, such as the shares outstanding.

SKIP the formatting!

Step 2: Enter the financial information for Company A and Company B.

Fairly straightforward, but remember that we need to calculate a few additional numbers for this to work, such as the shares outstanding for each company and the Net Income and EPS, at least for the buyer.

Step 3: Calculate the “missing information” – Net Income, EPS, and Share Counts.

Start with Pre-Tax Income, then calculate Net Income based on the tax rates for both companies, and then EPS… not completely necessary for Company B, but definitely need it for Company A.

Then, calculate the Share Count for both companies and the Enterprise Value (just for reference).

Step 4: Go up to the top and enter the key assumptions, starting with Question #1.

To save time, skip the (1 + Premium) * Share Price * # Shares calculation and just calculate the purchase price based on the premium to Company B’s Market Cap instead — same result either way.

Calculate %s for debt and stock, then the amount of debt raised, debt interest rate, and shares issued.

Then, fill in the information about the synergies — no information on expenses here, so we leave it out.

Step 5: Combine the Income Statements for Company A and Company B.

Start with the Synergies, and then combine all the other line items, factoring in those synergies on top. Remember to factor in acquisition effects, such as additional interest expense.

Calculate down to EPS, making sure you include the NEW shares issued in the transaction and increase Company A’s share count as appropriate.

Step 6: Calculate Accretion / (Dilution) and the Pro-Forma Credit Stats.

Take the combined company’s EPS and divide by the buyer’s EPS and subtract 1.

For the credit stats, the two key ones are the Leverage Ratio (Net Debt / EBITDA here) and the Coverage Ratio (EBITDA / Interest) – so calculate those each year.

Step 7: Create sensitivities… if you have time.

Here, we would argue it’s pointless since it takes more time and effort to set them up, and they don’t save much time beyond the model we already have — so we’re skipping this step.

Step 8: What is the POINT of this case study exercise?

Takeaway #1: Even if we pay a higher premium for a seller, the deal might be MORE accretive depending on the purchase method… debt tends to be less expensive than stock.

Takeaway #2: Company B is a very cheap asset — MUCH lower P / E and EV / EBITDA multiples than Company A.

When a more expensive buyer acquires a much less expensive seller, the deal will almost always be accretive. Company B’s significantly higher tax rate also makes a difference — Company A gets “free money” after the acquisition since it’s only paying 25% in taxes rather than 40%.

Takeaway #3: Using debt tends to produce more accretion than stock, but it also produces higher leverage ratios and lower coverage ratios — so there is a trade-off between accretion / (dilution) and the credit stats following the deal.