Merger and Acquisition Modelling Overview

Definition of Terms Used in Mergers and Overview
Merger and Acquisition Modelling Mar 5, 2021 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 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.

Premium
• .

Example of Synergy Estimate
• .

Negative Synergies and Costs to Achieve

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

Example of Accretion/Dilution Analysis

Earnings Analysis Should Include Constraint of Credit
Rating
• .

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 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 Terms – Example
Amount paid for the

equity of the target
What the equity
holders of the Includes debt of the
target receive target

Example of Sources and Uses and Credit Constraints

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

When the acquirer share
Floating Collar price increases, then the
exchange ratio declines
To evaluate the band in exchange ratio,
could adjust the sources and uses of
funds statement
When the acquirer share

price declines, the exchange
ratio increases

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

Alternative Methods of Analysis
• There are 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

Alternative Valuation - DCF

Use of Multiples in M&A Valuation
• .

Evaluation of EV/EBITDA Ratio
• .

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

Analysis in M&A

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 Accounting

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

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

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.)

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.

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)

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

Goodwill and Purchase Price Allocation
• Goodwill • Purchase Price
• GW = Equity Purchase price – • Purchase price is the amount of

Book Value of Target + Fees the fixed assets plus the net
Allowed – Asset Write-ups + goodwill (analogous to the
Liability Write-ups enterprise value)
• Using Abbreviations • Using Abbreviations
• GW = EqPrice – BVeq + Fees – • PP = EqPrice + Debt + Fees =

Write-up Existing Assets + Write-up +
Goodwill + Net WC
• Or since BVeq = Existing Assets
– Debt + Net WC • GW = PP - Existing Assets -
Write-up - Net WC
• GW = EqPrice – Existing Assets
+ Ex Debt – Net WC - Write-up

Transaction Fees–Summary

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.

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

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.

Begin with Consideration for the
Example of Purchase Price Allocation equity and then add the debt
assumed to derive purchase
price.
-in thousands TXOK Power Gas Winchester

Acquisition, Inc. Marketing & Energy
Transmission, Inc. Company, Ltd.
Purchase price:
Carrying value of initial investment in TXOK Acquisition, Inc. $ 21,531
Net
$
purchase
—
price is the
$ —
Acquisition of preferred stock, including accrued and unpaid dividends 158,750 consideration
— paid (including fees)
—
Value of preferred stock redemption premium 4,667 plus the net
— debt —
Cash payments for acquired equity — 63,615 1,095,028
Assumption of debt:
Term loan, plus accrued interest 202,755 — —
Revolving credit facility plus accrued interest 309,701 13,096 —
Assumption of derivative financial instruments — 38,098 —
Less cash acquired (32,261) (1,839) (118)
Net purchase price $ 665,143 $ 112,970 $ 1,094,910
Allocation of purchase price:
Oil and natural gas properties—proved $ 489,076 $ 122,972 $ 583,683
Oil and natural gas properties—unproved 60,840 Allocate
421 the purchase price
154,291 to
Gathering and other fixed assets 20,079 2,573 151,149
fixed assets and net working
Goodwill 64,887 21,249
capital. The remainder163,935
is
Current and non-current assets 37,460 2024 31,872
Deferred income taxes 26,783 goodwill
(31,424) —
Accounts payable and other accrued expenses (30,377) (3,318) (39,420)
Asset retirement obligations (8,203) (1,527) (7,793)
Fair value of oil and natural gas derivatives 4,598 — 57,193
Total purchase price allocation $ 665,143 $ 112,970 $ 1,094,910

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.

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.

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.

Introductory Case Exercise

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

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

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)

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

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.

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.

Reasons for Mergers and Acquisitions

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
This implies that you
• Better deals come from: should compute the
ROIC and understand
• Believable and unique synergies differences
• 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

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.

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

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 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 PowerPoint 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

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

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

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 SportsAuthority
• 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 TheraTech

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

Reasons for Problems in
Acquisitions Achieving Success
Increased Integration
market power difficulties
Overcome Inadequate
entry barriers evaluation of target
Cost of new Large or

product development extraordinary debt
Increased speed Inability to

to market achieve synergy
Lower risk
compared to developing Too much
new products diversification
Increased Managers overly

diversification focused on acquisitions
Avoid excessive
competition Too large

M&A Intermediaries
• Business brokers
• Accountants
• Lawyers
• Consultants
• Business valuation firms
• Commercial banks
• Investment banks

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.

Example of Merger Financial and Economic Objectives
Each objective
should be
quantified with
a financial
model

General Themes of Course

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.

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 are 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.

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.

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 the 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.

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.

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

Reference Slides

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.

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.

M&A Terms - Merger
• 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 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 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 step-
up 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

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.

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

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

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

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

Earnings Exchange Analysis

EV/EBITDA Adjsutments

• .

Synergy Questions
• .

Merger and Acquisition Modelling Overview

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Definition of Terms Used in Mergers and Overview

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• A few terms that will be used throughout the course.

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NRG Price: $22/Share

Premium: $2.1 Billion

After Tax Synergies

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• Uses and Sources of Funds in Acquisition

• Uses of funds include consideration and fees and may include

• Purchase Price Allocation:

• In an stock purchase, can elect to have the transaction treated

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Amount paid for the

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• Exchange Ratio and Share Exchange

• Financial ratios such as the price to earnings ratio, the market to

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When the acquirer share

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• Earnings Accretion is Success

• Earnings Dilution is Failure

• Net present value of free cash flow

• Net Present Value of Synergies > Premium is Success

• Net Present Value of Synergies <= Premium is Failure

• Stock Price Increases Relative to Comparable Companies

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• There are alternative methods for analysis of an acquisition, all of which

• Discounted Cash Flow

•Add after-tax PV of Synergies

•Evaluate Equity IRR and Variation in Equity IRR

• Integrated Merger Model

•Evaluate Credit Ratios and EPS Changes

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• Provide a general understanding of M&A models as background for

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• Cash and Accounts Receivable

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(Thus, firm has some discretion in when it is recognized as an expense)

• Kitchen Sink Quarter: Digging through their vaults, dredging anything

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• Begin with Purchase Price – Enterprise Value

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• Goodwill • Purchase Price

• GW = Equity Purchase price – • Purchase price is the amount of