The M&A Model – Accretion/ Dilution
In this blog (June 20th 2019) I will talk about the M&A (Merger & Acquisition) model, it basically is a financial model to determine whether a M&A transaction is “accretive” or “dilutive”.
My last blog of June 9th 2019 was about the LBO (Leveraged Buyout) model, in case you have not read it yet, it can be found here:
https://www.linkedin.com/pulse/leveraged-buyouts-lbos-joris-kersten-msc-bsc-rab/
The M&A model – Accretion/ Dilution: An Introduction
The M&A model consists essentially out of two standalone financial models, one for the acquirer and one for the target. These models are summed up in order to form “pro forma combined financial statements”.
As with a LBO model, historical financial data is entered into an “income statement (IS) tab” and “balance sheet (BS) tab” in Microsoft excel. And then assumptions like growth rates, margins, working capital assumptions etc. that drive income statements, cash flow statements and balance sheets are entered into “assumption tabs” in Microsoft excel.
And an offer price for the shares of the acquisition and acquisition structure (payment with equity vs debt, example 50%-50%) data are then entered into a “transaction summary tab” in excel.
After that the financing structure (how the debt part is built up), allocations of the purchase price premium (purchase price allocation (PPA)/ goodwill), assumptions around deal-related depreciation and amortization (because of asset write ups/ PPA) and estimated synergies are entered into a tab called “pro forma assumptions”.
Concerning the financing structure, a special tab is created in which for each debt instrument key terms are typed in. This tab is called “pro forma debt schedule”.
Once all the appropriate deal-related information is entered into the model, it should automatically update two tabs, 1 concerning the “pro forma credit statistics” and 1 concerning the “accretion or dilution” after the deal.
I will talk about accretion/ dilution later on in this blog, but first let’s take a look at some more basics of this so-called M&A model.
Build in flexibility with Microsoft excel
As with the LBO model, a M&A model is constructed with the flexibility to analyze a given proposed transaction under “multiple financing structures” and “operating scenarios”.
On the “transaction summary tab” in excel; basically the first tab, toggle cells allow the corporate finance consultant to switch amongst others between multiple financing structures and operating scenarios. Here for the “choose function” in excel is used, like I discussed in my blog on the LBO model.
This is just really handy, because it would be crazy to type in different operating scenarios and financing structures when your managing director or the client asks for this. It can now be done simply with building in a “toggle” with some choose functions. Excel is our best friend.
Financing structure and deal structure
An acquirer of a target company needs to choose among the available funds based on a variety of factors, think of cost of capital, flexibility on your balance sheet, rating agency considerations and speed and certainty to close the transaction.
Debt financing refers to the issuance of new debt or to use “revolver availability” to partially, or fully, fund a M&A transaction. Examples of debt instruments are: a revolving credit facility, term loans and bonds/ notes.
Equity financing refers to a company’s use of its own stock as an acquisition currency. An acquirer can either offer its own stock directly to the shareholders of the target. Or they can first issue shares and then use the cash proceeds to pay the shareholders of the target.
Equity financing offers the issuers with greater flexibility as there are no mandatory cash interest payments, repayments of principal and no covenants (as all the case with debt).
Goodwill, purchase price allocation (PPA) and deferred tax liability
In modelling a stock sale transaction “Goodwill” needs to be taken into account. When the purchase price exceeds the “net identifiable assets” of the target, this excess is first allocated to the target’s tangible and identifiable intangible assets. These are then written up to their “fair value” and we call this purchase price allocation (PPA).
These tangible and intangible asset write ups are then reflected in the acquirer’s pro forma balance sheet. And they are then depreciated and amortized over their useful lives which reduces after tax earnings.
This transaction related depreciation and amortization is not deductible for tax purposes. And from an accounting perspective, this discrepancy between book value and tax value is resolved through the creation of a deferred tax liability (DTL) on the balance sheet. For example called: “deferred income taxes”.
Goodwill is calculated as purchase price minus target’s net identifiable assets after allocations to the target’s tangible and intangible assets (PPA). Once calculated, goodwill is added to the asset side of the acquirer’s balance sheet and tested yearly for “impairment”.
A graphical representation of the calculation of goodwill is given under here. The tabel comes from the book: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl (exibit 7.4 in the book).This is the main book I use in my training sessions and my participants receive a hard-copy of this book when they register.
Merger consequences analysis
Merger consequences analysis measures the impact on “earning per share” (EPS) in the form of “accretion/ dilution analysis”. And it also measures the credit statistics after the deal because of balance sheet effects.
This analysis enables strategic buyers to fine tune the deal for ultimate purchase price, deal structure and financing mix. Of course, for this key assumptions need to be made regarding purchase price, target company’s financials (operating scenarios), and deal structure and forms of financing.
A corporate finance consultant does this by first constructing standalone operating models (income statements, balance sheets and cash flow statements) in excel for both the target and the acquirer. As mentioned, these models are then combined into one pro forma financial model that incorporates all the transaction related adjustments.
Merger consequences analysis: Credit statistics
Acquirers of target companies are often guided by the desire to maintain key target ratios for the credit statistics in setting up their M&A financing structure.
Most widely used credit statistics are grouped into leverage ratios (e.g. debt to EBITDA and debt to total capitalization) and coverage ratios (e.g. EBITDA to interest expense).
Merger consequences analysis: Accretion/ Dilution
Accretion/ dilution analysis measures the effect of a transaction on a potential acquirer’s earnings, assuming a given financing structure. It centers on comparing the acquirer’s EPS pro forma (after the transaction) versus on a standalone basis (before the transaction).
If the “pro forma combined EPS” is lower than the acquirer’s standalone EPS, the transaction is said to be “dilutive”.
Conversely:
If the pro forma EPS is higher, the transaction is said to be accretive.
A rule of thumb for 100% stock transaction (100% paid with equity) is that when an acquirer purchases a target with a lower P/E ratio (Price/ Earnings), the acquisition is accretive. In this case, transactions where an acquirer purchases a higher P/E target are de facto dilutive.
The latter could be reversed do by “sizable synergies”.
Accretion/ dilution analysis is a key screening mechanism for strategic buyers. Acquirers do not pursue transactions that are dilutive over the foreseeable earning projection period
For modeling purposes, key drivers for accretion/ dilution are purchase price, projected earnings for buyer and target (operating scenarios), expected synergies, form of financing, debt/ equity mix and the cost of debt.
The most accretive M&A deals have (relatively) low purchase prices, cheap forms of financing (more debt) and significant synergies.
A graphical representation of the calculation of “accretion/ dilution” is given under here. The tabel comes from the book: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl (exibit 7.23 in the book).This is the main book I use in my training sessions and my participants receive a hard-copy of this book when they register.
My next blog will be on “Discounted Cash Flow Valuation” (DCF valuation). Stay tuned!
And when you are interested in being able to prepare all the main valuation models for real in excel follow my valuation training in Amsterdam/ Zuidas.
More info below, and here you can also find my profile as an international trainer in Corporate Finance.
Training Business Valuation & Deal Structuring
This is a practical 6-day training in “Business Valuation & Deal Structuring” (Investment Banking M&A) and the main topics are: valuation, leveraged buyouts (LBO’s) and mergers & acquisitions (M&A’s).
The training mainly focusses on giving the participant hands on tools to build financial models in excel to determine the value of a company on 1) a stand-alone basis, 2) in a LBO situation and 3) in a buy-side M&A scenario.
In the training we will look at different valuation techniques to calculate “enterprise value” like: 1) Comparable companies analysis, 2) Precedent transaction analysis, 3) Discounted cash flow analysis (DCF), 4) LBO analysis and 5) Buy-side M&A analysis.
And we will look at different techniques to get from “enterprise value” to the “value of the shares” taking (adjusted) net debt into account.
The training is very practical in a sense that the trainer will explain the concepts first and will then apply them in class to real life companies with the participants. With all the calculations “Microsoft excel” is used to build the needed financial models.
This training is meant for analysts and associates from international investment banks. Moreover, the training is meant for analysts and consultants in: M&A, private equity, venture capital and strategy. In addition, the training is meant for accountants, tax lawyers, bankers in credit analysis, financial managers, CFO’s etc.
During the training will be focused on international companies listed on the stock exchange. But the valuation techniques are also applicable to (non-listed) private firms.
For any more question on this training feel free to contact by email: joris@kerstencf.nl and/ or by phone: +31 6 8364 0527 (time zone: Amsterdam).
Planning & location:
1. Wednesday October 2nd2019: 10 AM – 6 PM;
2. Thursday October 3rd2019: 10 AM – 6 PM;
3. Friday October 4th2019: 10 AM – 6 PM;
4. Saturday October 5th2019: 10 AM – 6 PM;
5. Monday October 7th2019: 10 AM – 6 PM;
6. Tuesday October 8th2019: 10 AM – 6 PM.
Sunday April 7th: Not a training day.
Location: Crowne Plaza Hotel – Amsterdam South. George Gershwinlaan 101. 1082 MT Amsterdam.
The hotel is located in Amsterdam South (financial district), right across train station “Amsterdam South” and about 15 minutes from “Schiphol Airport”.
Price & payment:
The price for this 6-day training is 3.900 euro excluding vat. And only 2.900 euro ex vat when you book before 31stJuly 2019 (1.000 euro early bird discount).
This price is for the 6-day training including study materials (A hardcopy of the theory + workbook of: Investment Banking: Valuation, leveraged buyouts and mergers & acquisitions of Joshua Rosenbaum & Joshua Pearl), coffee and tea all day, luxury lunch at lunchtime and a snack in the afternoon.
There is a maximum of 20 participants for the training based on first come first served. This way there is room for interaction in class.
You can register yourself by sending an email to: joris@kerstencf.nl.
You will then receive a registration form and additional details for registration. Or download the registration form and training manual at: www.kerstencf.nl/training
Trainer & Consultant: J.J.P. (Joris) Kersten, MSc BSc RAB
· 130 recommendations on his training can be found on: www.kerstencf.nl/referenties
· His full profile can be found on: www.linkedin.com/in/joriskersten
J.J.P. (Joris) Kersten MSc BSc RAB (1980) is owner of “Kersten Corporate Finance” in The Netherlands, under which he works as an independent consultant in Mergers & Acquisitions (M&A’s) of medium sized companies.
Joris performs business valuations, prepares pitch books, searches and selects candidate buyers and/ or sellers, organises financing for takeovers and negotiates M&A transactions in a LOI and later in a share purchase agreement (in cooperation with (tax) lawyers).
Moreover, Joris is associated to ‘AMT Training London’ for which he provides training as a trainer and assistant-trainer in Corporate Finance/ Financial Modelling at leading investment banks in New York, London and Hong Kong.
And Joris is associated to the ‘Leoron Institute Dubai’ for which he provides finance training at leading investment banks and institutions in the Arab States of the Gulf. This for example at Al Jazira Capital in Saudi Arabia and TAQA in Saudi Arabia.
In addition, Joris provides lecturing in Corporate Finance & Accounting at leading Universities like: Nyenrode University Breukelen, TIAS Business School Utrecht, the Maastricht School of Management (MSM), the Luxembourg School of Business and SP Jain School of Global Management in Sydney.
Moreover, he provides lecturing at partner Universities of MSM in: Peru, Surinam and Mongolia. And at partner Universities of SP Jain in Dubai, Mumbai and Singapore.
Joris graduated in MSc Strategic Management and BSc Business Studies, both from Tilburg University. In addition, he is (cum laude) graduated as “Registered Advisor Business Acquisitions” (RAB), a 1-year study in the legal and tax aspects of M&A’s. And Joris obtained a degree in “didactic skills” (Basic Qualification Education) in order to lecture at Universities.
Currently Joris is doing the “Executive Master of Business Valuation” to obtain his title as “Registered Valuator” (RV) given out by the “Netherlands Institute for Registered Valuators” (NIRV). This title will enable Joris to give out business valuation judgements in for example court cases.