CHAPTER 7
Buy-Side
M&A
Princess
Tapang
Mergers and
Acquisitions
● involve the (M&A)
purchase, sale, spin-off, and
combination of companies and their assets.
● allows companies to grow, adapt, and refocus
according to market trends and shareholder
demands.
● Activity increases in strong economies and
decreases in difficult times.
● Larger, high-profile deals often get media
attention, and M&A represents a substantial part
of investment banking activity.
● M&A involves complex decisions regarding
valuation, financing, deal structure, and timing,
with investment banks playing a crucial advisory
role.
Buy-Side
M&A Focus
● Buy-side M&A involves advising companies
on acquiring other businesses.
● The buy-side banker performs key analytical
work, including financial modeling (merger
consequences analysis), valuation, and deal
structure.
● In competitive bidding, the banker helps
outmaneuver other bidders within the
client’s financial limits.
● Bankers are chosen based on deal-making
ability, technical expertise, and sector
knowledge.
Buyer
Motivation
● Acquisitions enable ● Acquisitions are often ● Companies may
growth and profitability faster and less risky pursue bolt-on
through synergies, cost than building a acquisitions to
savings, and access to business from scratch. expand in familiar
new markets. areas or branch into
new markets.
Synergies in M&A
SYNERGIES Cost
Expected: benefits Synergies:
from the merger, Reductions in
including cost headcount,
savings and growth
facilities
opportunities.
consolidation,
Revenue economies of
Synergies: scale, and
purchasing
Enhanced sales
power.
opportunities via new
distribution channels or
product lines. Realizing synergies is critical for shareholder value,
with cost synergies being more reliably quantifiable.
Acquisition
Strategies
01. 01.
Horizontal Vertical
Integration: Integration:
● Acquiring companies at ● Acquiring suppliers
the same level of the (backward
supply chain to increase integration) or
scale, scope, and
customers (forward
market reach.
integration) to
● Offers cost synergies
improve efficiency
and cross-selling
and control over
opportunities but may
face antitrust
the supply chain.
challenges.
Conglomeratio
n Strategy
● Conglomeration involves combining unrelated
companies under one corporate umbrella.
● Unified Approach: Companies in conglomerates share
business strategies, best practices, and benefit from
shared management, infrastructure, and financial
resources.
● Diversification: A conglomerate diversifies risk and can
allocate resources to higher-growth segments within its
portfolio.
● Example: Berkshire Hathaway, a well-known
conglomerate, spans diverse sectors like insurance,
energy, retail, and transportation, leveraging its strong
management and investment philosophy.
● Trend Shift: There has been a general trend towards
more streamlined business models and away from
Forms of Financing in
M&A
Definition: Sourcing of internal and/or external capital
to fund an M&A transaction. Key forms include cash on
hand, debt, and equity.
Impact on Transaction: The financing method affects
earnings accretion/dilution, pro forma credit statistics,
and the amount the acquirer is willing to pay.
Factors to Consider: Acquirers consider cost of capital,
balance sheet flexibility, rating agency opinions, and
speed/certainty of transaction closure.
Cash on Debt Equity
Hand: Financing: Financing:
● Use of acquirer’s stock as
● Includes revolving credit
● Cheapest form; cost currency.
facilities, term loans,
● More expensive than
equals foregone bonds, and commercial
debt but provides
interest income. paper.
flexibility (no mandatory
● Cheaper than equity due to
● Limited by opportunity cash repayments).
tax deductibility of interest.
cost and potential ● Attractive when
● Constraints: debt
acquirer’s stock price is
repatriation taxes for covenants, credit ratings,
high; less desirable for
overseas cash and balance sheet
target shareholders due
flexibility.
to uncertainty in value.
Debt vs.
Equity
Financing
● Debt Financing typically offers
lower cost due to tax benefits
(interest is tax-deductible) and
doesn't dilute ownership. However, it
increases financial risk due to fixed
payments.
● Equity Financing avoids interest
payments but dilutes ownership and
potentially profits. It also implies
higher capital costs compared to
debt.
Deal Structure:
Stock Sale vs. Asset
Sale
Stock Sale
● Involves acquiring the target’s stock from shareholders. The
target company remains in existence and becomes a
subsidiary of the acquirer.
● Tax Implications: If shareholders receive equity, their capital
gains may be deferred; if they receive cash, taxes are
triggered depending on their tax status (individual vs. non-
taxable entities).
● Liabilities: Acquirer assumes all liabilities (past, present,
future) of the target, making it favorable for the seller as it
sheds liabilities.
● Accounting Treatment: Assets are revalued on the GAAP
balance sheet but not for tax purposes, leading to the
creation of a Deferred Tax Liability (DTL).
Deal Structure:
Stock Sale vs. Asset
Sale
Asset Sale
● Involves purchasing specific assets and liabilities. The target
remains legally in existence but the acquirer only assumes
the specified assets and liabilities.
● Tax Benefits for Buyer: The buyer can step up the tax basis
of acquired assets, resulting in real cash benefits from
depreciation over time.
● Tax Disadvantages for Seller: Sellers may face double
taxation — at the corporate level when assets are sold, and
at the shareholder level when proceeds are distributed.
● Practical Challenges: Transferring asset titles and licenses
may be complex and time-consuming.
338(h)(10)
Election
● This election allows the acquirer to treat a
stock sale as an asset sale for tax
purposes, providing the buyer with the
tax benefits of asset depreciation without
the challenges of an asset sale.
● Requires mutual agreement between
buyer and seller.
● Economic Impact: Increases the
purchase price the buyer is willing to pay
since it reduces the buyer’s tax burden
through asset write-ups.
The buy-side valuation process in mergers and
acquisitions (M&A) is an in-depth exercise used
to determine an appropriate purchase price for
the target company. It leverages a mix of
valuation methodologies, including comparable
companies, precedent transactions, discounted
cash flow (DCF), and leveraged buyout (LBO)
analyses. A comprehensive analysis often
displays these valuation ranges in a graphical
representation called a "football field," which
compares the results of these methodologies in a
simple and visual format.
Football Field
01. 03.
DCF Comparable
Analysis: 02. Companies: 04.
Typically the highest
valuation since it's Precedent Provides a LBO
based on optimistic Transactions market-based Analysis:
management : estimate based
projections and Usually offers Establishes the
on how similar
expected synergies. minimum price
slightly lower companies are
This method
values than DCF, financial buyers
incorporates currently valued. (private equity) are
discounted future cash including premiums
willing to pay, given
flows. paid for synergies
required returns and
and control.
leverage limitations.
01 02 03
Analysis at Various Contribution Merger Consequences
Prices (AVP) Analysis Analysis
In stock-for-stock A crucial part of buy-side valuation is analyzing the
The AVP, also known as a valuation matrix,
transactions, a contribution deal’s impact on the acquirer through a merger
calculates the implied multiples at a range
analysis assesses the consequences analysis. This model combines the
of transaction values and offer prices,
financial contributions of financials of the acquirer and target to assess the
comparing them against comparable
both the acquirer and the pro forma effect on metrics like earnings per share
companies and precedent transactions. For
target in terms of metrics (EPS), credit ratios, and overall financial health.
public companies, this approach starts by
like sales, EBITDA, and net This analysis helps refine the purchase price and
analyzing the target's current stock price
income. This analysis aids in determine the structure of the transaction (e.g.,
and calculating the implied enterprise
evaluating relative cash vs. stock mix) by focusing on factors like
value and multiples based on various
ownership in the newly accretion/dilution, premium paid, and potential
premiums, commonly ranging from 25% to
formed entity based on synergies.
45%.
these financial contributions.
Balanc
e Sheet Balance sheet considerations are crucial in analyzing the
Effects consequences of a merger. These factors play a pivotal role in
determining both the purchase price and the financing
structure. A balance between EPS accretion/dilution and the
overall balance sheet health is vital, as the most accretive
financing structure, typically all-debt, may not be the most
sustainable or attractive from a credit standpoint.
After the sources and uses of funds are finalized, balance
sheet adjustments are made to bridge the acquirer's and
target’s opening balance sheets to the pro forma closing
balance sheet. These adjustments facilitate the calculation of
the pro forma credit statistics, which are essential for
understanding the merged entity's financial health.
Strategic Considerations:
● Many acquirers prioritize maintaining target credit ratings to minimize the
cost of capital and investor perception risks. In some cases, a minimum credit
rating is a requirement for covenant compliance.
● Rating agencies provide target ratio thresholds based on companies' credit
ratings, guiding acquirers toward financing structures that maintain favorable
leverage and coverage ratios.
Credit Statistics
Key credit statistics include:
Leverage Ratios: Debt-to-EBITDA, Debt-to-Total Capitalization
Coverage Ratios: EBITDA-to-Interest Expense
Accretion/(Dilution) Analysis
Accretion/(dilution) analysis evaluates the impact of a merger on the acquirer's earnings per share (EPS). If
the post-transaction EPS is higher than pre-transaction EPS, the deal is accretive; otherwise, it's dilutive.
A common rule of thumb for all-stock transactions is that acquisitions are accretive if the target’s P/E ratio is
lower than the acquirer’s. The analysis also incorporates factors like synergies and transaction expenses,
which can influence whether the deal is accretive or dilutive.
Steps for Accretion/(Dilution) Calculation:
1. Combine acquirer and target EBIT.
2. Add expected synergies.
3. Subtract depreciation and amortization expenses.
4. Subtract both existing and new interest expenses.
5. Account for taxes and new share issuances (if applicable).
6. Calculate pro forma EPS and compare it to the acquirer's standalone EPS.
Accretion/(dilution) analysis is vital for potential acquirers, as dilutive deals may harm shareholder value,
except in cases of rapidly growing targets that may be dilutive in the short term but accretive in the long
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