Purchasing Products and Then Selling Them Again Without Any Reprocessing

Investment Banking interview questions: Merger Model (Basic)

Y'all don't need to empathise merger models as well as an M&A broker does, but yous practise need to more than than just the basics, especially if you've had a finance internship or full-time job before. It's of import to know the furnishings of an acquisition, and understand concepts such every bit synergies and why Goodwill & Other Intangibles actually get created. One matter that'due south not important? Walking through how all 3 statements are afflicted by an acquisition. In 99% of cases, you lot merely care near the Income Statement in a merger model (despite rumors to the contrary).

i. Walk me through a bones merger model

"A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is fabricated, and determines whether the buyer's EPS increases or decreases.

Stride 1 is making assumptions about the acquisition - the price and whether it was cash, stock or debt or some combination of those. Side by side, you determine the valuations and shares outstanding of the buyer and seller and project out an Income Statement for each

Finally, you combine the Income Statements, adding up line items such every bit Acquirement and Operating Expenses, and adjusting for Foregone Interest on Greenbacks and Interest Paid on Debt in the Combined Pre-Tax Income line; yous apply the heir-apparent's Revenue enhancement Rate to go the Combined Net Income, and then split by the new share count to decide the combined EPS."

ii. What'southward the difference between a merger and an acquisition?

In that location'due south always a heir-apparent and a seller in whatsoever K&A bargain - the divergence between "merger' and "acquisition" is more semantic than anything. In a merger the companies are shut to the same size, whereas in an acquisition the buyer is significantly larger.

3. Why would a company desire to acquire some other company?

Several possible reasons:

The buyer wants to proceeds marketplace share past buying a competitor.

The buyer needs to grow more than quickly and sees an acquisition every bit a way to practice that.

The heir-apparent believes the seller is undervalued.

The buyer wants to acquire the seller'due south customers then it can upwards-sell and cross-sell to them.

The buyer thinks the seller has a disquisitional applied science, intellectual holding or some other "underground sauce" it tin use to significantly enhance its concern. The heir-apparent believes it can accomplish significant synergies and therefore make the deal accretive for its shareholders.

iv. Why would an conquering be dilutive?

An acquisition is dilutive if the additional amount of Net Income the seller contributes is not plenty to offset the buyer's foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares.

Acquisition effects - such as amortization of intangibles - can likewise make an conquering dilutive.

v. Is there a rule of thumb for computing whether an acquisition will be accretive or dilutive?

If the deal involves just cash and debt, yous can sum up the interest expense for debt and the foregone involvement on greenbacks, so compare it against the seller's Pre-Tax Income.

And if it'due south an all-stock bargain y'all can use a shortcut to assess whether it is accretive.

But if the bargain involves greenbacks, stock, and debt, there's no quick dominion-of-thumb you tin can use unless yous're lightning fast with mental math.

6. A company with a higher P/Due east acquires 1 with a lower P/East - is this accretive or dilutive?

Trick question. You tin't tell unless you also know that information technology's an all-stock deal. If it'southward an all-greenbacks or all-debt deal, the P/Eastward multiples of the heir-apparent and seller don't affair considering no stock is existence issued.

Sure, by and large getting more earnings for less is good and is more probable to exist accretive simply in that location'due south no hard-and-fast rule unless information technology'southward an all-stock bargain.

vii. What is the rule of thumb for assessing whether an M&A deal will be accretive or dilutive?

In an all-stock deal, if the heir-apparent has a higher P/E than the seller, it will be accretive; if the heir-apparent has a lower P/E, it will be dilutive.

On an intuitive level if you lot're paying more for earnings than what the marketplace values your ain earnings at, you tin can judge that it will be dilutive; and likewise, if yous're paying less for earnings than what the market values your ain earnings at, you lot can judge that it would be accretive.

eight. What are the complete effects of an acquisition?

i. Foregone Interest on Cash - The heir-apparent loses the Interest it would have otherwise earned if information technology uses greenbacks for the conquering.

two. Additional Interest on Debt - The heir-apparent pays additional Interest Expense if it uses debt.

iii. Additional Shares Outstanding - If the buyer pays with stock, it must outcome additional shares.

four. Combined Financial Statements - After the acquisition, the seller's financials are added to the buyer's.

5. Cosmos of Goodwill & Other Intangibles - These Residual Sheet items that represent a "premium" paid to a company's "off-white value" also get created.

Note: In that location's really more than this (run across the advanced questions), simply this is usually sufficient to mention in interviews.

9. If a company were capable of paying 100% in greenbacks for another company, why would it choose NOT to practise and then?

It might exist saving its cash for something else or it might be concerned about running low if business organization takes a plow for the worst; its stock may also exist trading at an all-time high and it might be eager to use that instead (in finance terms this would exist "more than expensive" but a lot of executives value having a safety cushion in the course of a large greenbacks balance).

x. Why would a strategic acquirer typically exist willing to pay more for a company than a private disinterestedness house would?

Considering the strategic acquirer can realize revenue and cost synergies that the individual equity business firm cannot unless it combines the company with a complementary portfolio visitor. Those synergies boost the effective valuation for the target visitor.

xi. Why do Goodwill & Other Intangibles get created in an acquisition?

These correspond the value over the "fair market value" of the seller that the heir-apparent has paid. You lot calculate the number by subtracting the book value of a visitor from its equity purchase price.

More specifically, Goodwill and Other Intangibles represent things like the value of customer relationships, make names and intellectual holding - valuable, but non truthful financial Assets that show up on the Remainder Sheet.

12. What is the difference between Goodwill and Other Intangible Assets?

Goodwill typically stays the same over many years and is not amortized. It changes only if there's goodwill damage (or another acquisition).

Other Intangible Avails, by dissimilarity, are amortized over several years and affect the Income Argument by hitting the Pre-Tax Income line.

At that place's besides a difference in terms of what they each correspond, but bankers rarely go into that level of item - accountants and valuation specialists worry about assigning each one to specific items.

xiii. Is at that place anything else "intangible" too Goodwill & Other Intangibles that could also impact the combined company?

Aye. Yous could also take a Purchased In-Process R&D Write-off and a Deferred Revenue Write-off.

The first refers to any Inquiry & Development projects that were purchased in the acquisition but which have not been completed withal. The logic is that unfinished R&D

projects require significant resource to complete, and every bit such, the "expense" must be recognized as part of the acquisition.

The second refers to cases where the seller has collected greenbacks for a service but not yet recorded it as revenue, and the buyer must write-downwards the value of the Deferred Acquirement to avoid "double-counting" acquirement.

xiv. What are synergies, and tin can you provide a few examples?

Synergies refer to cases where 2 + 2 = 5 (or 6, or seven...) in an acquisition. Basically, the heir-apparent gets more value than out of an acquisition than what the financials would predict.

There are 2 types: acquirement synergies and cost (or expense) synergies.

Acquirement Synergies: The combined company can cross-sell products to new customers or up-sell new products to existing customers. It might also be able to expand into new geographies as a result of the deal.

Cost Synergies: The combined company tin can consolidate buildings and authoritative staff and tin can lay off redundant employees. Information technology might also be able to shut down redundant stores or locations.

fifteen. How are synergies used in merger models?

Revenue Synergies: Ordinarily you add together these to the Revenue figure for the combined visitor and then presume a certain margin on the Revenue - this additional Revenue and so flows through the balance of the combined Income Statement.

Cost Synergies: Normally you reduce the combined COGS or Operating Expenses by this amount, which in turn boosts the combined Pre-Taxation Income and thus Net Income, raising the EPS and making the bargain more accretive.

16. Are revenue or cost synergies more important?

No one in G&A takes revenue synergies seriously because they're so hard to predict. Cost synergies are taken a bit more seriously considering information technology's more straightforward to see how buildings and locations might be consolidated and how many redundant employees might be eliminated.

That said, the chances of whatever synergies actually being realized are almost 0 so few take them seriously at all.

17. All else being equal, which method would a company prefer to use when acquiring another visitor - cash, stock, or debt?

Assuming the buyer had unlimited resources, it would always prefer to use cash when buying another company. Why?

• Greenbacks is "cheaper" than debt because interest rates on greenbacks are ordinarily under v% whereas debt interest rates are almost always higher than that. Thus, foregone involvement on cash is almost always less than additional involvement paid on debt for the same amount of greenbacks/debt.

• Cash is also less "risky" than debt because there'due south no chance the buyer might fail to heighten sufficient funds from investors.

• It's hard to compare the "price" directly to stock, merely in general stock is the most "expensive" style to finance a transaction - remember how the Toll of Equity is nigh always college than the Cost of Debt? That same principle applies here.

• Cash is as well less risky than stock considering the buyer'south share price could change dramatically once the conquering is appear.

xviii. How much debt could a company effect in a merger or acquisition?

Mostly you would look at Comparable Companies/ Precedent Transactions to determine this. You would employ the combined company's LTM (Last Twelve Months) EBITDA figure, find the median Debt/EBITDA ratio of whatever companies you're looking at, and utilise that to your own EBITDA figure to get a rough thought of how much debt yous could raise.

You would also look at "Debt Comps" for companies in the same industry and run into what types of debt and how many tranches they have used.

19. How practise y'all make up one's mind the Purchase Price for the target company in an acquisition?

You use the same Valuation methodologies we already discussed. If the seller is a public company, yous would pay more attention to the premium paid over the electric current share price to make certain information technology'due south "sufficient" (generally in the 15-thirty% range) to win shareholder approval.

For private sellers, more weight is placed on the traditional methodologies.

20. Allow's say a company overpays for another company - what typically happens afterwards and tin you requite any recent examples?

In that location would be an incredibly loftier corporeality of Goodwill & Other Intangibles created if the price is far above the off-white marketplace value of the company. Depending on how the acquisition goes, at that place might be a large goodwill impairment charge later on if the company decides it overpaid.

A contempo example is the eBay / Skype bargain, in which eBay paid a huge premium and extremely high multiple for Skype. It created excess Goodwill & Other Intangibles, and eBay later ended up writing down much of the value and taking a large quarterly loss as a result.

21. A buyer pays $100 one thousand thousand for the seller in an all-stock deal, but a mean solar day later the market decides it'south only worth $fifty meg. What happens?

The heir-apparent'due south share toll would fall by any per-share dollar amount corresponds to the $fifty 1000000 loss in value. Note that it would not necessarily be cut in half.

Depending on how the bargain was structured, the seller would effectively only be receiving one-half of what information technology had originally negotiated.

This illustrates one of the major risks of all-stock deals: sudden changes in share cost could dramatically impact valuation.

22. Why do most mergers and acquisitions fail?

Like so many things, M&A is "easier said than washed." In practice it'southward very difficult to larn and integrate a different company, actually realize synergies and likewise turn the acquired company into a assisting segmentation.

Many deals are also washed for the wrong reasons, such as CEO ego or pressure from shareholders. Any deal washed without both parties' best interests in mind is probable to neglect.

23. What office does a merger model play in deal negotiations?

The model is used every bit a sanity bank check and is used to exam diverse assumptions. A company would never decide to practise a deal based on the output of a model.

Information technology might say, "Ok, the model tells us this bargain could work and exist moderately accretive -it's worth exploring more."

Information technology would never say, "Aha! This model predicts 21% accretion - we should definitely acquire them now!"

Emotions, ego and personalities play a far bigger function in M&A (and any type of negotiation) than numbers do.

24. What types of sensitivities would you look at in a merger model? What variables would y'all look at?

The almost common variables to look at are Purchase Price, % Stock/Cash/Debt, Revenue Synergies, and Expense Synergies. Sometimes you also look at different operating sensitivities, similar Revenue Growth or EBITDA Margin, merely it'south more common to build these into your model as different scenarios instead.

You might wait at sensitivity tables showing the EPS accretion/dilution at different ranges for the Purchase Cost vs. Price Synergies, Purchase Price vs. Revenue Synergies, or Purchase Price vs. % Cash (and so on).

- prepared by breakingintowallstreet.com and mergersandinquisitions.com.

bugghimple.blogspot.com

Source: https://finexecutive.com/en/news/_investment_banking_interview_questions_merger_model_basic_2_4_2015

Share this post