M&A Model Example

 

In this post, I am going to give you a quick overview of how a basic merger model works. Before you continue reading this post, it is important to point out you need to know how to build a comparables model in advance due to we will use this second type of financial model to build our merger model. In any case, you can find a comps model example in the Activision Blizzard Research Report already available in the blog.

 

https://drive.google.com/file/d/1bNBmugJEtjFCQ2TsXVqM2apv1ESrbifd/view?usp=sharing

 

First, download the template from the link above. In the first sheet, you can find the model inputs and assumptions that we are going to use to build the model. As you can see, we have included a list of seven potential target companies that could be acquired by the acquirer company so that you can choose any of them by clicking on the cell B3, and the model calculations and results will change according to the acquiree case chosen. Moreover, you can see a Sensitivity Analysis control table that will be used to perform a sensitivity analysis once we have the model results.

Besides, you can also find the assumptions table includes potential assumptions you may include in your merger model, though they will vary in every merger case. For example, in this one, we have included some very usual such as the acquisition premium that the acquirer will pay to perform the acquisition over the share price, several fees the acquiree will need to pay to perform the transaction, a change of control premium (commonly included as a covenant to pay a premium to the acquiree debtholders as consequence of the change of control about the company acquired), and the percentages of equity and debt that will finance the transaction.

Next, the comparables model sheet shows past data for both acquirer and potential acquirees. Below those data, you will find financial estimates and multiples for the next two years and the diluted shares calculations. This comparable model must be assembled before the merger model, which is assumed as “the next level” about it.

Following this, the next step is done in the calculations sheet. In the Capitalization Summary section, you will find the enterprise value calculation for both acquirer and acquiree previously chosen in the Inputs and Assumptions section. Subsequently, you will find the Acquisition Summary section that contains the transaction value calculation according to the acquisition premium, and debt and equity percentages taken from the assumptions table, and also all transaction costs assumed before as well.

Then, we calculate the future market value of total assets, assuming book values for all assets except PP&E, goodwill, and intangibles that need to be estimated with market values necessarily because their book values differ a lot from their market values because of acquisition premium, depreciation, and amortization expenses. Consequently, net income and cash flows must be adjusted according to this last considerable value difference along with other adjustments such as several fees and transaction costs, change of control premium, or annual interest expenses on the debt issued to finance the acquisition (be aware these costs are deductible so that there is a tax impact to be considered). The model also distinguishes depreciable from non-depreciable property percentages in the comparables model based on some information you can find in the 10-K as well as the average amortization period to calculate the incremental depreciation expense for every period.

Finally, this calculation sheet ends with Pro Forma Adjustments on both financial position and performance (represented by balance sheet and income statement items respectively).

One the one hand, in case of the Balance Sheet items adjustments, we assume that if the firm does not have enough cash and cash equivalents to pay the transaction costs, the firm needs to borrow money to be able to pay them necessarily. Hence, the total debt adjustment includes this issue along with other adjustments in relation to the new debt issued. The total equity adjustment also refers to the new equity issued, and total assets adjustments refer to the previous adjustments on PP&E, goodwill, and intangibles. As a result, you sum all these adjustments to get to the pro forma amounts.

On the other hand, in the case of Financial Performance adjustments, we must distinguish normalized net earnings and cash flows, which exclude one-time costs that are only incurred in the first year (transaction costs and change of control premium), from other costs that are paid annually (depreciation, amortization and interest expenses in this example). Regarding the adjustment on diluted shares outstanding, it corresponds with the new equity issued that includes an issuance discount included on the assumptions table. Lastly, the pro forma share price for the acquirer has been assumed to be the same as in the present to be conservative. However, this could actually be anyone different from the same due to we cannot predict the future market price after the acquisition is performed.

After all these calculations have been performed, the Outputs and Results section quickly summarizes all the above. The Sources and Uses of Cash section can vary a lot depending on the assumptions included in the model, but it is quite useful to check both total amounts calculated are the same. Regarding the Dilution or Accretion summary, you can compare how all those acquirer metrics have changed after the acquisition is performed, and you can do it for each of those acquiree options.

Finally, there is also some sensitivity analysis included to test the impact of changes in some variables used in the model on some key metrics such as EPS and cash flows per share or some ratios such as Total Debt/Capital and Net Debt/EBITDA. This sheet is linked with the Sensitivity Analysis Control table included in the first sheet and this last part is more complex to explain on a quick overview so if you want to learn more on how this works or you have any other doubt about the merger model as a whole, you can write an email as you did regarding other posts.