Q about an M&A deal

Say the deal size is $500 million, 33%cash and 67% stock. The acquirer issues 5 million shares for this, but then also increases 10 million share repurchase authorization limit. "Assuming this share repurchase is fully executed, this will result in a total financial impact to the company as if the acquisition were structured with 100% cash."

Just trying to figure out what the quote indicates. When I hear "as if it's structured with 100% cash," it sounds like an increase in the number of shares and therefore decreasing EPS does not matter anymore, because repurchased shares decrease the # of shares and therefore increasing EPS back to the same level, all assuming earnings don't change I guess? But it just doesn't sound right...

Anything else that I can get out of that statement?

 

Correct. Since you're issuing 5 million shares then immediately buying them right back, the net effect is zero issuance (which provides the same outcome as a 100% cash purchase).

EPS isn't mentioned in the quoted portion, though you're correct, pro forma EPS would be equal to a scenario in which the company made the acquisition with 100% cash.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 
NorthSider:
Correct. Since you're issuing 5 million shares then immediately buying them right back, the net effect is zero issuance (which provides the same outcome as a 100% cash purchase).

EPS isn't mentioned in the quoted portion, though you're correct, pro forma EPS would be equal to a scenario in which the company made the acquisition with 100% cash.

So help me with one more question. When you calculate EPS, it's net income / # of shares outstanding, right? So even if the firm repurchases the shares, I thought the number of shares don't decrease?

 
hot1590:
NorthSider:
Correct. Since you're issuing 5 million shares then immediately buying them right back, the net effect is zero issuance (which provides the same outcome as a 100% cash purchase).

EPS isn't mentioned in the quoted portion, though you're correct, pro forma EPS would be equal to a scenario in which the company made the acquisition with 100% cash.

So help me with one more question. When you calculate EPS, it's net income / # of shares outstanding, right? So even if the firm repurchases the shares, I thought the number of shares don't decrease?

When the firm repurchases, the number of shares outstanding does decrease. The repurchased shares become treasury stock, which when added to shares outstanding equals shares issued.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

Are you assuming the acquired company is just a basket of assets with no earnings/expenses? In this case, EPS stays the same.

Maybe im misunderstanding this question but if you're buying the company's earnings, this should be accretive to your EPS (all else equal and assuming you're buying the shares back at the same price they were issued at, ignore G&A/interest savings for simplicity). Effectively, you're increasing the numerator (earnings) while keeping the denominator the same with share repurchase.

 

not sure how you're relating this to cost of debt, though what was said before is correct.

i am curious now though because it was brought up implicitly. if the target has earnings and you zero out synergies etc., is an all cash deal always accretive to eps then? and accretive to book value as well (for bank deals)?

 
CeleryBurnsCalories:
not sure how you're relating this to cost of debt, though what was said before is correct.

i am curious now though because it was brought up implicitly. if the target has earnings and you zero out synergies etc., is an all cash deal always accretive to eps then? and accretive to book value as well (for bank deals)?

Almost always. Unless the yield on the interest income for the cash sitting on the balance sheet is higher than the earnings yield of the company you're buying (very unlikely).

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

About the cost of debt thing. Let's say that they announced the deal at $10/share, and then the company repurchases the shares at $12/share. So whereas the deal was structured with 33% cash and 67% stock, the repurchase makes it look like 33% cash + (67% * 120%) cash. Do you see my point? That extra 20% was the "interest rate" for stocks, which obviously seems higher than the interest rate for debt (or cost of debt). So my question is, why would they choose to do this? Is it because they didn't think share price would not increase that much before the repurchase?

 
Best Response
hot1590:
About the cost of debt thing. Let's say that they announced the deal at $10/share, and then the company repurchases the shares at $12/share. So whereas the deal was structured with 33% cash and 67% stock, the repurchase makes it look like 33% cash + (67% * 120%) cash. Do you see my point? That extra 20% was the "interest rate" for stocks, which obviously seems higher than the interest rate for debt (or cost of debt). So my question is, why would they choose to do this? Is it because they didn't think share price would not increase that much before the repurchase?

This whole paragraph assumes the deal was structured with a fixed share ratio (the share price at the time of announcement wouldn't matter otherwise). If you have a floating ratio (fixed $500mm purchase price), then you would issue enough shares at $x per share and buy them back at the same price - that's the same as if you structured the transaction with 100% cash (obviously you assume that your share price doesn't drop by more than 50% when you announce the acquisition, since 10mm shares wouldn't be enough to buy them all back).

If you had fixed exchange ratio (predetermined 5mm shares to be issued), then your share repurchase program would just be swapping that fixed exposure for reverse floating exposure (you pay less if your stock goes down and more if your stock goes up), but once again, since you're undoubtedly purchasing enough shares to finance the entire acquisition with cash, and the end of the day, you're in the same financial position as you would have been had you structured the entire transaction with cash.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 
NorthSider:
hot1590:
About the cost of debt thing. Let's say that they announced the deal at $10/share, and then the company repurchases the shares at $12/share. So whereas the deal was structured with 33% cash and 67% stock, the repurchase makes it look like 33% cash + (67% * 120%) cash. Do you see my point? That extra 20% was the "interest rate" for stocks, which obviously seems higher than the interest rate for debt (or cost of debt). So my question is, why would they choose to do this? Is it because they didn't think share price would not increase that much before the repurchase?

This whole paragraph assumes the deal was structured with a fixed share ratio (the share price at the time of announcement wouldn't matter otherwise). If you have a floating ratio (fixed $500mm purchase price), then you would issue enough shares at $x per share and buy them back at the same price - that's the same as if you structured the transaction with 100% cash (obviously you assume that your share price doesn't drop by more than 50% when you announce the acquisition, since 10mm shares wouldn't be enough to buy them all back).

If you had fixed exchange ratio (predetermined 5mm shares to be issued), then your share repurchase program would just be swapping that fixed exposure for reverse floating exposure (you pay less if your stock goes down and more if your stock goes up), but once again, since you're undoubtedly purchasing enough shares to finance the entire acquisition with cash, and the end of the day, you're in the same financial position as you would have been had you structured the entire transaction with cash.

Oh I see. So it's kind of like the arrangement thing that CeleryBurnsCalroies was talking about, except instead of the investors it might be the shareholders of the acquired company, or something like that. Now it's all clear. Thanks so much for your help.

 

i think you're getting caught up in the specifics too much. look at your original post. the statement seems pretty general and vague. and off hand. it also says "assuming the deal is fully executed" etc. etc. the example is based on principle. in all reality, i think if you want to buy a company w/100% cash, you would just do that.

if you do really want to get gritty though, you could have an arranged deal, where you have a deal locked in w/some of your key investors, who say "okay, i'll exchange my shares for cash" - thus, you won't have that 20% nonsense.

 
CeleryBurnsCalories:
i think you're getting caught up in the specifics too much. look at your original post. the statement seems pretty general and vague. and off hand. it also says "assuming the deal is fully executed" etc. etc. the example is based on principle. in all reality, i think if you want to buy a company w/100% cash, you would just do that.

if you do really want to get gritty though, you could have an arranged deal, where you have a deal locked in w/some of your key investors, who say "okay, i'll exchange my shares for cash" - thus, you won't have that 20% nonsense.

That's right... no more question. Thanks.

 

@northsider, not sure how your fixed share exchange rate scenario works out the same as the floating. are you saying you have to purchase an option to hedge your risk for share price going up/down? then your financial position be crappier, b/c you had to buy the options...

 
CeleryBurnsCalories:
@northsider, not sure how your fixed share exchange rate scenario works out the same as the floating. are you saying you have to purchase an option to hedge your risk for share price going up/down? then your financial position be crappier, b/c you had to buy the options...

No need for options, you're still going to end up at the same place.

So you have a $500mm acquisition with a $335mm hole to fill with equity financing. Say your stock is trading at $67, meaning you're issuing 5mm shares if your stock doesn't move. There are 100mm shares outstanding, making it a market capitalization of $6,700mm. You have share repurchase authorization up to 10mm shares, and for simplicity's sake, you have $670mm in cash on the balance sheet that you intend to use entirely for share repurchases. You announce the acquisition, your company's shareholders believe that the acquisition raises the equity value by 10% (random number), which means the NPV of the company is $670mm to your business.

Now the key is there can't be any free lunch.

Below, P is used to refer to the stock price.

Everyone knows that you're going to end up in the same spot at the end of this process: $0 cash, $7,370mm in equity value, x shares issued, ($505mm / P) shares repurchased (let's call this y), 100 + (x - y) shares outstanding.

No matter what, the same owners end up owning shares of the same business that is worth a certain amount. Doesn't it stand to reason that the same owners would have the same demand for the same stake of the same company, given that they already know the endgame?

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

honestly, at this point i don't even know wtf he means, lol. before, i had thought thought there was a book building process needed or something, though this is not the case, when you're only selling to one entity (the target). you sell to the target xxx new shares at yyy price set. then you buy from the target xxx shares at yyy price, is my understanding. or, you go buy those xxx shares from the market at the market rate? then, you're exposed to risk. this is the point where i say you have a prearrangement with some of your investors to buy at said price already to hedge. that or you go buy some sort of derivative hedge. case closed.

 

i follow you on everything except where you're getting to after the "below, p is used to refer to stock price." how did you get 505/P? also, are you saying x is still set at 5mm, or is the exchange executed at the new price after the appreciation? from my perspective i'm still not getting where the fixed/floating is coming from..

 
CeleryBurnsCalories:
i follow you on everything except where you're getting to after the "below, p is used to refer to stock price." how did you get 505/P? also, are you saying x is still set at 5mm, or is the exchange executed at the new price after the appreciation? from my perspective i'm still not getting where the fixed/floating is coming from..

$505mm is the $670mm in cash on the balance sheet less the $165mm in cash you will spend on the acquisition in either scenario.

x is not set a 5mm in the floating exchange rate scenario, but that doesn't matter. In the floating rate scenario the number of shares you repurchase is fixed; in the fixed rate scenario, the number of shares you repurchase is floating. It all arrives at the same endgame, which is the point of the statement, "The company will be in the same financial condition as it would have been had it paid 100% cash."

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 
  1. why would you use up your entire cash reserve on the buy back

  2. under those two cases, you're saying in one, you fix the number of shares bought back and the other, you fix the price you buy at (if i'm not mistaken), but that means that in the end, the two scenarios differ in the number of total shares outstanding at the end. thus, that would affect eps accretion %

 
  1. not sure what you mean by realized cost basis, where are you getting this stuff from

  2. what you're saying is going in circles. the sequence of events is: issue of stock at a fixed price based on vwap over whatever period of time to the investors of the target. then you buy back shares from the market via tender offer or via prearrangement, and there is no fixed/floating consideration. where are you getting this from?

 
CeleryBurnsCalories:
1. not sure what you mean by realized cost basis, where are you getting this stuff from

Where am I getting this stuff from? I don't understand this question. Your realized cost basis is the blended average of the cost at which you repurchased the shares. All I'm saying is companies don't say, "We will repurchase 10mm shares," they say, "We are authorizing a plan to repurchase up to 10mm shares." They then set aside a certain amount of cash to repurchase shares. Obviously, the lower the share price (which will bring down their realized cost basis for those shares), the more shares they can afford to repurchase.

2. what you're saying is going in circles. the sequence of events is: issue of stock at a fixed price based on vwap over whatever period of time to the investors of the target. then you buy back shares from the market via tender offer or via prearrangement, and there is no fixed/floating consideration. where are you getting this from?

This question doesn't make any sense to me. What do you mean there is no fixed/floating consideration? There most certainly is.

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

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"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

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