A bit confused on this merger modeling business
I have a few quick questions to hopefully finally understand how and when merger models are used:
1) Perhaps I am mistaken but isn't the point of a merger model to determine the accretion/dilution of said acquisition. If so, is there any purpose to undertaking such an analysis when the buyer is a private company?
2) Assuming I am mistaken and you were doing a merger model with a private buyer, where do you get all of their financial information? Is it common for private buyers to give the sellers all of their financial statements?
3) Similiar to #1, if the buyer is a PE shop, how do you go about doing a merger model? I am assuming this is not a bolt-on for a portfolio company but a stand alone buyout so there really isn't another entity to combine the seller with, right?
4) What about in instances when a really large public company acquires a very small company. For instance, there is some IP or other strategic rationale so a $10 billion dollar company buys a $5 million dollar company. Would the transaction even register in EPS so what would be the point of doing a merger model?
Hi 21BEM,
A merger model is used to analyze the combination of two companies. A merger model usually looks at the combined ('pro forma') company after the merger including the balance sheet and the income statement. Accretion/dilution is an analysis based on the pro forma income statement and is highly scrutinized for public companies as shareholders want the company to undertake deals that will increase the value of their shares (i.e. are Accretive). For private companies, this is essentially irrelevant and therefore an IRR model is usually used to figure out whether the investment is worthwhile.
If the company is private, generally the only way to get reliable financials is through a teaser or CIM that the company provides. Otherwise, you can use a combination of research and information from public comps to come up with a very, very rough estimate.
Sponsors are a special type of buyer. When they acquire companies, they usually only care about the IRR they can achieve so that they can return money to their investors. Sponsors typically acquire companies using a lot of debt and so they use a specific type of model called an Leveraged Buyout (LBO) in order to access their returns. This type of model basically forecast the target's ability to pay down debt.
It really depends. Especially in the tech space right now, large companies may function almost like venture capital firms and and invest/acquire in small early-stage companies. It's almost impossible to predict how these companies will perform financially so it is highly unlikely the buyer would build a merger model.
However, there are times when an acquired small company could potentially create a significant amount of value when coupled with the reach and resources of an enormous company. These synergies could result in a material change to EPS if realized, prompting the company to build a merger model to analyze the potential impact of the acqusition.
Hope this is helpful.
-GBS
Thanks for the response, it was very helpful.
I had two quick follow-up questions and one additional question:
1) Is the IRR model the same is the returns analysis for an LBO or is there an example online you can point me to?
2) I am probably misunderstanding your response to my 2nd question as I haven't actually ever worked in M&A but my understanding is the teaser/CIM is sent out by the sell-side bankers. What I was asking is, assuming you are the sell-side adviser to a company and private company is buying your client. Does the private buyer always provide the seller with their financials (I think I am talking about the due diligence exclusivity period)? Or is it in private transactions that the information sharing is more one-way i.e. a sell-side adviser in private deals doesn't do this work?
Essentially I might have some opportunities at some smaller middle market firms doing M&A. I don't really understand from a modeling perspective what work they do? Is it more valuation, building 3-statement models or what?
1) Yes, not sure if there's an online example though. Conceptually, yes its very similar to an LBO. The biggest difference would be the amount of debt used. You would want to look at the NPV of the cash flows received from the acquired company.
2) Ah okay thought you were talking about getting projections for a private target. Only in a few cases would a private buyer (or any buyer) provide their internal financial projections to the seller. The most common would be a merger of equals or whenever a significant amount of the buyer's stock is being issued to the seller. The seller would most likely want to perform some sort of reverse due diligence as they will now own shares of the combined company. One other scenario could be when there's some sort of deferred consideration. In this case, a seller would want to assess the buyer's ability to make the future payments.
3) From my experience on the sell-side, modeling is primarily done for valuation purposes. In order to determine if an offer is fair, you as an adviser need to have a view on what the company is actually worth. Most importantly, you have to manage your client's expectations on what the company is actually worth and one way of doing that is showing them various valuation methodologies.
This usually doesn't require a three statement model though. At small middle market firms, its very possible that your clients wouldn't have the financial expertise to build a full three statement model or one that is presentable to a potential buyer so you might help out on that.
Voluptates non pariatur velit est autem et tempore. Quia aperiam sed modi est rerum quos. Ut sint est eum nobis cupiditate sit eligendi. Unde eaque animi omnis ex.
Deleniti adipisci eius quis qui accusamus magni eaque expedita. Cupiditate molestiae soluta corrupti unde nobis voluptatum. Nemo a ducimus unde. Corporis ut sunt dolor in. Consequatur maiores voluptatem in est magni molestiae vel est. Fuga praesentium id qui nemo voluptatem sed delectus.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...