Accretion Follow-Up - Technical Question
Another user posted this question, but it never got completely resolved. Could anyone help figure this one out?
Company A with 100M market cap and P/E of 10 is merging with Company B with 60M market cap and P/E of 20. To whom is the deal dilutive and why? What is the new P/E of the combined entity? What do the synergies have to be worth for it to be dilutive to neither party?
Any insight on this is appreciated.
Edit: To make it easy, lets say they both have 1M shares outstanding. So Company A has a share price of $100, and EPS of 10 since Share Price/EPS = P/E. Company B has a share price of 60 and EPS of 3. Company B is overvalued so the deal is dilutive to Company A because the new share price ought to be $80 (100M + 60M = 160M/2M shares outstanding = $80 share price) and the combined EPS will be 6.5 ((10+3)/2), so the new P/E will be 12.3. Synergies are 3M
Wouldn't the equity of company B have to be wiped out? How would one mathematically arrive at 3M?
It would be dilutive to A, because B is trading at a lower yield than A. 5% vs 10%.
(100+60)/(10+3)= 12.3x
To be neutral for A, B need to trade at the same yield as A, which is 10%. However, B trades at 5%. Therefore, if B's market cap is 60, then at 10% yield, it would need to generate 6 in net income. B generates 3, so after-tax synergies would have to be 3 (= 6 - 3).
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Equity doesn’t ever get “wiped out.” Is this supposed to be an all-equity deal?
Just for the sake of answering the question (tho per the below, I think you might want to discuss more high level concepts), it’s as simple as this:
**Company A ** We know: Market Cap = 100 P / EPS = 10 Earnings yield is the inverse, so 1/10 = 10% That means, Market Cap / Earnings = 10 (since P/E = 10) So, 100 / Earnings = 10, or Earnings = 10
**Company B ** We know: Market Cap = 60 P / EPS = 20 Earnings yield is the inverse, so 1/20 = 5% That means, Market Cap / Earnings = 20 (since P/E = 20) So, 60 / Earnings = 20, or Earnings = 3
We assume, All stock deal
Calcs, Company A issues $60MM of stock to pay Company B’s shareholders, so Company A PF market cap is $160MM. Company A takes control of company B’s cash flows, so PF earnings are 10 + 3 = 13MM.
Now, our pre-synergy PF P/E multiple is $160MM / $13MM ≈ 12.3x, so our PF yield is 1 / 12.3 ≈ 8%.
If we want the deal to not be dilutive to either of the companies, we need to maintain the higher yield. If we know Company A has the higher yield (10%), we need to aim to maintain their P/E multiple (10x).
Our PF market cap is $160MM and target PF P/E is 10x, so our target Earnings is $160 MM / 10x = 16MM. Per the above, we have $13MM pre synergies, so we need $3MM in synergies.
Questions and answers: 1. It is dilutive to whoever has the highest earnings yield, or Company A (10% vs 5% from Company B) 2. You need $3MM of synergies at the earnings level, so you can maintain the higher yield P/E multiple. That means, the deal will be neutral to Company A but dilutive to Company B.
Hope this helps.
Repost to fix typos:
Just for the sake of answering the question (tho per the below, I think you might want to discuss more high level concepts), it's as simple as this:
Company A We know: Market Cap = 100 P / EPS = 10 Earnings yield is the inverse, so 1/10 = 10% That means, Market Cap / Earnings = 10 (since P/E = 10) So, 100 / Earnings = 10, or Earnings = 10
Company B We know: Market Cap = 60 P / EPS = 20 Earnings yield is the inverse, so 1/20 = 5% That means, Market Cap / Earnings = 20 (since P/E = 20) So, 60 / Earnings = 20, or Earnings = 3
We assume, All stock deal
Calcs, Company A issues $60MM of stock to pay Company B's shareholders, so Company A PF market cap is $160MM. Company A takes control of company B's cash flows, so PF earnings are 10 + 3 = 13MM.
Now, our pre-synergy PF P/E multiple is $160MM / $13MM = 12.3x, so our PF yield is 1 / 12.3 = 8%.
If we want the deal to not be dilutive to either of the companies, we need to maintain the higher yield. If we know Company A has the higher yield (10%), we need to aim to maintain their P/E multiple (10x).
Our PF market cap is $160MM and target PF P/E is 10x, so our target Earnings is $160 MM / 10x = 16MM. Per the above, we have $13MM pre synergies, so we need $3MM in synergies.
Questions and answers: 1. It is dilutive to whoever has the highest earnings yield, or Company A (10% vs 5% from Company B) 2. You need $3MM of synergies at the earnings level, so you can maintain the higher yield P/E multiple. That means, the deal will be neutral to Company A but dilutive to Company B.
Hope this helps.
How many actual calculations like this will we need to know how to do in IB interviews? I have yet to interview anywhere but I have had a few mocks and they've never brought up any questions where I have to make any real calculations.
I don’t know, but this stuff isn’t hard. If you can’t grasp basic algebra and yield comparison, you’re probably not cut for finance.
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