Confused with merger modeling..
Just getting into merger modeling and confused with a few aspects.. hoping someone can clarify...
- What's the relationship between enterprise value (mkt cap + net debt) and your purchase price (equity value + premium)... I know it "cash free/debt free" is assumed for transactions, but if EV is always being shown (think football chart, etc..) and is the mkt cap + net debt, where is my net debt being accounted for in my purchase price? Am I really saying, forget about debt and cash, I will pay current stock price + x% premium to buy all shares, then you as the seller can use the cash on your BS plus some of the cash I am giving you to pay down your debt?
Since the seller is using their cash to pay down their debt, that's why you adjust for forgone interest income? I assumed you do this if you bought them and used their cash to pay it down, but I guess both scenarios have the same result.. right?
If I'm understanding this correctly, then is it wrong to show the purchase price and enterprise value (implied) in the same analysis? For example, say I do my accretion/dilution out for the first 3 years, and show the stock price + premium I am paying, the "implied" enterprise value (that # + net debt), and the a/d each year.. does it make any sense to show EV, or is it irrelevant?
Similarly, in CapIQ when you look at an M&A transaction, under the transaction details at the top of the page it shows something like purchase price or price paid to shareholders, then "implied enterprise value" and calculates all the sales/ebit/ebitda multiples off this number. What are they doing here?
- Is there logic behind writing up the target's inventory?
I think that's it for now.. guess I'm just trying to wrap my head around the difference in using enterprise value (with premium on mkt cap) vs. equity value + premium for the accretion/dilution analysis. Any guidance is appreciated.
anyone?
its a little different with merger modeling than with a regular football field valuation. merger modeling is designed to model the effects of the merger given a sales price.
a good place to start if your target is a public company is the share price. You can pretty easily find data on recent transactions and the premium paid -- typically 20-30%. This is the price the acquiring company pays for the equity portion. Typically, the net debt is brought on to the pro forma (combined) balance sheet. Often, the pro forma liabilities are also adjusted to account for any debt that is issued to help pay for the equity.
I would not say that implied EV is irrelevant, but if the company is publicly traded, it won't matter if your implied EV is lower than the share price. On the other hand, if your target is not publicly traded, then you will go through an entire valuation and then show the a/d effect of your valuation range based on the merger model.
there are a few reasons for writing up. in reality, managers want to write up inventory as much as possible in order to attribute as little of the acquisition as possible to goodwill. there can also be a number of tax reasons.
But why is the target's net debt assumed by the buyer if we look at transactions as "cash free / debt free"? This is what I am hung up on I think.
If Company A is trading at $1.00/share, and I pay $1.10/share and acquire all of their equity, I assume all of their debt and also cash. This doesn't = cash/debt free in my mind, since you now have that extra liability (net debt).
I was reading another post on here about this topic, and people replied that the seller is responsible for servicing their debt when they sell. If that's the case, and my scenario of Company A above happens... what are they using to pay down their debt? I paid $1.10/share for all of their equity - that goes to the shareholders.. who is paying the debt then, besides the cash on their balance sheet (if debt > cash)?
I can see "cash free/debt free" transactions for private companies - you pay the owners X dollars, and they service their debt with their existing cash + cash you gave them for their company.
Doesn't make sense to say an acquisition of a public company is done as a "cash free/debt free" transaction, because the seller can't pay their debt off if their debt > cash by using the cash you gave them, as it is for shareholders, right? If I own 10 shares of Company A, and Company B buys Company A, I'm getting $10/share + a premium.. I'm not paying any debt with the money they are giving me.
So why does everyone say all transactions are done on a cash free/debt free basis?
so to be clear your question is: why aren't debt and cash part of the purchase price? if that's what you're asking you have to take a step back and think about the concept of an acquisition for a second. i've asked ppl on this forum to 'take a step back' before and had monkey shit tossed at me but i think it's important here because you seem to have some of the details down but are missing the bigger picture.
first of all, why would debt or cash ever be included in the purchase price? the acquirer is buying ownership (stock). now ask yourself "what determines the value of a company's stock?" consider what a DCF does and you'll understand that they are intrinsically considered.
you seem to be confused by the, call it, 'pro forma ownership.' after an acquirer purchases the target, the 2 companies are one and the same. those who owned stock in the target prior to the transaction either received cash for their shares and are completely removed from the combined entity, or they received shares in the combined company. you seem to think a seller still exists after the transaction takes place. it doesn't. it is the combined entity that 'assumes' cash and debt. there is no longer a seller and a buyer after the transaction.
hope this helps. let me know if you want any more clarification or if i misinterpreted your question entirely.
http://www.wallstreetoasis.com/forums/cash-free-debt-free-basis
Julian: your explanation does clarify most of what I was confused on, but the thread referenced above (mentioned in my 2nd post) asking about "cash free/debt free" concept... all the replies state that the seller is responsible for servicing their debt. This is what is confusing me. I understand what you're saying, I buy all the shares of Company A, now we are the same company and the debt/cash/everything else is one. So this doesn't equal the "seller is responsible for their debt" answer I saw elsewhere... unless it's saying the same thing but in different terms.
Why do we call transactions cash and debt free if they really aren't? Sure, we wipe out the existing debt the target had and replace it with new debt (refinanced, or paid off with existing cash), so it's "debt free" until you replace the debt... what am I missing with this phrase?
"debt/cash-free" is a very esoteric term. here's how i think of it: consider the value of a company's equity (which is what is being purchased) as the pv of all of its future free cash flows. the value of the target's equity is not a function of its current capital structure since it will almost undoubtedly change as part of a new company and throughout its life. thus, the current debt and cash are not part of the valuation/purchase price.
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