Apr 03, 2018

Thanks for posting this.

I'm still in the middle of technical prepping, so I had to do these with pen and paper. Is this normal/expected/acceptable for an Associate interview? I'm usually pretty good at mental math but accretion/dilution thinking is still new for me.

1. Accretive for A. Say A is 8 shares of \$10 (earnings \$8), B is 10 shares of \$8 (earnings \$10). A issues 8 more shares, now has 16 shares of \$10 with earnings of \$18. P/E has gone from \$10 to 8.8/8.9

2. Accretive for A. You're borrowing \$80 at 5%, or a cost of \$4 to add earnings of \$10. It would break even at 12.5% (1/(P/E of B)).

3. It should be less than 9; you can't just average the P/Es, think about it as averaging the earnings and what that would mean if the market cap was the same (market cap of \$80 and earnings of \$9 = P/E of less (This is only a guess after having done the math; but I think there's some truth in not being able to add/average P/Es, even of same-size companies).

4. It will be less Accretive because the company that's making it Accretive has a lower weight.

Say A has earnings of \$16 and is \$16 shares of 10; they have to issue 8 more shares to make the purchase and now have a market cap of \$240 and earnings of \$26; \$234 would be P/E of 9 but it's higher, so ~9.25

Pen and paper is ok for Level 3 and 4. Would be expected to do Level 1 and 2 without.

1. Correct.

2. Also correct.

3. I would relax your boundaries and say that it should be between 8 and 10. As per your answer to Level 1, it is slightly lower than 9. Basically, if B is negligible (ie doesn't move the needle), you would expect the PE not to move (be closer to 10). If the transaction is huge, the PF entity would be closer to the target so closer to 8. Close to 9 is not a bad guess, especially if they are the same size. This is a good lead in for the Level 4 question.

The first mistake I get is people averaging PEs which is NOT right. Try to find the right framework to get to the actual % accretion (Part B of this question). Once you have that, figure out the PF PE and see where you land.

1. Also correct. But need the actual exact % accretion.

General comment: You've talked to me about aggregates (at the corporate level, net income), but what is the effect at the shareholder level (EPS)? What are the exact % accretion? That's why you could be allowed paper for this question. Could also technically do without if you can keep the numbers in your head.

The only way to get the exact number correctly is to use a framework to structure your thoughts.

Thanks, my first thought was between 8 and 10 for #3 but I thought you wanted something more specific.

For #4, EPS was \$1 pre-acquisition in my example (16 shares, \$16 earnings), and is ~\$1.083 post-acquisiton (\$26 earnings, 24 shares), so it's 8.3% Accretive (or 1/12).

For #3, EPS was \$1 pre-acquisition and \$1.12 post-acquisiton, so it's 12.5% Accretive (1/8).

I'm not sure if I understand what you mean by framework; I had on my paper an easy way to look at the pre/post acquisition market cap/# of shares and earnings, which made it pretty easy to go from #3 to #4.

A good reminder that I need to remember to answer all parts of a question...

Thank you for the questions - very helpful

I have a basic question regarding the financing impact on the P/E ratio For level 2 question, a company issues debt to acquire company B. It is expected to pay interest at the end of the year and not right away. That said, should we deduct interest expense when calculating proforma earnings?

When calculating P/E ratio, do we usually calculate the P/E(fwd 12mnths) or P/E(current Earnings)?

Thank you

I say framework because the numbers can always change or you can be given different pieces of information (I could have nailed down A's market cap and Net income instead of just giving you PE and letting you make up your own numbers).

For instance, what if I had said A had Market Cap of \$1000 and Net Income of \$100? Or A is trading at \$10, EPS of \$1 and there are 100 shares? Or what if I didn't give you the # of shares? Notice that all the information is consistent with the information I provided in the question.

The key point is that in a short period of time in an interview, if someone throws a few small twists, you should still be able to handle the math.

Makes sense, I think the way I did it was still pretty adaptable, but hard to explain more without pictures of my work.

Thank you so much for providing the questions and such detailed feedback on my answers.

For level 3 and 4 don't you need the debt to equity ratios for part B of both?

Not really. If you make a simplifying assumption that you can assume the debt that is raised is either rolled or re-financed at a similar rate.

Best thread this month. Level 1&2 simply no need for math. Level 3, I knew average was not the way to go and considering the weight was more understandable so level 3 so not that hard. Level 4 b got me twisted. Can you pls explain with an example. Thanks

Here is my solution / framework for Level 3. You can use it to solve Level 4.

Step 1 - Describe Company A's Shares No debt EPS(A) = \$1 (by definition - PE of 10) Assume 100 shares

Step 2 - Describe Company A as a Whole Mkt Cap = \$1000 Net Income = \$100

Step 3 - Describe Company B as a whole B's Standalone Share Stats don't matter as equity / cap structure gets wiped in acquisition.

B's Aggregate (Company) Stats: Mkt Cap A = Mkt Cap B = \$1000 (This is given. For Level 4 - you just make this half instead. You can adjust for any ratio / size) Shares of A issued to B = \$1000/ \$10 = 100 Net Income = \$125 (Mkt Cap of \$1000 divided by PE of 8)

Step 4 - Describe PF Company A as a whole PF Mkt Cap A = Mkt Cap A + Mkt Cap B = \$2000 PF Shares of A = 200 PF Net Income A = Net Income A + Net Income B = 225

Step 5 - Work back down to PF A Shares Price per share = \$10 EPS(PF A) = \$225/200 = \$1.125

\$ Accretion / share = EPS(PF A) - EPS(A) = \$1.125 - \$1 = \$0.125 % Accretion / share = EPS(PF A) / EPS(A) - 1 = (\$1.125 / \$1) - 1 = 12.5%

What got me confused is when you said assume the same EV in level 3. I began to think about various combination of both company A&B capital structure which made it difficult until I saw that you assumed equity value are the same, hence the assumption of no debt you made at the beginning.

I was going mad because I have studied the crap out of technical and experienced some deals .It would be very depressing to miss or have no idea about the question.

Thanks for detailed example.

NA

Maybe I am reading this wrong, but two scenarios. Scenario 1 Co. A Equity 10\$ Earnings 1\$ 10 Shares 1\$ per share EPS of .10\$ P/E of 10

Co. B Equity 8\$ Debt 2\$ or Debt/Equity of .25 Earnings 1\$ 8 Shares 1\$ per share EPS of .125 P/E of 8

-Both have same Enterprise Value Co A aquires B Equity of 18\$ Debt of 2\$ Earnings of 2 18 Shares 1\$ Per Share EPS of .1111\$ PE is 18/2 or 9 Accretion of (.1111-.1)/.1 = 11%

Scenario 2 Co. A Equity 10\$ Earnings 1\$ 10 Shares 1\$ per share EPS of .1 P/E of 10

Co. B Equity 4\$ Debt 6\$ or Debt/Equity of 1.5 Earnings .5\$ 4 Shares 1\$ Per Share EPS of .125 P/E of 8

-Both companies have same Enterprise Value Co A acquires B Equity of 14\$ Debt of 6\$ Earnings of 1.5\$ 14 Shares 1\$ Per Share EPS of .10714 PE is 14/1.5 or 9.3333 Accretion of (.10714-.1)/.1 = 7.14%

It seems that you need the D/E or maybe I just misread your instructions or maybe I just haven't learned anything from the CFA institute.

No, you are right. I normally simplify by saying market cap is the same or make the simplifying assumption that they have the same "optimal capital structure" (that the companies are otherwise identical). I said EV was the same in this case. So you are right. Which is a good point that you need to make assumptions about the debt to equity mix.

someone they can stand to be around 80 hours a week

I think I read somewhere that Blackstone was going to double the size of its M&A group in the next few years...maybe hiring will be more lenient.

"We are lawyers! We sue people! Occasionally, we get aggressive and garnish wages, but WE DO NOT ABDUCT!" -Boston Legal-

Thank you for posting this. Great conceptual questions.

bump.

any thought on the above?

M&A interviewers are in general more technical and demanding than other areas of the firm.

On the style and mood of the interviewer. If your background is quantitative, and your prior work experience and educational background is solid, your interviewers will likely focus more on fit, how polished are you, and do you know what you are getting into, versus technical skills they would expect to teach you on the job.

thanks guys.

I'm not worried about fit too much. however, i might end up with a group that advises on different sectors than what i'm used to (general M&A vs. Real Estate Private Equity, which is what i do).

any input on the kind of technical aspects that they might as about?

SF? NY?

does it really matter?

No, it doesnt matter, but its probably sf anyways cause its tech.

I interviewed at several boutiques in sf and wasnt even asked a single technical question in any round at any bank. what a ridiculous thing to ask for.

its actually in San Diego, not sure why they asked for something this technical...

It's not that ridiculous. It lets them know

• how your finance background is
• how your communication/presentation skills are when you explain it
• how creative you are, sloppy, etc
• how you deal with ambiguity

you get the idea

are you going to take the job? had a similar interview last year, but the job had the M/A title and company talked about how much bonuses analyst can make 100K+ but at the end of the day it was pretty much cold calling. good luck and i would love to hear how it turned out!

Round 2 interviews coming up this week. I will let you know how it goes.

so did u come up with the answer to your post to get to round 2?

Update: so I did R2 today and it went really well.

I put my answers in a PowerPoint which scored points!

I had one slide on the M&A company 1 slide as an overview of the target company 1 slide analyzing financials 1 slide on valuation

He asked for referrals and will call me within a week or so....

Any questions I have to ask?

Anything I should look out for? (good or bad)

keep applying to places just in case this thing doesn't work out.

Btw, another piece of advice. Know certain reciprocals by heart. Saves the need for a calculator.

1/6 = 16.7% 1/7 = 14% (15% ish) 1/8 = 12.5% 1/9 = 11.1% 1/11 = 9% 1/12 = 8.25% 1/15 = 7%

PE of 9 has ke of 11.1%.

If you use simple numbers (mkt cap of 1000) this can help your math. You might even be able to do without paper.

Is this with the Palo Alto office?

ML's Tech M&A has done a few deals recently that are worth looking into. They advised Postini's sale to Google (650mm?), as well as RFMD's purchase of Sirenza (900mm). Expect the questions to be very technical. Small group w/ around 5 or 6 analysts but good deal flow. PM me with anymore specific questions about the PA office in general.

Thanks all for the feedback. If others have more specific deal/group information, please do share.

Pelbo

umm are these kind of questions common for entry level interviews?

Can be. I had a buddy get asked up to Level 3 for a second round. It depends. Your interviewers can always push you. I'd say Level 1 and 2 are fairly common for first round.

I don't think you need to use the tax. I believe the max price to avoid dilution is \$100 per share. I would give an explanation, but I'm not sure if it's right. If someone confirms that I'm right, I'd be happy to explain how I did it.

If you assume you pay by cash (this is the reason why they give you the tax rate, see below) Let's note X the amount you will pay, you will have to borrow X at the cost of debt which we assume is 5%. The cost of debt after taxes is 5%(1-40%)=3% because the interests costs are deductible Pro-forma net income = (120+10-3%X)/Number of shares Since it's a all-cash operation, the numnber of shares remains the same, therefore the breakeven price is when 10-3%*X=0 so X=300

Then if you assume you pay with shares, you don't need the tax rate and your answer seems good

(I know it's not traditional, but:) What if you assume that you purchase the company with existing cash on hand. Would the calculation then be the same as an all stock purchase of the company, yielding a purchase price of \$100 (if you want 0 dilution)?

Assuming an all-stock transaction and no other complications (e.g. no synergies, no increased amortization, etc.), the breakeven price is indeed \$100. Very simply, the transaction will be breakeven when the P/E of the target matches the P/E of the buyer. A P/E of 10x for Company B implies a Price of \$100 (10 * \$10 NI). Note that this is a signficant discount (67%) from where company B is currently trading (30x).

The tax rate is irrelevant in the above scenario. Tax rate will only come in to play if this is a partial or all-cash deal or if there are other adjustments that need to be made to proforma net income (like those synergies or amortization).

Author of www.IBankingFAQ.com

further to Londoner's post, in an all-cash transaction with 5% interest rate, the breakeven purchase price should be \$333, not \$300. Note that this is analysis is highly sensitive to the interest rate.

Author of www.IBankingFAQ.com

Yes, you'right, sorry. 10/0,03=333

Response to waanabebanker, no it's not the same as there is a cost of opportunity when using the cash you have on hands, and we generally assume this cost is the same than the cost of borrowing

don't worry Londoner, I won't tell your associate :)