I have a set of M&A interview questions I like to ask.
Interview Questions for Mergers and Acquisitions
In my career, I've only had two analyst / associate candidates answer all four levels correctly without coaching. Most people can get Level 1 and sometimes 2. Fewer get Level 3 or 4 even with coaching. Thought process is more important than answer.
Company A acquires Company B. Assume all numbers below are inclusive of premium and synergies.
Beginner Interview Questions - Basic Accretion / Dilution
Question:
- Company A has PE of 10 and company B has PE of 8.
In an equity-swap deal, is the transaction Accretive or dilutive?
Answer:
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
Mid-Level Interviewing - Earnings Yield
This is to break the people who read the Vault guide and quote the "cheaper earnings" answer / shortcut
Strong>Question:
Company A uses debt which has an after tax cost of debt of 5% to acquire B.
- Is the deal still (Accretive / dilutive) like in Level 1 question? More or less?
- What after tax cost of debt would make the deal approximately break even from an accretion perspective?
Answer:
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)).
Difficult Interview Questions - Merger of Equals (MOE)
This question requires a framework. If you blurt out a number: A. I bet I know what answer you're going to blurt out and it's wrong and B. you need to show me you put more thought into it regardless: Right number with no backup is the wrong number.
Question: Assume the companies are the same size (read: same market cap) and other reasonable simplifying assumptions.
- Without doing any math, what are some reasonable boundaries for the PE ratio of the PF entity?
- How Accretive is the deal in Level 1 as a %? Is your PF PE ratio within the bounds you expected?
Answer:
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.
Common Mistake: 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.
You can learn more about Merger of Equals below:
High Level Interview Questions - Full Merger Math
If you have the framework for Level 3, chances are you can probably get this one too
Question: Assume company A is twice the size of company B (read: market cap A = market cap B x 2).
- Without doing any math is the deal more Accretive or less Accretive? What are the PE bounds in this case?
- Now do the math and tell me exactly how Accretive it is. Does your answer make sense?
Answer:
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
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Mod Note (Andy) - This one was originally posted 8/16/2015.
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.
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
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)).
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).
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
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%