M&A Question Asked by PJT London
Hey all, I got asked to build a S&U for a Merger Model, as a part of an interview, by PJT London today. Here is exactly what I was told and what I made. The interviewer told me this was wrong and that talking to me was a big waste of time. Can someone comment if I really screwed this up? I wanted to argue with him but the Analyst hung up on me.
Co. A has Markt Cap of 200, Total Debt of 300 and Cash of 100. Co. B has Markt Cap of 100, Total Debt of 100 and Cash of 50.
Co. A is going to offer a 50% premium for company B and financing mix will be 30% cash, 30% debt and 40% stock. Draw up the sources & uses and tell me what will be the proforma numbers for market cap, total debt and cash if we need to estimate EV? Feel free to ask any additional questions. I didn't ask any questions and within a minute had drawn the following:
Uses Purchase of Equity 150 B's Debt Assumed 100
Sources
B's Debt Assumed 100
Cash on B's B/S 50
Cash used by A 30
Acquisition debt by A 30
Stock issued by A 40
I said proforma: Market Cap of 240 (200+40); Total Debt of 430 (300+100+30); Cash of 70 (100+50-50-30). Upon this, the PJT guy told me that this was an incorrect way to do it and that I didn't ask all the relevant questions to draw the correct S&U.
Can someone pls point to me where am I wrong? I think this guy is nuts and was purposely being a dick
Wow. I logged in for the first time after a near decade's hiatus to respond.
1) Your interviewer was a dick (was he French - that's something an insufferable French "grand Ecole" analyst would do
2) Think the answer is that you need to start from pro forma EV and work your way down. I'm not great at mental math but sounds like Company A's EV is 400 and Company B's is 150. So pro forma EV is 550. You paid a premium and bought B's equity for 150, 60% cash / 40% shares, so pro forma net debt goes up by 90 (60% x 150) and therefore net debt is 340 and pro forma equity value is 210. This is all pre-synergies.
The above might sound counterintuitive (pro forma equity value is only 210, while Company A started with 200 and issued 60 more) but if you think about it, the premium of 50 you paid is not value (i.e. you didn't create value out of thin air by paying a premium)...rather it is value leakage that is borne by the shareholders in the enlarged company in proportion to their shareholding.
In reality, you could argue that the "real" premium that B shareholders are getting is 38%, not 50% - their 23% (60 / 260) stake in MergeCo is worth 48, and they get cash today of 90, so the value of the consideration they receive is actually 138. This is the argument used by GKN's advisors in their defence against Melrose's (successful) hostile takeover in 2018.
NB the PV of synergies needs to be > than the size of the premium in order for the deal to be value accretive for acquirer shareholders
-friendly BB M&A guy in London
Some interesting discussion.
I disagree with the comment above that the incremental 50 does not add value to the acquirer, such that the PF EV is 550 instead of 600. While there is some validity, the reality is that the value that the asset will generate for the acquirer will depend entirely on the the PV of the future cash flows that the asset generates. If the asset generates 200 in value as the acquirer expects it to under its control, then the PF EV will be equal to 600 (400+200). Conversely, if the PV turns out to be less than what the acquirer paid, then the acquisition will have destroyed value for the acquirer.
The biggest problem with this question is that it is not very clear in a few areas. I'm not sure if that was the intent -- to test if the interviewee would ask the right clarifying questions -- or if it was just poorly worded.
If it were me, I would have clarified what the plan was for the target's existing debt. I think you made a reasonable assumption that the debt would be assumed and that the 30/30/40 mix would apply to the remaining 100 after the seller's cash was used. 9 out of 10 times you would be right. But if the debt was going to be retired, then the interviewer could have intended for the 30/30/40 mix to be applied to 200 (100 equity to be purchased + 100 debt to be retired). This would have changed your PF numbers.
I would also have clarified the premium. This is a much more nuanced point, so I doubt that it was the interviewer's intention. But I'll throw it out there, since it was the first question I had as I read the prompt. Half of the target's market cap is in cash. By paying 150, this means that the acquirer is effectively paying a 100% premium for the target's equity if cash is valued on a dollar-for-dollar basis. For example, if I owned a wallet that was worth 50 and it had a 50 dollar bill in it -- and you were willing to pay a "50% premium" for it -- would you pay me 150? Maybe, but probably not. You would probably pay me 75 for the wallet and 50 for the cash for a total of 125...because you wouldn't pay me 75 dollars for 50 in cash (in fact, in real life, if a target's cash is "trapped" somewhere, an acquirer might only pay 75 cents on the dollar for it or whatever). So depending on the interviewer's intent, that could have resulted in an offer for the equity of 125 vs. 150.
If I had to bet, my guess is that you went wrong around the treatment of the target's debt -- my latter point it a bit too nuanced for an interview. That said, based on the specific assumptions that you made, your PF figures are correct -- but the question is whether you made the "right" assumptions. Lastly, I also wouldn't discount the likelihood that your interviewer was wrong. It happens all the time.