I need some help on understanding this. I was asked to do accretion / dilution analysis real quick and told that when a company is acquiring a small, private company, they are acquiring "enterprise value" (meaning that the analysis should be driven off of enterprise value vs. equity value). The rationale was that the buyer gives proceeds to seller equal to amount of enterprise value and the seller keeps the cash on its balance sheet and retires any outstanding debt on its balance sheet.
Could anyone help me better understand this?
Thanks in advance for help!
EV = equity value + net debt
meaning if you buy a company you're not just buying the equity you're buying the entire company.
Say company A is buying company B for Company B has $200 of debt and $50 of cash.
You effectively will use the $50 to pay off their debt first and then basically taking on $150mm of new debt + whatever you're paying for the equity.
EV is used in M&A all the time b/c it gives you an idea of what you're buying net of the cpaital structure of the business
Transaction EV = Consideration to Shareholders + Warrants/Options + Earnouts + Total Debt - Cash
Don't forget minority interest.
so when company A buys company B, it will only pay for the equity part of transaction and NOT the debt right? If EV of company B is comprised of 200 in Equity value and 100 in Net debt, company A will only pay 200 (for the equity) and not 300 right, in essence "assuming company's A debt" but not paying for it? Im slightly confused about this "assuming debt" thing. Would appreciate some help!
Very good question, I would like to know as well. A controlling acquisition only requires the purchase of 51% of equity...so they aren't actually purchasing the debt portion to my understanding, but I think since they are the controlling shareholder, they assume, as the owner, the payment of the debt and its associated interest. Is that right?
Yes, basically. Assuming acquirer is acquiring all of the target (cash and debt), you have to take into consideration the cash/stock being used to acquire the company, as well as the net debt assumed in the transaction (because that's a cost). So if the target has $10 million in debt and no cash, and it pays $200 million in cash/stock, the total acquisition cost is $210 million. It's pretty simple actually -- the debt is a cost as it is assumed.
However... in the event of a large company acquiring a small, private company, acquisitions can often be made on a cash-free, debt-free basis. For example, Microsoft has made over 50 acquisitions since 2007, many of them very small deals. Often times, they'll acquire a company on a "cash-free, debt-free" basis -- essentially, they tell the company/shareholders to keep their cash and debt and just give them the company -- Microsft doesn't need the $1 million in cash or the hassle of dealing with a $10 million revolver and $20 million term loan. I'm not sure if this was what your interviewer was referring to.
Bobby, not 100% sure how to put this into words, but regardless of the portion of equity purchased, the debt is the responsibility of the company. The debt will have seniority to your equity portion, which means the company will have to pay off the interest and debt before you can receive any value. If you acquire 51% of the company, you'll combine the company on your balance sheet and the debt will be shown there.
Also, to delve a bit deeper into my above post, the reason a large company would do cash-free, debt-free is so it doesn't have to worry about the repayment of debt -- it will basically give the target excess cash (assuming valuation remains the same and there is a net debt position) and this will allow them to retire the debt and resolve their liability -- and the acquirer doesn't have to worry about it.
Great post, thanks for the explanation. Perfectly put.
Wait a sec, so you're saying that the acquirer generally doesn't actually tangibly pay for the net debt, they only physically pay for the equity stake, with the net debt being implied by transferring it to new parent's balance sheet? So when I read about an acquisition which says that the offer price was 10B but the transaction price was 15B, the 10B being the equity price, is all that was actually paid for with the 5B being accounted for on the balance sheet, is that correct? They don't have to issue new debt to purchase or refinance the targets existing debt, in the transaction, right?
Also you might want to take into consideration that most bond and loan agreements contain "change of control" provisions in which when over 35% of the stock changes hands and is no longer owned by the company, the bonds/loans become payable usually at 101% of par immediately. Sometimes this can be waived via amendments, in which case if you "assume" debt, it's not a cash outlay, but you would still add it to come up with "total transaction value". I.E. you can't acquire a company with $50 mm in net debt for its $100 mm equity cost and say the transaction value was only $100, because you are going to pay off that $50 mm one way or another, whether through a change of control put, or the assumption and subsequent refinancing and or repayment.
Bobby, it depends. In some transactions, the acquirier will "assume" the debt, although, as Solaxun mentioned, this is rare because there are generally provisions in the loan agreement that require the debt to be repaid upon a change in control. When this happens, it can be handled one of two ways -- the acquirer can pay for the debt/refinancing of the debt, which will result in a lower amount of cash received by the seller, or the seller can handle the debt, for which they would receive a higher cash payment from the acquirer (this is considered the cash-free, debt-free basis). Ultimately, after all debt liabilities have been resolved, assuming the same valuation, the seller will have netted the same amount of cash and the acquirer will have shelled out the same amount of cash.
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