M&A analysis (Accretion / Dilution) when target tech startup has negative FCF?

Hi All,


How should we go about M&A analysis (Accretion / Dilution) when the target tech startup has negative FCFF? EPS will decrease, so how to justify the txn quantitatively?
I believe it would be a standard question for people in Tech, as many highly valued targets have negative FCFF.

Appreciate the help!

 
Most Helpful

If you have negative FCF, you need to revise your operating assumptions to justify the deal, both in terms of expenses (typical stuff...bigger cuts if you have a full commercial team) and revenues (showing that you can operate the business or get a bigger slice of the market than competitors, cross-selling, etc.). You should also make sure you're using NOLs (Section 382) or decrease capex (perhaps through contract manufacturing?) or working capital needs (may be too aggressive). 

In addition, to lessen the impact of negative FCF so you can further justify a deal, you could revise transaction structuring to optimize for taxes (so do an asset deal or Section 382 election so seller pays more taxes...and there's gotta be more ways to optimize taxes through structuring), or simply lower your price. You should also make sure your explicit forecast is long enough (not 2 or 3 years).

 

I would agree this is the best approach for this, if you really wanted a model justificatoon for the deal.

The point of acquiring high growth tech companies is in its name - growth. You're not purchasing it to obtain immediate EPS / value accretion; you buy it knowing that it will potentially generate masses of earnings and cash flows in the future. A standard 1, 2 or even 5 year accretion will not showcase this benefit.

 

(1) Even if FCF was positive, it makes little sense to run accretion / dilution in an acquisition of a start-up (size too small) unless its growing at triple digits

There must have been some rationale why this start-up is acquired - use that as a starting point. With this start-up under your client’s umbrella, will you be able to grow certain product line perhaps?
 

(2) It all boils down to how much info you have.

(3) A bit puzzled how a start-up managed to get listed. Is it really a start up?

 

Surprised no one brought this up yet. If FCF is negative because of massive capex or NWC shortfalls while income statement items aren't negative, you can still have an accretive deal. That said, if capex is super high and the co is in growth mode, I'd bet operating results aren't that great either. But just saying "negative FCF" doesn't mean the numbers won't be accretive without further info. Especially if it's all-cash and therefore no share count dilution

 

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