Mergers & Acquisitions,
Accretion / Dilution Modeling
Sunday November 17, 2013
In partnership with:
Alexander Banh
Michael Karp
Chief Executive Officer
Chief Investment Officer
This presentation is for informational purposes only, and is not an offer to buy or sell or a
solicitation to buy or sell any securities, investment products or other financial product or service,
an official confirmation of any transaction, or an official statement of Limestone Capital Investment
Club. Any views or opinions presented are solely those of the author and do not necessarily
represent those of Limestone Capital.
Table of Contents
1. M&A Overview: In Practice & Theory
a) Types of Transactions
b) Merger Motives
c) Role of Investment Banks
2. Process
a) Buy-Side Process
b) Sell-Side Process
3. Accretion / Dilution
a) Deal Financing: Stock vs. Debt vs. Cash
b) Effects of an Acquisitions
c) Merger Model
1
I. M&A Overview
Types of Mergers & Acquisitions
Strategic vs. Sponsor Acquisitions
STRATEGIC
SPONSOR
 Strategic Acquisition: Purchase of an operating
business that is in the same industry or
complements the buyer’s current business
 Sponsor Acquisition: Purchase of a business by
a financial sponsor (private equity firm, venture
capital firm)
ACQUIRER
ACQUIRER
TARGET
TARGET
Which type of acquirer can afford to pay more?
3
Types of Mergers & Acquisitions
Horizontal, Vertical, Conglomerate Acquisitions
HORIZONTAL


Acquirer and the target are in the
same industry
Operating at the same industry
vertical / supply chain level
VERTICAL


Barrick / Equinox
CONGLOMERATE

May be operating in different
industries
Operating at different levels of the
same supply chain
AOL / Time Warner



Both of these companies produce
gold and copper
Acquirer and target are not
necessarily related to each other


Time Warner supplied content to
consumers through properties like
CNN and Time Magazine
AOL distributed such information
via its internet service
4
Conglomerate attempts to diversify
volatility in overall corporate
performance by buying unrelated
companies
Most conglomerates have been
dismantled as institutional investors
realized they could achieve
diversification’s risk reduction
benefits more efficiently through
realigning their own securities
portfolios and unwilling to pay a
premium for the diversification
efforts of conglomerate managers
Types of Transactions
Plan of Arrangement vs. Takeover Bids
Plan of Arrangement

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

Takeover Bid
No actual “plan” is prepared, showing the steps needed to
close the deal
No direct offer to shareholders
Requires shareholder approval of two-thirds majority
(66.67%)
Provides maximum flexibility for structuring
(e.g. three-way mergers)
Useful when:
• Multiple classes of shares involved
• Buying a subsidiary of a publicly traded target
corporation
Costs more and takes longer
Requires court approval
Must be a friendly deal
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5
Offer to acquire outstanding voting or equity securities
Bid must be made to all holders of the class with equal
consideration
• If bidder increases price, everybody who tendered
gets the benefit of the increased price
One Stage Process:
• If 90% of shareholders tender, then compulsory
acquisition of the remaining 10%
Two Stage Process:
• If only two-thirds tender, then move into second
stage process
• Company must call a shareholder meeting
• Shareholders will vote to merge / amalgamate,
requiring two-thirds approval
• Minority shareholders are squeezed out
Types of Transactions
Friend Deals vs. Hostile Takeovers, Stock Deals vs. Asset Deals
Benefits of a Friendly Deals Over Hostile Takeover Bids
Hostile Takeover Bid: An attempt to take over a company
without the approval of the company’s board of directors,
making offers directly to shareholders to gain a controlling
interest.
Friendly Deal: A business combination that the management
of both firms believe will be beneficial to shareholders, and is
mutually negotiated.
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Retention: Targets key management and key employees who would leave in the event of a hostile takeover
Due Diligence: Bidder needs to conduct extensive due diligence on the target company’s financials to satisfy its own board or
financial backers
• Much more difficult with a hostile takeover as target management will withhold non-public information
Deal Protection: Special ancillary conditions of the deal can be negotiated between the two companies in a friendly deal
• Break fees, no-shop, go-shop clauses
Tax Benefits: Only realizable through structured, negotiated transactions
Regulatory Approval: Government approval is much easier with the cooperation of the target company’s management team
Stock vs. Asset Deals

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Stock deals are by far the most common, where the aggressor purchases the entire entity by buying up all equity ownership
The option for an asset deal is only available in a friendly negotiated transaction
• A shell firm with a corporate charter remains after the target firm uses the cash to pay back shareholders and debt holders
and “liquidates itself” or use proceeds to “reinvent itself” as a new corporation
Advantages of an asset deal
• Acquirer is only purchasing the assets that it desires, and keeping only the employees that it needs
• Avoids target firm’s contingent liabilities
• Ability to depreciate purchased assets at purchase value and not historical cost to claim higher capital consumption
allowances
6
Defensive Tactics Against Hostile Takeover Bids1
General Tactics


Poison Pill / Shareholder Rights Plan
Press releases and mailed correspondence to TargetCo’s
shareholders from senior managers of the target company
undermining the bid in attempts to convince shareholders
not to tender shares
Target management / accountants can nitpick at the
takeover bid for areas where the acquirer failed to meet
regulatory requirements in their documentation

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
White Knight

Automatically allowing existing shareholders to buy a
large number of shares in TargetCo at a discounted price,
thus increasing the number of shares the aggressor has to
purchase to gain control of the target
Makes the takeover more expensive
• Aggressor can concede and start negotiating in the
friendly process, or fight the imposition of poison pill
in media / court
Poison pills are only effective as a delaying tactic to give
boards time to seek out superior offers
Golden Parachute

White Knight: Seeking out a firm that management feels
more comfortable handing over control to because of
favourable and negotiated terms
• Even if the white knight is unsuccessful in its
defensive bid, the terms of the deal will still be better
because it bid up the price
Golden Parachute: Management severance packages
that are triggered upon takeover
• Increases the cost of takeovers, sometimes
prohibitively so
Pac Man

Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
7
Target company buying acquirer company, effectively
negating loss of control
Defensive Tactics Against Hostile Takeover Bids1
Scorched Earth / Crown Jewels

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Unicorp / Union Gas / Burns Foods 1986 Case

TargetCo makes itself unattractive to the aggressor
Crown Jewels: A type of Scorched Earth strategy in
which TargetCo sells off all its attractive assets
• If the acquirer’s original merger motive is to acquire
assets such as oil wells or patents by buying
TargetCo, it can no longer be done since TargetCo
has already sold them off
Another form of the scorched earth strategy involves
TargetCo spending all the excess cash on its own balance
sheet on acquiring a company that has absolutely nothing
to do with its business model, is unable to realize
synergies, and is just wasting cash
• Makes TargetCo less attractive to acquirer
Unicorp / Union Gas / Burns Foods Case Study
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
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
8
Unicorp Canada (P/E firm) made bid to acquire Union Gas
(second largest gas distribution company in Ontario at the
time)
Union Gas arranged a friendly buyout of Burns Foods (a
meatpacker in a completely unrelated industry) for $125
million as a “scorched earth” strategy
Unicorp persisted with the takeover
Unicorp gained control of Union Gas, and subsequently
sold Burns Food back to the Burns family for $65 million
($60 million below the original acquisition price), leading to
a $60 million loss for Union Gas shareholders as the cost
of the failed efforts of the scorched earth strategy
How do we gauge the probability of a merger’s success?
Silver Lake / Michael Dell Management Buyout of Dell Case Study

Amended offer price of $13.75 per share in cash consideration, plus payment of a special cash dividend of $0.13 per share, for
total consideration of $13.88 per share in cash


Why did the share price react in January BEFORE the deal announcement (yellow line)?
What does the share price reaction on the amendment date mean (orange line)?
Source: Bloomberg
9
How do we gauge the probability of a merger’s success?
Silver Lake / Michael Dell Management Buyout of Dell Case Study
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Market price and trading volume reactions of the target is a good indicator of the likelihood of the bid’s success
If TargetCo price immediately jumps above the bid price, investors think the bid is too low and higher competing bids are likely
If the target price hovers around the bid price, investors think the bid is fair
If there is no unusual spike in volume, this means that shareholders are sitting on their shares, and unwilling to tender, which
means the likelihood of the bid’s success is low
If there is a spike in volume on the announcement date, TargetCo shareholders are selling out to merger arbitrageurs, and a
change in control is inevitable
Source: Bloomberg
10
Merger Motives1
Why do companies merge or conduct acquisitions?
Glencore’s 2012
acquisition of Viterra
(US$6.1bn)1
Glencore’s 2013
merger with Xstrata
(US$82bn)
Commodities Trading
Commodities Trading
Agriproducts
Mining Company
1. Glencore Xstrata website
11
Merger Motives1
Why do companies merge or conduct acquisitions?

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Gain market share
• Market / monopoly power
• Glencore has made so many acquisitions over the
years that it has become fully “vertically integrated”
and holds significant market share in all commodities
that it trades
Fewer organic growth opportunities
Too much cash on balance sheet
• Common issue for large tech companies
Seller is undervalued (“cheap”)
Up-selling and cross-selling opportunities
Patents, critical technology
• E.g. Google buying Motorola Mobiliity
Entering new market and / or new country
• CNOOC / Nexen, Petronas / Progress
Diversification
Turnaround: Target management is doing a poor job
SYNERGIES
1. Glencore Xstrata website
12
Merger Motives1
Cost & Revenue Synergies
Cost Synergies

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

Easiest to understand, measure,
and predict
Building consolidation
Layoffs of redundant support and
administrative staff
Economies of scale
• Spread fixed overhead over
a large number of units
• More bargaining power
against suppliers
Vertical Integration
• Disintermediation removes
mark-ups, delivery fees
Target may have key
competencies, technology, or
infrastructure that can help
reduce the costs of the acquirer
Revenue Synergies





Cross-sell products to new
customers
Up-sell products to existing
customers
Expand into new geographies
Market / monopoly power
Revenue synergies are tough to
predict, hard to measure, and at
time intangible
Other Synergies




Source: Breaking Into Wall Street
13
Net Operating Losses
• Bidding firm with past
losses could acquire a
profitable target and then
apply its NOLs
• Profitable bidding firm could
acquire a target that is
losing money, and apply its
NOLs to its own stream of
net income
Increased Debt Capacity: A
larger, more stable firm can
sometimes get cheaper financing
more easily
Depreciation: Write up purchase
assets to fair market value,
providing a larger depreciation tax
shield
Goodwill: Amortization of
goodwill which leads to similar tax
benefits as a greater depreciation
base, but no longer allowed under
IFRS
Theoretical Underpinnings of Merger Motives & Gains1
Perfect Capital Markets vs. Imperfect Capital Markets
Definitions


Merger Gain: Situation where as the direct attributable result of the combination of two firms by way of takeover, merger, or
amalgamation, post-combination market value of the resulting enterprise exceeds the sum of the pre-merger market values of the
entity’s constituent firms
Synergy: Realization of any changes in revenues, expenses, operations, mgmt. policies, risk profile, & future prospects of a
merged firm that results from the merger which causes the post-combination market value of the merged firm to exceed the sum
of the pre-merger market values of its constituent firms
• A synergy is any post-merger development that can create a merger gain
Different merger gains are theoretically possible depending on whether the assumption is made that we operate in perfect
capital markets or imperfect capital markets conditions
PCM Conditions
ICM Conditions
1. Price Takers: No one party has influence on the price
2. Equilibrium: Excess demand and supply do not exceed
beyond a transitory moment in time
3. Most investors have and exercise the opportunity to hold
widely diversified portfolios (i.e. only beta risk matters)
4. Dissemination and understanding of corporate and
economic news must be quick enough such that share
prices instantly and unbiasedly reflect all available public
information
5. Homogenous expectations about the uncertain future
1. Imperfect competition in securities market, incl. price
manipulation
2. Persistence of disequilibrium prices
3. Inefficient incorporation of information into security prices
4. Heterogeneous expectations among investors about
security returns
5. Presence of transaction costs and other market frictions
6. Predominance of investors who do not hold widely
diversified portfolios
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
14
Theoretical Underpinnings of Merger Motives & Gains1
Merger Motives Capable of Creating Merger Gains in PCM & ICM
Merger Motives Capable of Creating Merger Gains in Perfect and Imperfect Capital Markets
1.
2.
Increase Market Power: Monopoly or monopsonic power
Cost Reduction through Economies of Scale: Decentralization, managerial specialization, elimination of duplicate activities).
Economies of scope (Coca-Cola), Canadian banks takeover of trust & mutual fund managers
•
It is unlikely that Canadian deals will lead to significant economies of scale due to the small size of the Canadian market
3. Vertical Integration
4. Complementary Strengths & Resources
5. Improved Management & Efficiency: Eliminated conflict of interest when Joe Segal owned both Zellers & Fields, Zellers
acquiring Fields eliminated competition between the two companies
6. Gaining Access to Scarce Resources: Property rights, government licenses, new technologies, natural resources, non- public
information
7. Other Strategic & Defensive Benefits: Cisco 1990’s acquisition spree, IBM purchase of Lotus, Disney & Pixar both defensive
and strategic theme park synergies with Pixar characters
8. Reduction in Beta Risk: In PCM environment, almost all merger related sources of corporate risk have no relevance or can be
duplicated without cost by investors
•
PCM risk reduction merger gains occur when managers use control over operations of the merged firm to implement more
conservative risk averse strategies and policies such that prospective beta risk of merged firm is less than weighted
average of the pre-merger betas of constituent firms
9. Tax Savings: TLCF, CCAs, tax shelter laws by entering into lines of business with more favourable tax laws (Valeant & Biovail)
10. Financial Benefits: In PCM, reduction in bankruptcy risk is of no value as long as there are no costs associate with bankruptcy.
•
Real costs of going bankrupt such as legal fees, fire sale liquidation losses, produce merger gain, since reduction of
bankruptcy costs is not possible through investors manipulating the markets by themselves
PCM merger gains happen only if the combination of merged firms can achieve some benefit that individual investors
could not have achieved on their own through manipulation of their own personal security portfolios
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
15
Theoretical Underpinnings of Merger Motives & Gains1
Merger Motives Capable of Creating Merger Gains in ICM Only
Merger Motives Capable of Creating Merger Gains in Imperfect Capital Markets Exclusively
1.
2.
3.
Sales & Earnings Variability Risk Reduction via Diversification
•
There is little evidence supporting existence of conglomerates & may be valued at a discount to total market value of
component firms
•
A big firm containing a bunch of unrelated business leads to management inefficiency
•
Conglomerates cannot move in and out of investments as easily as individual investors can
•
Investors’ reliance on accurate accounting information, and the uncertainty associated with conglomerates’ financial
statements means blurred disclosure
•
Conglomerates sell at discount to full break up value because upon divestiture, the firm has to pay capital gains taxes on
gains from constituent firms
Financial Advantages
•
Moving the acquired firm towards its optimal debt ratio = increased debt subsidy for debt financing
•
Better ability to set dividend policy to the share-value-maximizing level
•
Access to funds, lower transaction costs w/ issuances, more media & ibanking attention
•
Cash transfer within a conglomerate between a cash cow business unit to a cash-strapped one with high growth
Presence of Bargains or Inflated Share Prices
•
Disequilibrium Prices: the market price of the target can be less than true intrinsic value, with gains accruing to
acquiring firm when the target realizes its intrinsic value
•
Liquidation Value: When the market value of the target firm is below the combined value of constituent assets, the
acquirer can realize merger gains by selling bits and pieces of the target firm off post-acquisition
PCM merger gains happen only if the combination of merged firms can achieve some benefit that individual investors
could not have achieved on their own through manipulation of their own personal security portfolios
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
16
Theoretical Underpinnings of Merger Motives & Gains1
Merger Motives Capable of Creating Merger Gains in ICM Only
Merger Motives Capable of Creating Merger Gains in Imperfect Capital Markets Exclusively
3.
4.
Presence of Bargains or Inflated Share Prices (…cont’d)
•
Different risk aversion of acquirer and target shareholders: If acquirer has a lower cost of capital, what is fairly
valued to the target shareholders will be a bargain to the acquirer
•
Disturbance theory of mergers: In period of significant change in economic conditions, valuation differences are
especially prevalent
•
Bargains: Arise from acquisition of small, closely held companies with low volume, such that the true value has not been
fully priced into the stock due to lack of interest or knowledge from the market
•
Bankruptcy: Firms are likely to sell at bargain prices when they have gone bankrupt or owners want to sell out quickly for
personal reasons (such as management wanting to retire)
•
Investment Canada Act / Net Benefits Test: Artificially segments corporate acquisitions market such that Canadian
firms can buy firms at prices lower than they would otherwise have had to pay, and foreign firms need to pay a higher
premium
Accounting Magic
•
The acquiring buying a firm with a lower P/E than its own through a share exchange offer
•
Presumes that investors only focus on accounting numbers, and that they must price stocks according to a simplistic
formula (stock price = EPS x P/E), AND that aggressor P/E multiple will not change materially as a result of the merger
•
When one firm acquires another, the market often mistakenly applies the acquiring firm’s higher P/E multiple to the whole
merged firm, rather than using a weighted average of the P/E multiples of the pre merger firms
“While
• the motive of conducting an acquisition to “secure assets at a bargain” is a legitimate one, it is not likely that
sufficiently large undervaluations exist to make bargain hunting a dominant motive because it would be eliminated with the
takeover premium paid to shareholders. Firms are not able to identify bargains any better than the market in general, so
benefits of a genuine bargain acquisition are overrated.”
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
17
Why do most mergers and acquisitions destroy value?
Value Destruction


About two thirds of mergers and acquisitions destroy value
From 1980 to 2001, acquisitions resulted in an average of 1 – 3% decline in acquirer share price, or $218 billion of value
transferred from acquirers to sellers (McKinsey & Co.)
Reasons Why Mergers Fail1
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Management egos
• Managing a bigger company means bigger
bonuses if compensation is tied to equity
Diversification results in loss of management focus
Acquirer paid too much for target
Unsuccessful at integrating disparate corporate
cultures leading to attrition of key personnel
Managers focusing too intently on cost-cutting measures
to neglect day-to-day business, resulting in lost
customers
Easy to overestimate synergies
• Synergies are often not enough to overcome
control premium and financing / transaction fees
• Synergies take time to realize
Winner’s curse
• When an attractive target is put into play,
competing bidders often enter and bid up the price
• Potential merger gains become slimmer
Overpaid (1994)
CEO Power Struggle (1995)
CEO Power Struggle (1997)
Systems Integration (1998)
Overpaid (2001)
Unsuccessful Integration (2005)
Horrible Timing (2007)
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
18
Role of Investment Bankers in M&A
Strategic M&A Advisory
How do investment bankers add value to M&A transactions?

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Structure of Transaction
• Plan of arrangement, takeover bid, amalgamation
Consideration
• Cash, shares, preferred shares, warrants, special
warrants
Offer / Bid Price
• Requires a full suite of valuation work
Deal Terms
• Break fee, reverse break fee, go-shop clause, right
to match
• Are options assumed by buyer, cashed out, or
ignored?
• Mgmt lock-up agreements, for board of directors,
large shareholders


Tax Consequences
• Creation of goodwill
• Transaction structure and consideration will affect
taxes
Execution
• M&A process can be lengthy
• Many legal procedures need to be followed
• Due diligence
Regulation
• Certain deals must be carefully structured to
maintain compliance with anti-trust, national
interest, and other legal issues
• Many large deals get blocked by the government
• How can the acquirer avoid restrictive regulatory
legislation preventing the deal from passing?
Investment banks can add a great deal of strategic value compared to more transaction oriented situations like equity or
debt issuances. Many investment banks focus exclusively on M&A as their niche.
19
Role of Investment Bankers in M&A
Strategic M&A Advisory
How do investment bankers add value?
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
How does a firm choose an investment bank?
Special Situations
• Buying firm after bankruptcy or restructuring
 Deloitte acquiring Monitor
• Insider bids (protection of minority shareholders)
• Reverse mergers
• Three-way mergers
Fairness Opinion
• Independent valuation to determine if offer price is
fair, associated with lower fees for the bankers
• Most Boards of Directors require a fairness opinion
before approving the deal
Other
• Spinoffs / divestitures
• Acquisitions / divestitures of specific assets,
especially in oil and gas, mining, real estate (Scotia
Waterous, Brookfield Financial)
• Hostile Defense
 Is our company undervalued?
 Are we vulnerable to a raider?

Relationship business

Strategic expertise can play a role
• Certain banks are strong in certain sectors

Can banks compete by lowering their price?
• Most banks have competitive pricing and similar fee
structures
• Decision to hire an advisor is rarely based on fees

Buy Side Advisory
• Ease of and terms of financing offered by each bank
is an important decision criteria

Stapled Financing Package
• The sell side advisor provides financing for buyers
• Buyers no longer need to scramble for last minute
financing
Investment banks can add a great deal of strategic value compared to more transaction oriented situations like equity or
debt issuances. Many investment banks focus exclusively on M&A as their niche.
20
Role of Investment Bankers in M&A
Buy Side vs. Sell Side
Buy Side vs. Sell Side

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
Good Case Studies to Read Up On
Investment banks can advise on the buy side or sell side
Buy Side: Advising the acquirer / aggressor / bidder
• Helps buyer determine the right bid and deal terms
• Can be complex with multiple bidders or with hostile
takeover
• Takes 16 – 36 weeks
• Takes another 3 – 4 months to close after
announcement
Sell Side: Advising the seller / target
• See previous slide
Sell Side, Strong Side?
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
Investment bankers are paid a small portion of the total
fee up front (work fee)
The bulk of the fee is not paid until the deal is closed and
approved by regulatory bodies
Sell side advisory roles have much higher chance of
closing than buy side advisory roles
When a company is being sold, they are being sold for a
good reason, and there is a high likelihood that they will
be sold
On the buy-side, if there are multiple bidders, and the
bank advises only one bidder, then it may not be
successful
21
II. M&A Process
Buy Side Process
Assessment
(4 – 8 weeks)

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

Contacting
Targets &
Valuation
(4 – 8 weeks)
Pursuing the
Deal & Due
Diligence
(4 – 10 weeks)
Definitive
Agreement &
Closing
(4 – 10 weeks)
Analyze competitive landscape
Identify potential targets
Find key issues to address:
• Pensions, contingent liabilities, off balance sheet items, inside ownership, unusual equity
structures, special warrants
Build out acquisition timetable, most of which have the tendency to be optimistic



Contact potential target candidates
Negotiate a confidentiality agreement (CA)
Perform preliminary valuation on target, including trading comparables, precedent transactions,
discounted cash flow analysis, accretion / dilution model, LBO floor valuation


Send letter of intent (LOI) with details of initial offer
Conduct due diligence: Create data room, analyze products and services, analyze the company and
industry, assess the company’s financials, identify contingent liabilities, conferences with management,
auditors, lawyers, site visits
Finish valuation

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

Finish due diligence
Arrange, negotiate and execute definite agreement
• Board must approve transaction for it to be considered “friendly”
Provide financing, unless stapled financing package in place
Conduct any required filings and announce deal
Seek shareholder and regulatory approval, deal may take another 3-4 months before official close
23
Sell Side Process

Find An Advisor
(1 – 2 weeks)

When a firm wishes to sell itself, it will usually either:
• Contact an investment bank with which it has a strong relationship
• Contact an investment bank which has strategic expertise in the company’s sector
• Invite multiple investment banks to a beauty contest
During a beauty contest, multiple investment banks will present their qualifications, expertise, proposed strategy, key issues,
and universe of buyers to the firm


Identify seller’s objectives and determine appropriate sale process: broad or narrow auction?
Broad Auction: Contact many potential buyers, more bidders usually means a higher price
• Risks leaking competitive information, and there is also a higher chance that the process itself will be leaked, which
interferes with the deal itself and the morale of employees
• Often the best option if the public is already expecting a sale
Strategic Review: When a company announces they are doing this, usually means a broad auction
Narrow Auction: Contact a few strategic buyers to prevent the leaking of competitive information
First Round





Contact potential buyers
Find An Advisor
Negotiate and execute confidentiality agreements
Send out Confidential Information (1
Memorandums
(CIM) and initial bid procedures letter
– 2 weeks)
Prepare management presentation, build data room, negotiate stapled financing package if needed
Receive initial bids, and filter buyers to second round
Second Round




Facilitate Management Presentations: Mgmt. brings bankers to presentations to add legitimacy
Facilitate Due Diligence: Site visits, open up data room to buyers
Send out final bid procedures letter and create a draft of the definitive agreement
Buyers make final bids

Evaluate final bids, negotiate with top bidders, and select the winning bidder, which may not always be the highest bidder
• Other factors like deal terms, type of consideration, future plans are also important factors to consider to ensure that
the buyer is willing to cooperate with existing management’s vision to lead to a smooth transition
Arrange for fairness opinion (if needed), receive board approval and execute definitive agreement
Announce Transaction
Closing: Shareholder approval, regulatory approval, financing, and closing
May take 3-4 months for acquisition to officially
24 close
Preliminary
Assessment
(2 – 4 weeks)
Negotiations &
Closing
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III. Accretion / Dilution Analysis
Financing Takeovers – Choice of Consideration
Stock vs. Cash Consideration
Benefits of Stock Consideration
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Benefits of Cash Consideration
Good if the acquirer’s stock is doing well
• Many stock acquisitions by tech companies before
tech bubble burst
Better for tax
• With cash acquisition, capital gain is immediately
taxable
• With stock, these capital gains can be deferred
Beneficial for acquirer if it is cash strapped and does not
have excess cash leftover
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Cash is generally cheaper than equity
• The opportunity cost of balance sheet cash is
forgone interest on cash
• Typically 1%, while cost of equity is usually double
digits
• Debt is also generally cheaper than stock
Good for confident buyers
• With cash, buyer retains 100% of the benefit since
acquiring shareholders own all of the entity’s shares
• Target shareholders will NOT receive the acquirer’s
shares in exchange for their own
Less uncertainty
• Stock offers are usually made with an exchange
ratio and have no fixed value
• Stock price could fluctuate before tendering of
shares
• Cash is a fixed value (assuming no currency risk)
Better if stock of acquirer is weak
• Cash is more common in economic downturns
Will result in better profitability ratios
• However, liquidity ratios will decline
Financing Takeovers – Choice of Consideration
Stock vs. Cash Consideration
Buy Side Considerations of Share Exchange vs. Cash1
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Canadian law does not permit bids contingent upon the acquirer’s securing financing and requires bidder to have adequate
financing arrangements before the bid is made
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Factors distinguishing between cash & share exchange:
• Willingness to Share Gains: If cash is used to finance takeover, target firm’s shareholders do not participate in synergy
related gains except to the extent that it has been priced into the offering price
• Disclosure: Cash offer lower level of disclosure, while a share exchange offer requires an offering memorandum and
takeover bid circular
• Ownership Control: Cash transaction does not change ownership control position of aggressor
• Tax Considerations: If TargetCo shareholders have embedded capital gains tax in their shares, they will prefer to do share
exchange and get the aggressor’s shares in return for tendering their own to avoid “tax deferred roll over” if they took cash
or debt
 Institutional shareholders non-taxable & indifferent
• Non-Tax Shareholder Preference: Institutional investors (that owned shares in TargetCo) prefer to receive cash, if they
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are concerned that the takeover will not create added value, but shares if they think the aggressors’ shares will increase in
market value
Market Value of Aggressor Firm’s Shares: If the aggressor’s shares are overvalued, it will want to trade its own shares as
“currency” of the transaction for TargetCo’s shares (will get more shares of TargetCo per share it gives up)
Need for Approval of Aggressor Firm’s Shareholders: In an all cash transaction, the management of the aggressor does
not need shareholder approval
 In a share exchange, management also does not need shareholder approval, as long as shares issued does not exceed the authorized
maximum share capital
 Many firms have a clause in the IPO prospectus that gives management unlimited authorized maximum share capital
Source: Cannon, William. “The Analysis of Mergers and Acquisitions”, 2013.
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Accretion / Dilution
What is accretion / dilution?
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Effects of an Acquisition
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Accretion: If pro forma (combined) EPS of the merged
company is greater than the acquirer’s original EPS
Dilution: If pro forma (combined) EPS of the merged
company is less than the acquirer’s original EPS
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Acquirer P/E of 10x, Target P/E of 5x, Accretive?
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What is the consideration?
• Assume all stock
This transaction is accretive
• In an all stock deal, the transaction is accretive if the
P/E of the target is less than the P/E of the acquirer
• You are paying for a company that is generating
more earnings than you are per dollar of stock price
• Your shareholders are paying less for $1 of earnings
than you would normally
• Your EPS will thus go up if you buy their relatively
underpriced stock with your own relatively
overpriced stock
Note: we have not accounted for financing fees,
transaction fees, or synergies
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Depends on the consideration
Foregone interest on cash
• Opportunity cost of balance sheet cash used in the
transaction is lost interest income
Interest on debt
• If leverage is used, additional interest expense will
be charged to the acquirer
Additional shares outstanding
• If consideration is a share exchange, acquirer will
have to issue additional shares from treasury
Combined Financial Statements
Creation of Goodwill and other intangibles
• Write up target’s assets from historical cost to fair
value
• Goodwill represents the premium over this amount
(approximately)
Accretion / Dilution
All-Cash Acquisition
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If a deal is financed only through cash and debt, there is a shortcut for calculating accretion / dilution
If: interest expense for debt + foregone interest on cash < target’s pre-tax income, then acquisition is accretive
Think of it as: pre-tax cost of financing being used < pre-tax income being consolidated with your own
Assumes no synergies, transaction fees, financing fees
Complete equation:
Accretive if: Transaction Fees + Financing Fees + Interest Expense On Debt + Foregone Interest On Cash
<
Target’s Pre-Tax Income + Synergies
Mix of Stock & Cash Consideration
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There are no shortcuts for finding accretion / dilution for acquisitions that use a mix of cash and stock
• Must build merger model
Advantages of using a merger model:
• Intrinsic valuation allows you to understand break-even syneries, key variables, as well as bull, base, and bear case
scenarios
Disadvantages of using a merger model:
• Using precedent transactions may provide a more objective view, since there is less room for manipulation
• Difficult to model out synergies, transition costs, effect on corporate culture and employee morale
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Accretion / Dilution
Merger Model Walkthrough
Steps to a M&A Accretion / Dilution Model
1. Input purchase price assumptions (% cash, % stock, % debt)
2. Build stand-alone income statement and balance sheet for acquirer AND target
3. Allocate purchase price to the writing-up of assets to fair value, the creation of new goodwill, and
transaction fees
4. Build a sources and uses of capital table to calculate the necessary amount of sponsor equity needed
to fill the gap
5. Make adjustments to the target’s balance sheet based on Step 3
6. Create pro forma post-merger balance sheet and income statement, making adjustments for any
synergies or new debt / interest expenses
7. Calculate post-merger fully diluted shares outstanding
8. Did EPS increase? Sensitize analysis to purchase price, % stock / cash / debt, revenue synergies, and
expense synergies
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Accretion / Dilution
Advanced Merger Model Concepts
Deferred Tax Liabilities
Goodwill
 Writing up target’s assets to fair value creates
deferred tax liabilities (DTLs)
 On your books, it seems like you don’t have to
pay as much tax, since you are writing up your
assets up and increasing your depreciation base
 In reality, you still have to pay the same amount of
tax
• Naturally, the government does not let you
reduce taxes by writing up the target’s
assets after an acquisition
 There will be a discrepancy between your books
and the taxes you actually pay
 This discrepancy creates a DTL
• DTL = Asset Write-Up x Tax Rate
 We write up the target’s assets from historical
cost to fair market value
 We then have to account for any DTLs created
Equity Purchase Price
less: Seller's Book Value
Premium Paid Over Book
add: Seller's Existing Goodwill
less: Asset Write-Ups
less: Seller's Existing DTL
add: Writedown of Seller's Existing DTA
add: Newly Created DTL
Merged Company Goodwill
Almost never asked in interviews.
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