Transaction Rationale

Value Creation (continued)

Strategic buyers (operating companies seeking horizontal or vertical expansion) create value through operating synergies, including hard synergies (actual cost savings) andsoft synergies (revenue increases). Financial buyers (private equity sponsors) get limited operating synergies, and instead focus on seeking maximum equity returns.  

The Total Net Value of the target company equals the Enterprise value of the stand-alone target company plus value of the synergies minus transaction cost. If the offer is less than the total net value, then the difference between offer and total net value is the value created for the buyer in this transaction.  

Value Creation Analysis is really an estimate based on current information and assumptions, which may or may not be realized later (synergies may be less, transaction cost may be more) resulting in value that was destroyed or lost in the transaction (need to watch out for this). 

Modeling Process 

When building the merger model, we start with creating the Acquirer and Target models. It’s very important to have the same structure (mapping) for both acquirer and target. Each is laid out the same way, including assumptions, three statement model(includes income statement (P&L), balance sheet, cash flow), supporting schedules and discounted cash flow (DCF) models (provides intrinsic value of the business).   

Deal Assumptions are organized into categories like (a) Transaction Inputs (acquirer and target names, share prices, number of shares outstanding, transaction date), (b) Scenarios – Synergies & Financing (synergy alternatives that may play out and financing alternatesthat acquiring company may have), (c) Purchase Price (consider takeover premium and target’s share price), (d) Sources and Uses of Cash (confirm transaction is properly funded, including money being raised and what’s being spend), (e) Purchase Price Allocation (PPA) (calculate goodwill after allocating the purchase price).  

We take the Acquirer and target Models and the Deal Assumptions and come up with the Closing Balance Sheet (add balance sheet of the two companies and make necessary adjustments), which will be used to drive the forecast and the pro forma model.  

We build the Pro-Forma Model (three statement and DCF) by taking the acquirer stand-alone model and adding the target model, then making any required adjustments (including an integration section).  

We then perform accretion and dilution analysis, where we look at pro forma per share metrics (like Earnings per Share – EPS) to see if the new combined entity is better off than the acquiring company was on its own prior to the transaction. If EPS increases after an acquisition, then the combined company shareholders are better off (accretion) from the transaction. If EPS goes down, then it’s dilutive for the shareholders. Accretion or Dilution analysis results may be influenced by factors like the way the transaction is financed (easier to analyze an all-cash deal than a cash & stock deal).

We perform sensitivity analysis to look at potential impact in the intrinsic per share value of the combined company due to any change in assumptions (like takeover premium or revenue enhancements, etc.).  

Share Price Impact: If the market views the transaction as positive, the share price of the combined company will be higher, and value is created by the transaction.