Merger Model: Cash, Debt, and Stock Mix

[@wenkaiyang1487]

Brian, on 9:30. you mentioned the seller uses their extra cash to fund the deal. Why should seller spend cash to fund the deal? Shouldn't the deal be funded solely by buyer? In general, should seller engage in funding process at all? Is it just a negotiation between two parties on how to fund the deal?

[@financialmodeling]

This is a really old video and is not the best way to think about it. Please see the more recent one on cash-free/debt-free deals for a better explanation (and more Excel examples and a written explanation). Effectively, Excess Cash goes to the buyer (reducing the effective purchase price) or it is distributed to the seller's shareholders as the deal closes, also reducing the effective price.

[@wenkaiyang1487]

Merge models in this video vs financing for a project vs LBO, are there differences in those three scenarios

[@financialmodeling]

Yes, there are differences. One big one is that "stock" is not a relevant purchase method in LBOs. Another one is that refinanced debt is treated a bit differently in these scenarios, as it's almost always explicitly replaced in a merger model as a separate line item, but in an LBO model, the new debt to replace the existing debt is simply part of all the tranches of debt on the Sources side.

[@desijiga2002]

Thank you very much great work. I cant find excel spreadsheet to this file? Could you please attach? thank you great work again.

[@financialmodeling]

Thanks. There's no Excel file for this one, but if you look at other merger model examples in this channel, you can find similar examples/models with the Excel file below the video (click "Show More" and scroll down).

[@kamm7323]

Is there such a thing as a "divestiture model"? What's the best way to think about a divestiture and it's impact on EPS?

[@financialmodeling]

Yes, but it is just the reverse of a traditional merger model... so you remove the divested company's assets/liabilities, reflect the cash received for selling the division, and then you remove the divested company's pre-tax income contribution. Mechanically it would be almost the same, but the signs would be reversed... also it's actually easier because you don't need to calculate Goodwill or allocate the purchase price or anything like that, it's just a matter of removing associated assets and liabilities and reflecting the cash received from selling the business.

[@kamm7323]

Mergers & Inquisitions / Breaking Into Wall Street Thanks. The only thing I'm wondering about is how you reflect the new EPS. Is there a standard approach similar to accretion/dilution? I am thinking of 2 possible options: 1. You assume that all proceeds are in cash and it's used to buy back shares and so the share count goes down and EPS doesn't drop too much as a result of the divestiture. 2. You assume all proceeds are in cash and distribute that to shareholders and incorporate that one time dividend into the EPS. Is there a standard approach or just something you decide on a case by case basis?

[@financialmodeling]

Mohammad Kamran Mahmood Yes, those are 2 possible options but I don't think there's one universal way to do it. For example, if the company's stock price has risen substantially since the divestiture was announced it might not make as much sense to repurchase shares anymore; vice versa if its share price has fallen. So you could take either approach and note what you've done depending on what makes the most sense numbers-wise.

[@jimmyhong2824]

Can the buyer use cash from the seller to fund the acquisition? I'm confused about the differences between Source & Uses section and the cash/debt/stock mix above. Thanks

[@financialmodeling]

The Sources & Uses schedule tells you what the buyer is *really* paying for the seller. The Cash/Debt/Stock mix is more like the "list price" when buying a home - what you appear to be paying - but the S&U schedule represents what you are *actually* paying. The seller can use its own excess cash to repurchase some of its outstanding shares, reducing the purchase price for the buyer. This is not exactly the same as the buyer using cash from the seller to fund the acquisition, but it has the same effect and is shown the same way in the S&U schedule.

[@dbsk06]

Cost of equity = yield = 1/(p/e) = net income / equity value 3:37

[@financialmodeling]

??? I'm not sure what your question is. That is another way to approximate the Cost of Equity, yes, and it's more applicable in an M&A context.

[@luismipawns]

Hi! Can I ask where can I get equity research reports (updated) ? such as those from JP morgan, Standard and poor, etc.

[@financialmodeling]

You can't do this easily without access to Capital IQ, Factset, or some other database at a bank. You might be able to use Google to find some results if you search for very specific terms. No bank in their right mind would make high-quality research readily available for free to anyone who wants it.

[@fritzwaldow359]

Hi, why exactly are we not using all the excess cash but only some part of it when it is the cheapest option ? Thank you very much.

[@financialmodeling]

Companies must maintain a minimum cash balance at all times to run their operations, so you can't assume that all cash will be used to fund deals.

[@nhile8595]

Hi, can i have your excel spreadsheet ? :"> i am stuck with the assignment on merging AMP and Suncorp Thank you

[@financialmodeling]

+Alexandra Le There are plenty of sample spreadsheets in the other lessons in this channel if you take a look...

[@nhile8595]

Oh and also may i ask, do you have any video about the basic of financing method, because this is my first time study the Investment Banking subject, however, the textbook i am provided does not have enough information and i also tried to search the internet but it just getting more and more confuse. And if it is ok, would you mind if i ask you some question about financing for the M&A transaction? My group is trying to merge AMP and Suncorp. Thank you so much

[@financialmodeling]

+Alexandra Le We're happy to answer quick questions on KZbin, but we can't provide detailed help with homework assignments or tasks for clients if that's what you're looking for.

[@pv0315]

very intuitive . thanks.

[@financialmodeling]

Thanks for watching!

[@shoubhitamin4220]

Can i used the PEG Ratio as a denominator instead of PE to calculate the cost of Stock

[@financialmodeling]

No, not recommended because PEG doesn't represent the cost of issuing new stock.

[@yoelherman5344]

Thanks a lot. Quick question - it is not very clear, why if the companies (the buyer and the seller) are in the same size, it's more ok to use stocks to close the deal?

[@financialmodeling]

Because companies only have so much cash and can only raise so much debt, so past a certain level, stock is the only option.

[@marigeri993]

hi, thank you for your time and passion to do this for us, it is so precious! just 2 doubts. first: assuming I'm the buyer, If I have cash and I can velocize the reimbursment of by debt that costs me 5% every year, is it still correct that the cost of cash is how much I earn from it? second: when we say to use stocks to buy a target, do we mean new issuing right? if yes, why do we assume the same price per share of the acquirer as per before transaction? In theory all the previous acquirer shareholders will have less control on the combined entity so the value should be lower, doesn't it? Which is the rational behind? thank you so much! I love your way to teach something complicate in so easy way! ciao, Mari from Italy

[@financialmodeling]

Thanks. I don't understand your first question. For your second question, yes, it always means issuing new stock. You assume the same share price as before the transaction because issuing new stock won't necessarily change the stock price in a predictable way. you normally handle this by creating a sensitivity table that shows the deal results at different ranges for the buyer's share price.

[@marigeri993]

Thank you! About the first question, I mean: I'm the buyer, I have a debt that costs 5% year, and I have a certain amount of Cash which earns 1.5% year. In the video we say that the cost of Cash is the missed earning (so 1.5%). Could I say that it is 5%-1.5%=3.5% in the case above? My doubt is due to the fact that whit that Cash I Could early repay my debt that costa 5%. Sorry if I was not clear again. Ciaooo e grazie!!

[@financialmodeling]

@@marigeri993 I think you're over-thinking it. Companies cannot necessarily repay Debt earlier, for one thing, so this calculation isn't necessarily valid.

[@Akki420ish]

They: So which department do you work in? Me: Murders & Execution s They: Sorry? Me: Mergers & Acquisitions

[@daveaditya4515]

just when I needed it, sweet :)

[@financialmodeling]

Thanks for watching!

[@karlh2245]

Fantastic video. Thanks for your great work Brian. But I don't fully understand the part where you compare the relative expensiveness of equity with the cost of debt and cash. You used the reciprocal of the P/E multiple, aka. the earnings yield. From what I know, the cost of equity is not exactly the same as the earnings yield. So would you mind explaining the rationale of using the earnings yield instead of the cost of equity? Much appreciated.

[@financialmodeling]

You can calculate the Cost of Equity in different ways. That is why no one agrees on exactly how to do it. In the context of valuation, you normally use the risk-free rate + beta * equity risk premium (or variations). But if you're measuring the Cost of Equity in the context of its EPS impact, 1 / (P/E Multiple) is the method. If you used the CAPM method here, it would not accurately predict the EPS impact.

[@arshakasriyan6562]

Would this work for acquisitions with financial institutions?

[@financialmodeling]

+A Asriyan Yes, but the difference is that most financial institutions deals (at least those involving commercial banks) rarely use cash - so deals are some mix of debt and stock. You can still use the same analysis, but for banks you also care about other metrics and analyses, such as how regulatory capital is affected and what the post-deal ownership is, if deposit divestitures will be required, etc.

[@arshakasriyan6562]

+Mergers & Inquisitions / Breaking Into Wall Street why don't bank deals use cash? Why would you use debt vs stock for funding an acquisition? This is for a case study and I want to make sure I get the theory behind it right.

[@financialmodeling]

+A Asriyan The full explanation is beyond the scope of our KZbin channel because these are intended to be short samples from our courses (please see the Bank Modeling course for more), but basically cash at banks often represents inter-bank holdings to/from other institutions and therefore can't be freely used on acquisitions. That's not always the case and there are times when banks use cash to make acquisitions, but debt and stock tend to be more common.

[@1MTrader1975]

where can i get this excel sheet please..!! thanks.

[@financialmodeling]

This one is not available.

[@hannachoi8792]

5:58 How do we know they have 50 million worth of cash?

[@financialmodeling]

"$59 million worth of cash." We know this because we have the seller's Balance Sheet, shown at 5:42, which shows $59 million of cash.

[@darshanm8068]

Please attach excel template sirrrrr

[@financialmodeling]

It's not available for this one, but there are many similar examples in the other M&A tutorials here.