Merger Model: Cash, Debt, and Stock Mix
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- Опубликовано: 20 окт 2014
- In this merger model lesson, you'll learn how a company might decide what mix of cash, debt, and stock it might use to fund...
By breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers"
... might use to fund a merger or an acquisition - and you'll understand how to determine the appropriate amount of each one in a deal.
2:24 General Order of Funding for M&A Deals
4:49 Cash - How Much Can You Use?
9:56 Debt - How Much Can You Use?
14:08 Stock - How Much Can You Use?
16:32 Exceptions
18:03 Recap and Summary
How Do You Determine the Cash / Stock / Debt Mix in an M&A Deal?
Very common interview question, and you also need to know it for what you do on the job.
3 ways to fund a company, and to fund acquisitions of other companies: use cash on-hand, borrow the money from other entities (debt), or issue equity (stock) to new investors.
But how does a buyer in an M&A deal decide whether it should use…
50% debt and 50% stock vs.
33% debt, 33% stock, and 33% cash vs.
50% cash and 50% debt vs….
And the list goes on.
Easiest: Think about the "cost" of each method, start with the cheapest method, use the most of THAT method that you can, and then move to the next cheapest method, and continue like that.
GENERALLY:
Cheapest: Cash, since interest rates on cash are lower than interest rates on debt, and tend to be low in general.
Next Cheapest: Debt, since it is still cheaper than equity and since interest paid on debt is tax-deductible.
Most Expensive: Stock, since the Cost of Equity tends to exceed the Cost of Debt… in theory and in practice.
To Compare Them: Look at the "After-Tax Yields"… for debt and cash, just take the Interest Rate and multiply by (1 - Buyer's Tax Rate).
Stock: Take the buyer's Net Income and divide by its Equity Value (or "flip" its P / E multiple).
SO: Always start with cash, use the most you can, then move to debt, use the most you can, and finish up with stock.
Cash - How Much is "The Most You Can?"
Easy: Company has minimal cash and can't use anything, or it has a huge cash balance and can use all of it.
More Common Case: Look at the company's "minimum" cash balance and use the excess cash above that to fund the deal.
EX: Company has $500 million in cash right now, but its minimum cash balance to keep operating is $200 million…
So it can use $300 million of its cash to fund the deal.
How to Determine: Can be tough, but sometimes companies disclose it…
...or you can look back at historical cash balances and make a guesstimate based on that (what was its lowest cash balance in past years?).
Debt - How Much Can You Use?
So let's say you've now used $300 million of cash to fund the deal… but it's a deal for $1 billion total.
How much debt can you use to fund the remainder? $700 million? $300 million? $500 million?
Easiest Method: Calculate the key credit stats and ratios for the combined company - for example:
Total Debt / EBITDA
Net Debt / EBITDA
EBITDA / Interest Expense
And see what amount of debt makes these look "reasonable", in line with historical figures and also figures for comparable companies.
EX: Let's say that if the company uses $500 million of debt, its Debt / EBITDA is 4x.
Historically, it has been around 2-3x, and no peer company is levered at more than 3.5x.
If that's the case, we'd say that 3.5x - 4.0x is probably the "maximum" (whatever amount of debt that means).
Here: We have the Debt / EBITDA and other ratios for the Men's Wearhouse / Jos. A. Bank peer companies.
Stock - Now What?
Often used as the "method of last resort" because:
A) It tends to be the most expensive method for most companies.
B) Most acquirers don't like giving up ownership and diluting existing shareholders unless absolutely necessary.
So in this example, if we've used $300 million of cash and $500 million of debt, we're still not quite at $1 billion... need an extra $200 million, which we can get by issuing stock.
of Shares = $200 million / Buyer's Share Price.
Technically, there's no real "limit," but it would be very odd for a company to give up more than, say, 50% ownership to another company… unless they're very close in size.
Exceptions:
Buyer has an exceptionally high P / E multiple (Amazon) - stock might be the cheapest!
Buyer wants to do a tax-free deal (Google / RUclips) and it's much bigger anyway, so won't make a difference.
Companies are similarly sized - stock might always be necessary because cash/debt are implausible (mergers of equals).
Summary
Which purchase method do you use?
MOST relevant when companies are closer in size… doesn't make much difference when the buyer is 100x or 1000x bigger than the seller.
Order:
1. Cash - Any excess cash above the company's minimum cash balance.
2. Debt - To the upper range of the Debt / EBITDA of comparables (and other metrics).
3. Stock - For any remaining funding that's required; ideally give up well under 50% ownership.
just when I needed it, sweet :)
Thanks for watching!
very intuitive . thanks.
Thanks for watching!
Merge models in this video vs financing for a project vs LBO, are there differences in those three scenarios
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.
Hi! Can I ask where can I get equity research reports (updated) ? such as those from JP morgan, Standard and poor, etc.
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.
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
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.
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
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.
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!!
@@marigeri993 I think you're over-thinking it. Companies cannot necessarily repay Debt earlier, for one thing, so this calculation isn't necessarily valid.
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.
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.
Cost of equity = yield = 1/(p/e) = net income / equity value 3:37
??? 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.
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?
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.
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?
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.
Thank you very much great work. I cant find excel spreadsheet to this file? Could you please attach? thank you great work again.
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).
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?
Because companies only have so much cash and can only raise so much debt, so past a certain level, stock is the only option.
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.
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.
Hi, can i have your excel spreadsheet ? :"> i am stuck with the assignment on merging AMP and Suncorp
Thank you
+Alexandra Le There are plenty of sample spreadsheets in the other lessons in this channel if you take a look...
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
+Alexandra Le We're happy to answer quick questions on RUclips, but we can't provide detailed help with homework assignments or tasks for clients if that's what you're looking for.
where can i get this excel sheet please..!! thanks.
This one is not available.
Can i used the PEG Ratio as a denominator instead of PE to calculate the cost of Stock
No, not recommended because PEG doesn't represent the cost of issuing new stock.
Would this work for acquisitions with financial institutions?
+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.
+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.
+A Asriyan The full explanation is beyond the scope of our RUclips 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.
5:58 How do we know they have 50 million worth of cash?
"$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.
They: So which department do you work in?
Me: Murders & Execution
s
They: Sorry?
Me: Mergers & Acquisitions
Please attach excel template sirrrrr
It's not available for this one, but there are many similar examples in the other M&A tutorials here.