This is a, um, a fun topic, an interesting topic, definitely one that, um, similar to last week, and we're just gonna scratch the surface of a lot of this stuff.

Um, but I'm happy to, um, you know, to, to answer any curiosities you might have or anything that's specific, you know, as well that, um, that, you know, that I don't, may maybe hit on here, um, because of my, my need to cover a lot of ground in a short period of time.

But we're gonna cover, uh, merger and acquisition analysis.

We're calling it m and a cash deal, just kind of one type of deal that we're gonna look at.

And we'll, we'll, uh, we'll talk about a few other types as well, just sort of generically.

Um, if you go over to the, um, to the, to the webpage, you can find the material there.

The, the workout empty is what we're gonna do.

That's on the, uh, December 6th, m and a cash deal section.

Uh, my colleague, Yolanda is with us as well.

This is the, um, 11th and next to last session.

We've got one more after this, which is really kind of a wrap up session.

And this is, um, um, the last sort of piece to the puzzle, uh, more or less, there's one tiny little thing that we didn't cover in, in our kind of valuation survey on precedent transactions, which I'm gonna cover a little bit next week.

So even though it says like it's a football field, the football field being just sort of the output table in a presentation that you will use to present.

In order for me to tie it up, I wanna talk a little bit about precedent, precedent transactions as well.

So that will kind of dovetail nicely with some of the stuff we talk about today, because I'm gonna talk about some of the different types of transactions that you can, you can execute in, um, you know, under the umbrella of m and a and that, that will, um, that will op, hopefully open up some, some, uh, questions that you might have or curiosities about how we, how we apply that assessment of, or, uh, kind of understanding of what type of deal it is to what impact it might have on the analysis itself, right? The enterprise value analysis or, um, however, you know, we're, we're looking at it.

So let me start.

Uh, I'm gonna, I'm going to share, and we'll go over to the good old whiteboard.

I'm gonna start just by asking, you know, we're, we're talking about, um, one company buying another company, one company buying another company.

What are some, some considerations that we need to understand, you know, what are the considerations when one company buys another company? Let's just talk about some very high level, uh, m and a stuff if we could, and let me get my, my chat open here.

Um, please feel free to just hop in and, um, and tell me, you know, they can be, you know, quantitative. Certainly that's where our focus is gonna be, but also potentially qualitative, uh, as well.

Uh, what are some m and a considerations when one company buys another company? What do we have to think about? Who wants to break the ice here? Who wants to break the ice? One company is buying another company.

Oh, so John, John gets right to kind of the heart of the matter.

Accretion dilution, accretion dilution.

Uh, so that would be, will there be any, uh, shareholder dilution? Will there be any shareholder dilution? So John, while I've got you on the, on the keyboard there, um, why might there be shareholder dilution in an m and a deal? So, shareholder dilution, just to, you know, uh, again, uh, refresher for anyone who's perhaps newer from this, maybe laterally in from another area, that's when the value of, of your, your share is actually decreased because of, uh, something, you know, either, um, uh, in terms of the, the, uh, shares increasing, uh, the, uh, the shares outstanding increasing or the earnings decreasing, right? So, um, that's what, that's what, uh, dilution is.

Um, so what might a, what might impact, um, and, uh, Maxwell as well has accretive or dilutive, what might impact for anybody either of those two, uh, folks who just jumped in on that, what might make a deal accretive or dilutive, what might make it, what would make a particular value per share go up or down purely as a result of the transaction, not as a result, obviously in post transaction trading, you know, value, because that would, um, you know, that's something different. We're talking really when we talk about, um, purchase price of the target, the purchase price of the target.

Yeah. So certainly, um, the, um, you know, the, the, the more we pay for a company is going to have an impact, uh, on, on that accretion, dilution, uh, factor, right? The price of the target.

And what we're really focusing on when we talk about accretion, dilution, I'll put accretion in here too. It shouldn't be all negative, but the accretion, the dilution is the one we really gotta be conservative.

This is, um, earnings per share is what we're talking about here.

So we don't really care too much about how the market, uh, at this point, how the market might respond to the deal. That's gonna impact a lot of stuff, don't get me wrong.

But we wanna make sure that we, we understand that, um, if I own a stock in the current earnings per share of that stock, um, you know, uh, is a dollar per share, um, what is going to change post deal, right? What is going to change post deal, um, and the price of the target is gonna be something that impacts this.

Um, primarily because, uh, we have to figure out, of course, how we're gonna pay for this transaction, right? How we're gonna pay for this transaction.

And that's kind of the focus really of some of the exercises here today is determining, um, when we pay for, when we set a price for a target, how does that flow through and impact this ction dilution? So how will we pay for the target now? What are ways that we can pay for the target? See if we can drill down on this a little bit more in terms of at least the dilution part of it. What are some ways that we can pay to acquire a company? One of them we covered last week, I think, uh, quite, quite, uh, extensively.

So John, again, thank you.

Um, we can, we can, um, pay with, uh, cash the old fashioned way we can pay with debt, which is kind of the LBO way, right? Although not every debt transaction has to be, uh, has to be financed with debt.

Or we can pay with equity and we can pay with equity really two different ways.

We can do, um, uh, you know, kind of a, a simple raise equity financing in the market, and then use that cash to effectively, you know, pay for the target.

That's the simple way.

And that's not done, you know, as much, uh, certainly, um, in the era of cheap debt, um, in the era of cheap debt, you don't need to, um, to, uh, raise equity financing, which is a lot more expensive. Yeah. Sorry, uh, max, I'm, my q and A screen got cut off, so it didn't look like that there were any more answers there.

Now I've pulled it up into the top of the monitor and I can see, I can see you there.

So, um, so, uh, Maxwell also commented on the, on the use of, uh, of, of shares here as well.

So cash is the old fashioned way.

Debt of course, is kind of the more common way, uh, certainly in the LBO world.

Uh, although when we pay with debt, what are we really doing, right? We're really just kind of raising financing to, to take the cash and pay the target owners with, right? So that technically is also cash.

And then equity financing, it can go two ways, right? So with equity, we can raise new capital that would be similar to raising new debt capital and pay in cash, or we can trade shares, trade share values.

And that would be, uh, a little bit different because here we're actually, we're actually not, uh, taking them and taking cash and giving it to them.

We are actually giving them shares in the proforma company going forward now.

So these are the three options.

Now, why might you choose one or the other? Why might a company choose cash or a combination of cash and debt or equity? What are some, um, some things that would factor into the corporate finance team's and the investment bankers analysis of that formula? Let's start first with cash.

What happens when, uh, if we decide we're gonna pay for something entirely with cash? What are some things we need to consider there? I, yeah, John has said, uh, post deal cash on the balance sheet.

So how much cash do you have and how much do you need post deal to continue to run the company? So this might be something that would be, so if a very large company we're acquiring a smaller company, it might be possible to do all cash deals.

You certainly hear a lot of all cash deals come up, you know, they're probably the most common in a sense if it's big company buying a small company.

But we need to consider, uh, cash available and cash needed.

So that's, that's kind of what we need for cash on the balance sheet. And what about debt? What might you need to consider for debt? Let's say we've used all the available cash we have, we're buying a larger target, and we can't just empty the coffers.

What might we need to consider with debt? Alright, Maxwell, I'm on you this time.

I see you pop up over there.

If the company believes the values of shares will go up, they will pay with cash.

So let me think about this for a minute. If the company believes that the value of the shares will go up, they would pay with cash.

Now I'm trying to think how that rationale value you're thinking of the value of the target shares or the value of the shares post, post comp, uh, post transaction.

Definitely we would definitely consider the, the, the current cost of, uh, of, uh, of capital.

Yeah. So lemme let, let me first focus on that Max, and then we'll come back to the next point.

'cause I think it might actually play more in with the equity piece.

Um, I guess it also depends on how you are looking at this deal from the target's perspective or the acquirer's perspective. So let me just deal with the debt, this, um, cost of debt.

So first of all, um, you know, is, is debt, you know, cheap or is it more expensive? Um, so if it's expensive, of course that's gonna make you think twice.

Now, um, our other Max has pointed out, uh, debt capacity, and that's a very big one.

Um, because what we've gotta think about here is how much debt can a company take on, let's say, let's say we're going to go back five years and the cost of debt is very, very inexpensive.

Um, you still can't just lever up the wazoo because you're, you're going to trip either covenants in your existing debt facilities, or even if a company doesn't have any debt, you might actually trigger, uh, you know, a credit rating situation where you're gonna get notched down or downgraded potentially.

So we gotta be careful of that.

So, um, with debt, we've gotta consider the cost of capital as, as, um, Maxwell has said. And then as Max said, we've gotta look at our debt capacity.

How much debt can a company take on without, uh, you know, either either going sub investment grade or just losing a credit rating or something that a lot of analysts don't consider? What is the company comfortable with? Because a lot of companies, uh, that are, that are not in the levered category, aren't comfortable with a lot of debt and don't, don't want that, uh, that burden.

So cost of capital and debt capacity.

Okay, so now I want to talk about the last one, which I think might come back to what, what Maxwell what you were talking about earlier, which is when, um, you know, what are we gonna think about specifically with the equity? What are the implications of equity? When would we choose one versus another? Choosing equity versus not choosing equity.

Now, I maybe, uh, just to let, let Maxwell off the hook here for a second.

Um, or, or sort of to honor his first comment.

Um, if you were gonna receive his compensation shares of a, of a company that was buying you out and, and you obviously felt that the company post transaction, you were bullish on it, uh, you would have, you know, what they call skin in the game if you would take the shares.

So someone's paying me for my company in shares, and I am now an owner of that pro forma post-transaction company.

So if I believe it's a really good deal, and, and hopefully, you know, you know, hopefully it is, uh, not just in terms of the valuation for the exit, but for the company going forward.

You know, if I, if I feel I pulled one over on the buyer, I might just wanna, I might just wanna skid addle, right? But, um, but, but you know, generally that's not the case.

And I could tell you some very sad stories about, about this.

Um, if we have time at the end, I, I might.

But, um, if you believed, and I think what I'm gonna do from, from Maxwell's comment there at the top of the q and a, if the target company believes the values of the shares will go up, then they would be certainly open to receiving shares.

And certainly if, uh, you know, if, if the, if the, uh, acquiring company, you know, is obviously they're gonna, they're gonna be bullish on the post deal company, they're gonna want to push that if they want, you know, if, if, if they want to pay in shares.

So that's certainly something that we would consider.

Now, why also might the acquiring company want to pay with equity? Why might they want to pay with equity? Why would a why would an acquirer want to pay with equity, uh, now assuming, uh, you know, assuming that that, that, you know, maybe can't pay with cash and don't want to pay with debt, or they can only pay so much with raise so much debt under their current facility.

Um, what makes for a robust m and a market, what makes for a robust m and a market, uh, availability of capital is certainly, you know, one that we've talked about, but what, uh, what else makes for a robust m and a market? Any thoughts on that? Oh, max tax law.

Oh, max, don't make me go into tax law, please.

Uh, certainly there are changes in tax laws that can impact.

There haven't been really, I can't think of.

I mean, there were some that were, that were changing when I was an analyst that really impacted analyst associates that really impacted m and a.

I used to sit outside the, for some reason, they stuck the m and a tax guys on the, in the area where I was and let left. And there was just, 'cause we, they were, they were just kind of reorging and didn't know where to put 'em.

Um, so the two tax m and a tax experts, they were probably tax lawyers, um, were right, kind of, they had the offices near where my cube was, and I used to, it was just a stream of m and a people m in there all day.

And I knew because, you know, a lot of that would end up in, in, in l fin eventually if there was a significant, you know, piece of debt to raise.

So I could always tell sort of how late my night was gonna be if, if the line outside, uh, that, that office got really long.

Um, but, uh, there hasn't been a ton lately that I can think of that that would, um, I mean there, I mean, not big ones. There's always little ones. Uh, I'm gonna talk a tiny bit, um, max about some of the, some of the kind of overall implications, uh, tax implications of doing an m and m and a deal in a second.

Uh, the o our, uh, my other Maxwell here, um, says, uh, purchasing with equity acquires the, um, uh, allows the acquirer to be more flexible.

So flexible meaning that you've still got cash and, and debt capacity to do deals.

I I assume you, you're saying that you're, you're, you're basically, um, keeping the balance sheet, the rest of the balance sheet open, and that certainly is, is true.

Uh, but don't forget that equity is, you know, from a cost of capital perspective, regardless of where the rates are, always the more expensive one.

So what happens is, is that, um, uh, uh, we're going to go through the analysis of this.

Uh, in our problem. What happens is, is that stocks of, of companies, um, when we're thinking about paying with equity can be thought of as currencies.

And when one company's stock is very valuable, that means that it's, it's, you know, trading very high.

When a company's stock is trading very high, it's very valuable, particularly relative to others, right? So we would look at things like PE ratio and whatnot.

That's like having a very, very strong currency.

That's just like having strong dollars and trying to, you know, buy up, you know, another non-US currency, right? So the stronger your currency is, generally the more you can buy of another currency.

So when the market is writing high, we, we, we tend to see a lot of m and a activity.

Now, obviously, that also can imply when a market is, uh, equity market's riding high, that the targets are riding high as well, but not everything moves at the same kind of level, right? So if one company has got very, very valuable equity, that is impetus to use equity as a takeover currency, and we'll, we'll, we'll go through the math of that, um, momentarily, but that's just kind of the overall, um, okay, so target seller would want to, um, uh, share, and then the acquirer will use equity if the, uh, value of their equity is high.

So we can actually just think of like a little tiny example here. Very quickly, I'll just kind of, I'll go over to, uh, um, the workout and just kind of do it off to the side over here, just so we can see what, what I mean.

So, um, let's just say that we're looking at a company that the, the, the, the, and the value of the company that we're buying, just call it the enterprise value, is a thousand.

And if we're, if we're thinking about, about, um, buying that company with equity, uh, just think about, let's say in, in the current market, the, uh, there's, uh, the, the target has, you know, um, let's say the, the share price is, uh, a hundred share price is 100, just two share price of the tar of the, uh, acquirer share price is 100.

So how, how many shares would have to be issued to acquire that $1,000 target? I'm gonna make this target ev Well, obviously we would just think about the, the number that we have to get to and then divide by that, by that, uh, share price.

And that tells us in effect, you know, how, how many shares would have to be used to acquire that target.

So this is like scenario one.

So let's look at scenario two, and let's just say that it's a slightly cooler market.

Now I'm gonna say it's cooler for the acquirer. Maybe the value of the targets are, you know, there's a lot of competition for the targets, right? And let's just say now that the, um, the acquirer's share price is now 80.

So now how many shares does the acquirer have to issue? They have to issue 12.5.

So this becomes, in effect, a more expensive transaction for the acquirer because the value of their share price is lower in scenario two.

And that means that they have to then kind of give more of their shares to, um, to, uh, uh, complete the transaction.

Now, now this kind of raises sort of brings us back full circle to the original kind of point of discussion, which is what causes dilution in a deal? Well, what causes dilution in a deal is this type of thing right here.

Whereas you are issuing equity to pay for a company, you are, you know, if you think about what EPS is, right? EPS go back to my whiteboard. EPS is, is the earnings over the shares.

So if we just did, did a deal where we had to issue 10 more shares, as I showed here, what we've done is we've effectively increased the denominator.

And if the share price, if our share price is, is depressed in the market, that means that our currency is depressed in the market.

If we have to use that equity to buy a target, that means that the, the number of shares we have to issue is, has gone up.

And that's gonna be even more dilution.

So anything that increases shares can cause dilution.

Now, the denominator is fighting against the numerator.

The denominator is fighting against the numerator.

Because if we're just talking about a company that's got, let's just say, you know, a hundred dollars of earnings and, um, 10 shares, we've got $10 per share, right? That's the existing company.

If I just go ahead and add shares to the bottom, I'm gonna dilute the owner's EPS.

If I make that 20, my EPS just dropped to five, I've diluted the ownership.

But what am I getting when I acquire a company? What am I buying? What am I buying? Hopefully positive cash flows and earnings, hopefully true.

So now, um, my earnings can possibly increase as a result of the deal.

I dunno what happened in my pen here outta ink.

Increased earnings can fight that dilution.

And then obviously, decreased earnings through a loss, if you're acquiring a loss making company, would obviously have an impact, uh, as well.

Um, typically we normalize these earnings and we're using what we call forward earnings.

So hopefully you're not buying, you know, a company that's got a, you know, a lot of, uh, losses, although that that is a strategy sometimes, um, or, you know, you're buying a company that's still kind of early, you know, early in its, um, um, lifecycle where it is generating losses, that's totally possible.

So the increase of the earnings will, will fight against that dilution. And the decrease of earnings would, of course add to dilution.

Um, and that's kind of, sort of the battle here with accretion dilution is how fast can you make the numerator increase relative to the denominator? Relative to the denominator.

Um, let's think for a moment about, um, what's happening to, um, uh, a company's, uh, a company's earnings as they go through an acquisition.

And this kind of falls under my original question of what are some things that have to be considered, um, what are the changes to earnings? So we kind of did a little bit on the denominator, which was the, the equity part of it, whether we're using equity or not equity, if we're using shares, we're obviously changing that denominator, but what about the numerator? What, what could change the numerator? So I'm gonna put this here.

Uh, we've already talked about obviously the, the base earnings of the company that we're acquiring, right? So their net income per share on a base level is what we're buying.

Hopefully it's positive, but I'm just gonna put that in here as targets.

Earnings being the first kind of, uh, thing to consider.

What, what else might, might we consider here? What, what are, what, what are things that could impact the numerator here in a deal? Things that we would consider when doing an m and a transaction? All answers are good answers.

If you haven't, if you haven't, uh, haven't suggested anything, haven't chimed in, please feel free to do that.

Max saying revenue or, um, potential synergies, revenue or other kinds of increases.

So certainly when you buy a company, you're hoping that there're going to be, there's going to be growth synergies, either in revenues or earnings.

Very true. And we have to, we have to consider that, because again, if you can, if the more you can, you can punch up that numerator relative to any changes in the, in the denominator, you're fighting that dilution.

Um, and the thing you don't wanna bring back to the board of directors is that you're doing a massively dilutive deal to existing shareholders.

'cause why would they want to do that, right? Why would you want to go to shareholders and say, you know, you're getting diluted by a significant percentage here to do this deal. They're gonna say, well, when, when are we gonna make that back? So you gotta figure out ways to fight that change.

And one of them is through the selling of these synergies.

Okay, what else? What else could be a part of this? What else would be a part of this? Shelby? Great.

So cost synergies is definitely one that we would consider.

So that kind of, you know, you always start out like thinking about the revenue and the growth synergies, the earning synergies, but honestly, they're very hard to kind of really sell at this point. They used to be easier to sell.

Everything was a, you know, was a synergy, revenue synergy or an earnings synergy, you know, but, but ultimately the ones that are really easy to sell are when you can say, look, this is gonna increase, you know, cost efficiency.

We're gonna be able to, you know, shut down some redundant plants, uh, things like that.

So cost synergies are going to impact the earnings in a positive way as well.

Now, along with that, there can be some, some, um, something related to cost synergies, which, which aren't as helpful.

And what, what might that be? Kind kind of related to cost synergies, but really kind of on the, on the flip side that results from a transaction.

Yeah, Aaron, fantastic integration costs.

So as, as, um, helpful as it might be to, you know, to shutter a bunch of plants and to close down offices or redundancies in staff, executive staff, the problem is, is that those do have more near term costs in many cases, because you've gotta actually, um, you've gotta pay people severance. You've gotta, you've gotta, sometimes, you know, uh, if they're assets that can be sold, great, but sometimes you've gotta, you know, physically close things down and that can, that can, you know, the unwinding of assets can cost.

So, uh, on the negative side here, we're gonna do integration, uh, m and a, we would call like m and a severance style costs.

I'm putting 'em in parentheses.

Um, I'll take the parentheses off here to be consistent.

Um, integration and severance costs, 'cause those are gonna work against you.

Okay, fantastic.

What else could work against our, our earnings or, or what else could work in favor of our earnings? If you think, if you can think of anything, I think probably just sort of exhausted most of the, um, Shelby cannibalization.

Oh, that, that totally could, um, cannibalizing existing sales. That's, that's a good one. I mean, hopefully, you know, that would come out in the wash up here, but I'm gonna put that in parentheses up here too.

Cannibalization, um, hopefully you can kind of over override that with some cost savings, but certainly that could impact it.

Uh, Aaron, excellent transactions and financing costs.

So here we're talking about, um, talking about all that debt that we got, you know, hopefully for dirt cheap.

Well, that's gonna, that's going to, you know, appear on the income statement as a new cost that we didn't have before because it's debt supporting, you know, new assets that are on the books.

So we have to have the increased financing cost, and there will al also be transaction costs.

Now, a lot of the transaction costs, um, actually don't flow through the income statement. If you're talking about like, advisory stuff, advisory fees, they, they're gonna come right outta retained earnings, but they're the, um, the cost of issuing debt or issuing equity, um, not equity.

Actually equity comes out of the retained earnings as well, but the cost of issuing debt will hit the balance, uh, sorry, the income statement as a, as a negative, negatively impacting item.

So I'm also gonna put, this is gonna be interest and debt fees.

And the last one, I think probably that, um, the last one I think that, that we, um, often overlook That's sort of related to that, sort of related to the increased in financing costs.

I'm wondering if Erin, since she, um, seems to have a handle on, um, on this side of the coin, wondering if there's another related, potentially negative, negatively impacting item.

Now, I'll give you a little bit of a hint. Let's think back to an all cash deal.

What, what, what could an all cash deal, how would that impact the income statement? There would be no interest.

Aaron's got it. Saw a hand go up, Um, hed hedging no hedging costs.

Hedging costs, yeah, probably there might be some added hedging costs to, um, there might be some hedging, uh, transaction.

He hedging costs as well.

Um, sometimes they, they put, um, collars on the, on, on the, on, on the equity to lock in the price from moving around if you're gonna pay with stock.

It's kind of an advanced thing.

I was thinking actually a little bit, a little bit easier than that.

Um, I was thinking about the, the loss of, of, um, interest income or financial income from any of the cash.

Uh, the, you know, the, either the liquidation of the marketable securities or the ca the, the interest bearing cash, usually pretty small, but, you know, any good analysis would kind of have that in there as well.

So I'll put in here, decreased, um, interest income, financial income.

Okay. So that's kind of, um, you know, in a nutshell what's going to be, you know, underlying the analysis here, this kind of accretion dilution analysis. So what I, what I wanna do now, just to get it off of, off of the whiteboard and off of the, uh, off of the chat and kind of into the numbers, is let's just kind of look at, um, you know, a, a a couple of warmup problems just to sort of get us to understand sort of what's going on here.

Um, and then, um, and, and then we'll do sort of a, a, a mockup of an accretion dilution analysis itself.

So I'm gonna flip over to the workout.

Um, let me also just stop here and, and ask, are there any questions on what we've talked about so far, um, on these kind of considerations that we're thinking about here in doing an m and a deal? And, you know, a lot of, um, you know, a lot of the, the stuff that we've talked about are the things that you would consider, you know, in an m and a deal.

Um, meaning, you know, are are there integration costs? Are there synergies? Uh, how should we pay for this, right? Um, what are the costs of capital? What's our, how, how, how valuable is our currency right now? These are all things that we would, we would, you know, be considering when we think about doing, uh, an m and a deal.

So, on the workout tab, if you would go over to the first tab, I just wanna do some, uh, just kind of some, some warmup here just to think about, you know, sort of what's, you know, what's happening when we, when we, when we go to buy a company.

And, and this is just more of a review at this point, because I don't, you know, some of this stuff we talked about many weeks ago, or maybe some of you didn't see it, maybe you skipped it 'cause you've already know it, you already know it.

But it would be kind of a good sort of review of how we get into a deal.

So this just says, calculate the equity purchase price for froger.

And these are the assumptions. We've got a current share price of $34 and 15 cents.

Uh, I don't know if it's dollars or not, but I said dollars.

Um, the next bit we're given here is the offer premium.

So the offer premium is what we have to go to the shareholders or the board of directors of the other company with, and present to them as why you should do the deal, which is to say, we're offering you 25% over your current share price.

And, and that's, you know, uh, an assumption that you'll obviously play around with a lot, but that's going to drive up, obviously, the value of the deal.

H how much, how much above that you need to go, or perhaps maybe if you can get it for less, um, shares outstanding, that's of the target.

Um, we're also given, uh, weighted average shares outstanding also for the target.

We're given the options outstanding, the option strike price and the restricted units outstanding.

So this is just a quick little review of that, uh, treasury stock method that, um, that, you know, that we did when we were talking about early stage valuation stuff.

Um, uh, now it's sort of being introduced here, kind of a more applied, um, contextual way.

So what is it gonna cost us? What do we have to come up with to buy this company? This is why we need to think about this on a fully diluted basis.

So the first thing we've got here is we've got a choice between basic shares and weighted average shares.

Um, the basic shares, uh, I'm gonna assume are the, are the, uh, shares outstanding from the front of the 10 K or 10 q.

Most recent weighted average shares, uh, are also as of the most recent 10 q, which are we gonna use? Anybody remember, what are we gonna use for figuring out the purchase price, equity, purchase price of the target basic shares, outstanding or weighted average shares, who remembers Basic shares? Then dilute says Shelby.

Um, show of hands for Shelby.

Shelby, I think, I think they're all behind you.

I can feel it. I can feel the hands going up.

So yeah, we're gonna use the basic shares. The basic shares, um, are what we want, the weighted shares we're going to use for earnings.

So this is an income statement item.

The basic shares tell us kind of what are the shares outstanding currently that are supporting the equity on the balance sheet.

And this is, um, remember, as I've said a few times over the course of these sessions, the valuation is a balance sheet exercise.

So we want the basic shares because they are supporting the equity on the balance sheet. I'll just write that over here. Supporting equity on balance sheet.

Okay? Now, uh, we have to adjust, and the way we're gonna adjust is we're gonna use the, uh, the treasury stock method.

Treasury stock method says we're gonna take the market price minus the strike price, divide that by the market price, and then we're gonna multiply that times the options.

So the dilution from the options is going to be equal to what's the market price here? Shelby, I'm gonna come back to you on this.

What's the market price here that we're gonna use? Aha, the current share price? Well, that's the trap, Shelby.

The current share price is the trap.

And the reason why the current share price is the trap is because if you think about this, if you're an option holder, Shelby, if you have, if you're an option holder in this company, when this deal gets done, let's just say you have options at 36 bucks a share to, to exercise.

If we were going purely by the current share price of $34 per share, you would, you would not count your options because they would be, quote unquote, out of the money.

They would be higher than the share price, the actual share price.

However, this deal is getting done at 34 15 plus 20%.

So I'm gonna actually calculate the, what we call the acquisition equity price, or the acquisition share price.

And that's gonna be what we have to use to do our m and a math, the acquisition equity price, because that factors in what the deal is gonna be consummated at, and that's gonna unleash potentially a whole other bunch of shares that were locked up in options that are now in the money.

Does that make sense? Does that sound good? So I'm gonna take the current share price times one plus the offer premium, and that's gonna get me to an offer price of 42.7.

So, Shelby, good news, your options at 36 are now in the money.

Are now in the money. So I'm gonna take the 42.7, I'm gonna subtract the strike price, which is on average 37.25.

I'm going to divide by the market price of 42.7, and that's effectively gonna give me the, um, uh, the, the amount, uh, what's, what, what I call it, the, the dilution factor.

This is gonna gimme the dilution factor, which is 0.12. And now I have to apply that times the actual options outstanding, which is the two 20.

And that means that basically I'm gonna have to issue, um, 28 more shares to cover all these 220 options.

So again, just to re reword this from the teaching a few weeks ago, I can almost, with the cash I get from people like Shelby who own the options, they're gonna, they have to buy them for me at their strike price.

Strike price is pretty high relative to this, to the acquisition price.

So I'm getting a lot of cash.

Me being the company, I'm getting a lot of cash from the option holders when they buy out their options.

Now I have to give them shares.

Well, I take this chunk of cash, I go into the market and I buy the shares on the open market.

Why do I do that? Because when I buy shares on the open market that are already trading, there's no dilution.

I just, I'm on E-Trade, I'm on Charles Schwab broker.

I call up my, I, there's no dilution there.

The company has nothing to do with that.

There's no new equity being raised, et cetera.

It's just already existing shares.

Now, the problem is, is I don't quite have enough because of the difference between these two share prices, which is the, that little bit that I'm missing.

Now I'm outta cash. So what I have to do is I have to actually issue new shares out of quote unquote treasury.

When I issue shares out of treasury that have been locked up, that increases the float of shares outstanding.

Anytime shares outstanding goes up, and earnings don't change, I get diluted.

So that 28 is what's diluting the shares outstanding right now, or the earnings per share right now, I should say.

Now, um, I'm gonna take the, um, oh, I've got, I've got some restricted stock units.

Those are nice and easy because restricted stock units basically have a zero strike price. They're very protected.

So every stock unit kind of transfers into shares at one for one.

So there's massive dilution from RSUs because they're, they're, you don't get any cash from, from the holder of the RSU. Those are typically very, very high level managers, right? So now I get, um, 1000 plus 28 plus 100, and I get the new shares outstanding of 1128.

And then that's gonna give me my, uh, equity purchase price of the 1128 times the offer price.

And that's how much equity I need to buy out from the target shareholders.

Any questions on that? It's just a little bit of a warmup here so that I'm not, um, doing it entirely new once we get into the problem.

Everyone good with that? So again, this offer price is sometimes called the acquisition share price.

Alright, cool. Um, there's another one here.

I don't think we need to, let me see.

I thought I had marked another one here.

Um, I think, let me see.

Equity of Nord Strain acquired for 2000, acquired 30% equity to complete the today. All right, let's just try this one again, another little warmup.

Um, before we get into the, to the accretion dilution math.

So workout five here, um, is gonna kind of take the next step.

And the next step in this is, is what we would call kind of a, you know, sources and uses.

That's just gonna map out how we, how we plan to pay for the transaction and, and what exactly we're getting in exchange for that.

Um, so again, I think we went over sources and uses in the, in the, uh, private equity analysis last week.

But, but really it starts with the uses.

We wanna figure out what we're buying first.

So my uses of funds here, uh, in this case are, is gonna be the equity purchase price, are now the uses of funds can also potentially include any, any debt that's being refinanced. And we'll, we'll see that in the more comprehensive problem in a moment.

But for right now, um, all we have to do is, um, bring in the 2000 for Nordstrom's equity, nor not Nordstrom, Nord Strand, Nordstrom's actually in the news. Anybody know why? Anybody know why Nordstrom is in the m and a news? Anyone seen it? Anyone see the, um, glare on my screen here? Anyone see any news on Nordstrom? The, the Clothier clothing company? No.

Well, they had, um, they were in talks with, uh, to buy Neiman Marcus, actually.

Um, and, uh, they, they couldn't work it out.

So it's not, not happening as of right now, but, um, but that's, uh, just kind of a coincidence there.

So my total uses here is gonna be the 2000. Now how are we paying for this? Okay, so I've gotta come up with the 2000. Now we're saying here that we're, we're using 30% of equity financing to complete the transaction.

So again, you know, for right now, we're not really getting into shares and all that kind of stuff.

I'm just gonna assume that the, you know, the equity, you know, is, um, uh, it, it doesn't really matter. We can, we can assume the equity is being raised as cash, or we can assume that the equity is actually being transferred to the seller.

It doesn't really matter 'cause we're not getting into the details of it, but the equity financing is gonna be the 30% 0.3 times the equity purchase price.

And that means that we've got a, a funding gap of, um, of 2000 less than 600, which we're gonna have to raise with debt.

So I'm just gonna take the 2000 here and subtract the 600, and that gives me my debt financing.

Now, typically, you know, again, on the OBO side, we start with debt first and then figure out the equity last.

Um, a lot of times in traditional m and a analysis, you know, investment grade m and a analysis, we actually start with the equity.

And again, the reason is, is 'cause we, you know, we, we kind of want to figure out how much dilution we're, we're willing to accept here.

How much dilution are we willing to accept? So, uh, to me that kind of pushes us into that question of how much dilution are we willing to accept, pushes us into the, uh, more comprehensive problems, which are, which are on the next couple of tabs, the m and a cash deal, um, uh, one and two. Now, we're probably only gonna have time to do one of these.

Um, so I'm gonna do one and two are almost identical, so I'm going to get through one, and then I'm gonna allow you to kind of complete two on your own, the m and a stock deal.

I don't think we're gonna have time to do, um, but it's possible.

So I will leave that, um, you know, kind of for, uh, the time being.

And if we have time at the end, I'll, I'll try and get through it.

Uh, quick pause for the cause.

Any, uh, any questions on anything we talked about, any curiosities about m and a that we haven't discussed so far that you'd like to kind of check in on before we, um, before we move on to the math or the maths as my colleagues say? No.

Okay, so, um, let me just, uh, gimme a second here to adjust my, my, uh, blinds to keep some That lovely la sunshine.

Sometimes it's just too relentless having a, having a particularly beautiful day here.

Okay, let me just blow this up a tiny bit.

Anybody working in, in, in, in m and a or an m and a related area? Just curious or see, see m and a, any, any kind of m and a transactions in your area? All? Okay, so let's look at this. We've got an acquirer and a target.

Um, we've got some information about all the kind of stuff we've already looked at.

Um, there's a, um, some balance sheet information as well, uh, that we're gonna have to figure out, you know, for the, um, you know, for the, uh, sources and uses.

And then we've also got, uh, kind of a rehash of the, um, of, of the option stuff as well.

So the first thing, you know, we can see here is that, um, uh, Looks like we're doing a deal, uh, for, uh, a company that, um, is gonna be paid for with some combination of, of, of kind of cash debt, um, and, uh, and, and, and equity.

Now, I, I, I should say right off the bat, it, it, it can be a little bit, um, a little bit confusing, maybe misleading.

We're talking about doing sort of, you know, all cash deals or cash deals, and yet we're still introducing the concept of equity here.

Um, I I really just wanna show, uh, what would happen if equity were raised to do the deal.

Um, I'm not gonna do any of the, any of the analysis for, um, uh, uh, kind of share exchanges.

That's kind of a different type of transaction.

Uh, I really just wanna show you sort of the impact on accretion dilution when equity is issued, uh, whether they hand cash to the sellers or whether they hand actual shares.

That's actually more of a tax, uh, issue as, uh, as I think Max was poking around at a little bit earlier.

And I do wanna talk about those maybe kind of as a wrap up at the end.

But for right now, it's really, it's really not necessary to understand that.

We really just want to understand the, um, you know, the, uh, you know, the kind of the, the, the math behind what makes something accretive or dilutive. Okay? So we've got some cash, we've got some debt, we've got some equity.

We're gonna just, you know, see the impact. Okay? So the first thing I'm gonna do is I'm gonna calculate my acquisition share price, and that's gonna be, uh, the $4 per share times, uh, one plus the premium.

Now, what, what sets the premium? Well, the premium is, is really, you know, where all the work is done on the, you know, by, you know, by the advisory team on the acquirer side is figuring out what is that right price that, that, um, they, they think that the board will accept, um, the shareholders will accept.

Um, and also, um, you know, keeps the, the acquisition price down.

So that's hopefully coming out of some of the, some of the work that we've spent the last few weeks doing Now, um, I'll talk a little bit more about that at the end.

And then next week, because we, we haven't really talked about, you know, how to set that premium, you know, o over, you know, the, the, the current price we haven't, that's, that hasn't been really in our, in our valuation, um, uh, to date. So I'll talk a little bit about that, uh, in more detail later.

Um, now let's figure out what that means in terms of an equity purchase price.

So the, uh, diluted shares outstanding, we need to do that, that calculation again.

So now we can just kind of do it really quick, right? We can just do again, the, um, market price is now replaced by the acquisition share price, minus the strike price.

Strike price is lower than, so we know just looking at it that it's in the money, right? I could wrap this in a, in a formula so that it never goes to zero, that would be the right way to model it, but I'm just gonna do it quickly this way.

Um, divide it by the acquisition price and then multiply by the options outstanding.

Then my dilution amounts to $2 per, uh, excuse me, two shares as my, um, formula text runs away from me.

Uh, we get an, an additional two shares or 2 million shares, or whatever the denomination is that we have to factor in for the acquisition total.

So 31 plus the two, and that's gonna give us 33 total shares.

Now, you'll notice on the left, I've only got the acquirer's diluted shares, as I think I mentioned probably when we covered this stuff.

You'll almost never, ever, ever look at a basic shares number, a basic shares, EPS or, you know, a basic shares.

There's, there is no basic shares valuation number.

It's all on a diluted basis.

So, um, I'm not even showing that calculation on the acquirer side.

We're only gonna look at the acquirer's EPS when we get to it on a fully diluted basis.

Okay? So what's the market cap? Well, I'm gonna do the market cap of both here just because I'm here.

Um, that's gonna be, uh, in this case, the 1 32 0.2 for the target, that's effectively telling me what the acquisition equity price is, right? The acquisition equity price here, um, is, oh, wait a minute, I'm sorry.

Did I do that right? Yeah, that's the existing market cap.

And then this is the acquisition equity value, which is gonna be the five times, the 33, and then that's the, uh, acquisition equity value.

So that's a little bit misleading. We don't do a lot with, um, you know, the actual market cap except to maybe, again, just show, you know, that that premium, you know, in, in whole numbers, not, not on a per share basis.

Okay? So the, the next thing we have to do is start getting, you know, kind of, um, a sense here of what the valuation adjustments are.

Now, in this case, the acquisition enterprise value is going to be impacted by some, a couple of items that have come up in the, um, in the course of the analysis.

Now, the, the, the existing debt, we already know that's always a part of ev.

So the market cap plus the net debt is gonna give us an enterprise value. We've also found that there's a 20, uh, whatever denomination of pension deficit adjustment.

So the de the deficit is underfunded, and we need to make sure that it's actually funded properly to figure out kind of what the true value of the company is.

That's a stakeholder.

That's that, that's, you know, gotta be there for the analysis because it's, it's currently, uh, off balance sheet, so to speak, right? So I'm gonna take the 1 65 of the acquisition equity value, I'm gonna add the debt, I'm gonna add the pension, and that's gonna give me an acquisition ev of 2 25.

Now lastly, I've got this working capital adjustment here.

What's the working capital adjustment? Well, um, basically what we found is that, again, through the due diligence, that there's, uh, kind of a, a, a need, uh, for an additional, uh, 10 of, of, of funding.

Um, perhaps it was some inventory that was wasn't valued properly, or some receivables that, that, you know, aren't collectible or something, something of that nature.

So that's what the working capital adjustment is, and we'll, we'll see that play out, uh, once we get into the sources and uses.

Okay? So we kind of get, have a sense now what of what it's gonna cost us.

Let's, um, let's go down and fill out the sources and uses of funds.

So my acquisition equity value here is, that's gonna be what we calculated above for the 1 65.

Uh, the net debt is the 40.

And, and here we're thinking about net debt because we're gonna refinance it, right? We're gonna have to basically buy out the existing obligations and roll them into new obligations.

Now, do we have to do that? Well, I mean, in theory, no, it's just, it's just debt being rolled into debt.

Uh, the, the issue is, is that, you know, from a legal perspective, you know, you've got, um, you've got a whole bunch of credit agreements and loan agreements or bond agreements that are for one company that doesn't exist anymore.

So they kind of need to be made whole, there's just no legal borrowing entity anymore.

So we have to, we have to refinance them, swap them out.

We've also gotta top off the pension, put some money into that to make sure that that stakeholder is taken care of, and we have to make this working capital adjustment to account for, in this case, it's positive 10.

So it's a funding, uh, need, so to speak, that has to be met.

Now, here come the fees.

Right now the fees, uh, in this example here are basically the, um, uh, the fees for the kind of the, the overall acquisition.

So we, we typically, we should break these down debt, uh, debt fees versus, um, versus, uh, uh, uh, advisory fees because one, one hits the income statement, the other one gets deducted from retained earnings.

But in this case, you know, we're not, we're not really gonna do that.

We're just gonna, we're just gonna kinda make a wholesale sort of adjustment here.

And that wholesale adjustment is basically saying that we're gonna take a half a percent of the entire ev of 2 25, and that's gonna give us our fees.

So how much do I have to come up with? Well, I have to come up with 236.1.

Now I have to figure out how I'm gonna pay for this.

How am I gonna pay for this? Okay, well, we have some assumptions.

What we've basically said it here is that we are going to issue, um, we're going to issue some, some, um, new equity to raise cash to do the deal, new equity to raise cash to do the deal.

So let's start with that.

I think it's kind of the easiest, sort of lowest hanging fruit.

And in order for me to calculate the equity funding, I'm, I'm actually gonna do it, um, a little bit more, um, kinda the way it's done in, in the real world.

Now, technically speaking, what I've said is we're gonna go into the equity capital markets, we're gonna raise some cash, and we're gonna, and we're gonna put that cash into the deal.

So that being the case, that new cash while is costing us dilution to get it right, because we are raising new shares to get it, that cash is still cash.

In other words, I'm not taking the shares theoretically in this all cash deal.

I'm not taking the shares and giving them to the target.

But to be realistic, normally when we do a deal that has an equity component, we are giving shares for the reasons that, that Maxwell, uh, raised earlier.

Uh, they, there's some upside in the deal.

That way we can perhaps, you know, get a lower acquisition premium by giving them some of the upside of the equity.

So think about that for a moment.

If we're using equity funding, who can we give the equity funding to? Who can we give equity funding to? Well, we can only really give it to the current equity holders.

If you are JP Morgan and you have 40 million of, of bonds, uh, or, or 40 million of loans outstanding, I should say, you, you don't care about upside, you don't want stock.

That's just, I mean, that's like not the way lenders, creditors think about things.

There, there is no upside to credit as you learn, uh, from working in credit.

Um, the upside is you get your money back.

So when we calculate this equity funding, you know, again, in real life, the way we're gonna think about this is I'm gonna take the acquisition equity value, and I'm gonna multiply it by the percentage of equity financing.

And that's gonna give me the amount of equity funding in dollars that I can use for this deal.

Pensioners don't want equity.

Debt holders don't want equity. Preferred stockholders don't get equity. They gotta get cash. So where's that funding gonna come from? Well, that funding is gonna come from the debt here.

Now, I'm not using any balance sheet cash 'cause I, I haven't been given that information, but I could use some balance sheet cash as much as I want here.

I'm basically saying that it's all coming from the debt.

So, um, I've got kind of two debt debt facilities here. I've got a revolver and I've got the, uh, kind of long-term debt.

So the revolver, the revolving credit facility that's here primarily for what, what do I have the revolving credit facility here for? You don't see them used a lot, flexed a lot on, on close of a deal.

Usually they're for post, they're for post deal, right? They're for post transaction needs.

But why do I have it here? What's this revolver gonna help me with? Am I just gonna kind of put half in the revolver and half in the debt? Try to keep, keep both tabs really low.

What should I do with that revolver? Anyone? Anyone pay working capital? Yeah. Shelby that's there for the working capital because it's a perfect match.

Revolving credit facility is like a credit card.

It's short-term financing for a short-term financing need.

So I'm gonna just put, plug that 10 into the working capital adjustment, or you can link it to row 16 or you can link it to row 29.

Doesn't really matter. And, um, now I can very easily solve the debt funding, uh, by taking my total uses of funds, backing out the revolver, backing out the equity financing, and I get my debt funding Look so good.

Okay, complications to this in the real world.

Well, o other fees would be, would be a complication.

And perhaps if we were looking at a debt capacity situation where, um, we, you know, we needed to kind of model this according to how much debt could they take on that would complicate this as well.

Um, otherwise, you know, um, you've got debt, you've got two different types of fees.

You've got debt and advisory, and then, you know, obviously, uh, a more fine tuned approach to the capital structure issues on the right hand side.

Now, now that we know how much equity, new equity we have to raise, we can actually start this accretion dilution math.

Um, the acquirers, um, shares outstanding.

That's kind of where we start with.

So the acquirer shares outstanding.

Um, that's going to equal the 15 from above.

I, so that's kind of, you know, again, the baseline of where the current EPS is.

Now obviously, you know, EPS you know, we typically, um, you know, we t we again, 'cause EPS is a balance, is is not a balance sheet issue. It's a, it's a, uh, you know, it's an income statement issue.

Um, you do sometimes have to deal with that, that weighted shares business.

But I, I'm gonna, I'm gonna kind of table that for the time being.

Uh, I just need to, I, I wanna figure out at a point in time when we do the deal, what are the, what is the accretion or what are the new shares? What is the new share total going to be? So in terms of the new shares issued, um, how, how am I gonna figure this amount out? How am I gonna calculate the new shares that the acquirer has to, has to issue to raise 49.5? How can I figure that out? They need to raise 49.5 in dollars.

How can I translate that into shares Shelby equity funding divided by acquire co-share price.

So, exactly, I'm gonna take the equity funding and I'm gonna divide it by what the acquirer's current share price is. This is that little exercise I did off to the right.

This is what's impacted by that currency factor.

How valuable is acquire codes currency right now? And in this case it's 18 bucks a share.

So that's gonna give me the new shares that are gonna be issued.

And so the proforma shares outstanding are gonna be 17.8, and I can, uh, take the, um, uh, current shares over the, over the, um, proforma shares.

And that'll tell, kind of tell me sort of what the share dilution is in percentages. I'm issuing an additional 15%, an additional 15%.

So that, you know, that to me seems, you know, seems significant, right? That seems significant.

Now, of course, we don't know what we're getting for these shares, so we, we can't really make any determinations yet on the dilution, but we certainly have a big kind of hurdle to go over.

Now that kind of leads me into the next bit of math, which I think is, if anything, the math itself is not easy.

The concept, I think can be, you know, sort of a challenge.

And I, I, I set, I set for myself a challenge every, every, uh, season that I go into teaching this. And I, you know, I teach it mostly, you know, during, during our, our peak, you know, summer that I'm gonna, I'm gonna figure out a way to kind of get this through to people because it's a little bit odd in some ways, but I think it makes, you know, it can make a lot of sense and hopefully I've teed it up properly with this concept of stock as currency.

So if I am thinking about my stock is currency, what I said earlier was that the market, you know, uh, and generally when the, when the equity market is hot, we see a lot of m and a deals because, because the share prices are elevated, the problem is what if the targets are also elevated? So if my stock is flying high, it's valuable as a currency, right? Um, where was that little example I did? Is that off here? If the, I dunno where it's, um, here it is.

If, um, if my stock is flying high, then my stock, uh, if my share price is flying high, then my stock is valuable as a currency and I can, uh, use fewer shares to acquire a company.

Um, if my stock is not flying so high, I have to use more shares.

Now, the, the, the question though is what am I getting in return? What am I buying? Because, you know, if the market is hot for everyone, we, we all might be expensive.

So this concept of relative PE helps me understand how valuable is my stock, the acquire co stock relative to the stock that I'm acquiring.

So let's take a look at, um, let's take a look at this acquirer pe.

So what is the acquirer price to earnings ratio in in year one? Well, if I take my acquirer share price, which is the, uh, 18, and I divide it by my acquire co EPS, which is in row 45, what I get here is the price to earnings ratio as we sort of stand.

Now, this is a forward multiple because typically this stuff, again, in the m and a world is done off of forward, forward multiples. You could do trailing as well, but it wouldn't probably be as relevant.

So again, all I did was calculate my PE for, for the acquiring company.

I'm just gonna do year one for right now 'cause the rest is just a copy job.

So that's how valuable my stock is in terms of, you know, a PE ratio.

Now, the problem is, is that again, I need to see what I'm buying to determine whether my currency is high or low.

My acquisition pe again, back to the first point with Shelby, I need to go and get my, my takeover price, which is the five bucks a share.

And I need to divide that by the earnings of the target, which is the 0.28.

And what that's telling me is that because of what I valued this stock at, which is $5 a share, the the price to earnings ratio, the cost, the multiple of value to earnings, the multiple of value to driver is higher for the target than for the acquirer.

So this is relative now. So we can compare which company has a higher value stock by the market, the acquirer.

So if I were buying this company entirely with stock, would this deal be accretive or dilutive? I'm using a less powerful currency to buy a more valuable currency.

So that means I'm gonna have to issue a lot of stock to do it.

And so on paper, this is telling me that this would be a dilutive deal purely using equity.

Does that make sense? Any anybody need a, uh, a re a rewording? No. Max is saying it's okay. Shelby says somewhat.

Somewhat. Um, so, um, trying to think how to, how to get at it without just re, re, re, re uh, reiterating.

Um, the, the, the, um, the, the price per earnings is, um, is again, is trying to get to an understanding of what I am paying for a, a company's earnings, right? For every dollar of earnings, I'm paying 14.3 times.

In the case of my acquirer for my acquisition pe I have to pay $17 and 90 cents to get $1 of earnings.

So to acquire their earnings, to acquire that company's or the target company's earnings, I am using a currency or, uh, a, a a, um, a payment method that that is, that is only worth 14.3 times.

So it's like, you know, it'd be like trying to, um, you know, a just let's just use Canadian dollars versus US dollars.

Canadian dollars aren't worth as much.

You need more Canadian dollars to buy something in US dollars, right? You need more of the Canadian dollars to buy something in US dollars, or you need more US dollars to buy something in pounds because of that translation factor that that currency translation.

So that's effectively what this is, is, is doing for us.

Now, it's only doing it in terms of equity.

So the problem is, what happens when I introduce debt? Now debt is cheaper than equity, correct? Um, that's something we've established, I think, you know, for several weeks now.

So if I'm buying a target and I'm using debt, what am I doing to the overall cost of capital? What am I doing to the overall cost of capital? I'm lowering it, right? I'm basically saying that my funding is going down, my funding cost is going down. Sorry, my funding cost is going down because I'm using a cheaper amount of debt.

Well, again, how can I kind of put this into terms? Well, what I'm gonna do is I'm, I'm going to make a kind of very crude cost of equity calculation.

And what I'm essentially saying is that if I take a multiple and I invert it, what that basically tells me is the, the yield or the expected return on the same, on on the same thing.

So if I take one over the 14.3, what that tells me is that the, the sort of expected return on something I pay 14.3 x for is about 7%.

Now, I know we, this doesn't really look like what we did for the cost of capital, which was a, you know, based on the capital asset pricing model, and that's because that was based on the capital asset pricing model.

But, but in theory it kind of works the same, which is to say that, um, when you take a multiple and invert it, you get the return of the thing that you're valuing.

So the equity here is expected to return 7%.

Now the return just to, just to have another, another practice at it, the, the expected return of the, uh, target company or the company we're trying to acquire.

If I do one over 17.9, that works out to about 6%.

I'll put these into one more decimal place just so we can see that, um, differentiation a little bit more.

So now, uh, what I've got here is I've established kind of a relationship.

The relationship is, is that the, the more I pay for something in terms of multiple, the lower the expected return.

Now, why is that? Well, if you think about what drives value in the market, and certainly I know we can get into growth and we can get into upside and things like that, but generally what you're paying for is the consistency and the stability of a company to generate earnings, generate profits, generate cash flows.

So the higher valued companies are the safer betts.

Now you could say, well, you know, what, what, you know, what about Bitcoin? Or something like that. Now, I, I get it, I get that there are, there are some, some, you know, obviously exceptions to this, but in general, when we think about companies that have premiums for share price, like Apple, right? For example, um, what you're paying for is that stability that that brand name that, and that translates into sort of a lower expected yield.

Now, the riskier a company is the lower the multiple will be because of that risk.

And that then turns into mathematically a higher expected return.

A higher expected return is rewarding the risk.

So let's shift this now to, to the conversation of debt.

With debt. We know what the return on debt is because the return on debt is generally the, you know, what we pay for it, what we pay to have debt, will we pay to, to, to, um, borrow.

And that cost of debt or the yield on debt similarly reflects the risk of that loan.

So it's the same exact principle, the same exact principle.

So the risk to lending to this company is 5%.

Now, fortunately with debt, which we don't have with equity, we get, we actually have an adjustment to debt because of the tax shield.

So when we talk about the cost of debt, we always have to talk about the cost of debt post-tax.

So this 5% really isn't 5%.

The cost of debt to lend to this company, to this acquiring company is not 5%, it's five times one minus the tax rate.

So I'm going to put that adjustment in and that'll get us into a more kind of correct cost of debt, the after-tax cost of debt, okay? Where am I going with this? Well, now I'm gonna work backwards.

I know what my expected return is on debt, on making a loan to this company.

What does that actually translate into in terms of a multiple? And that multiple is going to be the inverse of the yield.

So I've just gone backwards.

I've done a kind of a complete circle here.

And now what this is saying is that the buying power of debt as a currency is higher.

Why is it higher? Because it's, it's less costly and therefore, uh, will have a more positive impact on the deal, right? It's less costly and therefore will have a positive impact on the deal.

It won't cause any dilution, a little bit of dilution in the interest, but that interest is what's being measured here, right? So what I see here is that I've got a cost of equity funding at 14.3, which is gonna make me immediately dilutive if I do the deal with a hundred percent e equity.

But if I start bringing debt in, now my 28.6 times is greater than the 17.9 by a pretty good number.

And so what that's gonna do is by using more debt, it's going to make this deal less dilutive.

And so what this type of analysis does is it gives us kind of a back of the envelope way to look at a deal.

If somebody comes to you at your desk and says, Hey, we're looking at something, I'm looking at a, you know, at a, um, you know, a potential deal. This only works for public companies, obviously.

Um, company, company a, which is the acquirer, has a 22 times PE multiple.

And I wanna buy a company that has a 15 times PE multiple, and I'm gonna use all stock.

We're just gonna give them shares.

Now, you know, from this analysis that 22 times is a more powerful currency, and therefore to buy a company at 15 times earnings, 22 times earnings makes the deal, immediately accretive, immediately accretive.

Whereas if I flipped it around, or if I looked at this deal and I said, this deal I'm gonna do with all equity, well, my equity is less valuable and therefore I'm, I'm in a bit of, I'm, I'm in a bit of trouble here from an accretion dilution perspective, how does that, how does that sit right now? We're going to finish the math here just so you can see it kind of play out.

But does that make sense? But could you amplify the returns with debt if the debt cost is lower than your pe Well, the debt cost, um, when you say the debt, the debt cost is lower than the yield on the equity Shelby, correct? So you're saying if you use more debt, could you amplify the returns? Is that what you're, is that not what you're saying? Yeah.

Right? Oh yeah. So Shelby, if, if somebody, if, if, if in this example, you know, I i, if you're, you're saying could I amplify the returns even more, right? By saying, Hey, this is a cheap asset.

Yeah, hey, this is a cheap asset.

Why don't we actually just, you know, layer on a bunch of cheap debt and we'll amplify the returns that, well, that is what leverage always amplifies the returns that was last week, right? So the reality is, is that yes, it, it could, but we'd also, you know, if, if the, and this is where the, the math below is gonna help us.

If that premium of one company's pe over another company's PE is powerful enough, it, it's possible that we could even, uh, you know, in other words, our currency is strong enough that we, we don't even need debt.

We don't need any debt. It's possible.

Now, that would have to be a pretty significant kind of valuation, but you know, certainly, um, you know, it, it does happen.

There are plenty of deals that are only, uh, that are, that are full equity, a hundred percent equity financing.

And that's just because, you know, it just, it just makes more sense that way.

Um, and, and again, the cost of debt might have something to do with it as well, but in general, debt always amplifies returns.

Absolutely. Okay, so let's actually see what happens when we, uh, you know, we kind of do the math out and we're gonna take the, um, kinda list of things that, that, um, that, that Shelby and Max, both Max's and Aaron, uh, kind of helped me put together.

Um, we're gonna build up the income statement on a pro forma basis.

And what I'm gonna do here is I'm gonna start, I don't care about the actuals so much, I really only care about the proforma because when this analysis is done, it's almost always done.

Um, it's almost always done, uh, on, on a proforma basis.

It's never done on an actual basis.

I think the solution has the actual in there, but we don't, we don't have to worry about that.

Okay? So my acquirer net income, and now, um, I'm doing this, I'm going back from per share to whole, whole dollar amounts or whole currency amounts because that's generally the way we present the kind of pro forma income statements and whatnot. Or, or done pro forma, not, not in per share amounts, right? So my, my net income here, um, it, again, I'm gonna, I'm gonna do this sort of as if the transaction didn't happen.

So what that means is that I can take my EPS and multiply by my wa my waySo kind of prior, you know, to any new shares happening.

And that's gonna give me my, um, acquirer net income.

And then my target net income is gonna be this 0.28 times the 33.

So that's just telling me here again, how these, how these companies look standalone.

Okay? Next thing I've gotta do here is I've gotta a factor in the synergies and the synergies have to be done, um, post, post-tax.

So there's a lot of theory about synergies.

Some people say the synergies should be adjusted locally at the local tax rate, some local being the target tax rate, some syner, some people think the synergies should be adjusted at the acquirer tax rate. Really, I guess it depends where the synergies are happening, right? Um, so I'm gonna adjust, we only have one tax rate here, so our problem is solved, but that's kind of a more advanced question that you might wanna bring up in a more detailed merger model.

So I'm gonna take my synergies, which we have an assumption here that they're about five bucks a year, and I'm gonna multiply times one minus the marginal tax rate, and that's gonna give me my post tax synergy amount.

Now, what is the interest on the acquisition debt post-tax? Well, the interest on the acquisition debt post-tax, that's gonna be just the, the, the, the interest on, um, the, the new debt.

So what we're assuming here is that any of the previously funded debt is already happening.

'cause it's already being picked up.

It's coming from, we have two models coming together.

We have standalone target, standalone acquirer.

Those both are happening as though this deal isn't going on.

So the existing debt is funneling into that.

That's in the, uh, EPS.

What I want here is just my interest on the, uh, acquisition debt post tax.

So again, I'm gonna take that, um, interest rate.

Um, I, you know, I can just actually go up here and do it.

I already did that calculation off to the right.

So I can just go over here and grab that 3.5 and multiply by my acquisition debt.

Now, the, the, um, the acquisition debt that we have in this transaction here, um, the acquisition debt that we have in this transaction, um, we, we kind of have to be careful.

'cause if we look up, if we look up above, right? If we look up above our debt funding here, um, our debt funding of 1 76 0.6, that's proforma, right? That's proforma.

So what we need to do is we need to kind of back out the, we need to back out the, um, the, uh, existing, uh, debt from that.

Is that because that, that existing debt, again, that's already being kind of picked up, um, in, in the, um, target EPS.

So what I'm gonna do here is I'm gonna take this G 27 and I'm going to add to it the revolver, 'cause that's new debt as well.

And then I'm gonna subtract the existing debt of 40, and then I'm gonna multiply that by this 3.5 off to the right, and that's gonna gimme 5.1.

Now I need to flip this because it's detracting from earnings or gonna lower my earnings, and now I can calculate my pro forma, uh, net income, and that's gonna be the 26.5.

Okay? Now, what are the pro forma shares outstanding? Well, that's where we have to kind of go in and, uh, bring in the new, the new shares.

So the pro forma shares outstanding, and this is where it could get a little bit messy with the weighted average and the, and the basic in, in theory, you know, the, when we're looking at, at the, the forecast years, we, we kind of assume that there aren't a lot of changes in the share totals.

So your, your basic and your weight, I'm sorry, your, you're fully diluted and your weighted average shares in a forecast in theory should not be that different because we're not assuming share buybacks, we're not assuming a lot of new options and whatnot.

So, so what I'm gonna do just to kind of make this, um, simple, is I'm just gonna go up here and get the 17.8 and I'm gonna assume that once, you know, the deal closes going into the next forecast year, which is our year one, that there are no other changes in the shares.

And if that is in fact the case, then there's zero difference between fully diluted shares outstanding and weighted average, fully diluted shares outstanding.

There's no difference at all.

So, uh, I go and pull that 17.8 in, and now I take my pro forma EPS, which is the 26.5 divided by the 17.8, and I take, I take that and compare it to my standalone EPS.

And what does that tell me? Well, that tells me that the deal is highly accretive.

If I look at my standalone EPS of of 1 26 0.5, and I compare it to what the deal is gonna bring, it's, it's highly, it's highly accretive.

Now, I can copy this across, but chances are, if it's accretive in the first year, uh, I didn't, I didn't anchor my debt.

Mea coba gotta anchor all this, anchor that, anchor this.

I think everything else, I gotta anchor my synergies too.

So what happens when you take your eye off the modeling ball for a moment? All right, that should all work now probably.

Nope, EPS didn't work. That's gotta be anchored.

Copy these over. Alright? So usually if you're accretive in year one, you're gonna be creative in years two and three.

It's just kind of the, the nature you know of it.

Um, now this is, this is highly accretive deal, right? So, you know, you might, you, you might want to kind of question, um, you know, some of the assumptions at this point, or you might just want to accept the fact that we've got a very low cost of debt and we're using a very small percentage of equity.

Um, you know, there's some other stuff down in here that we can, um, you know, we can kind of look at.

Uh, but, but because I don't have a ton of time left, I want to, I wanna just make sure that we're, we're, we're focusing on, um, what makes something accretive or dilutive. So I wanna play with the assumptions a little bit.

Um, and what I wanna do is I want to just say, for example, what happens if we go to a hundred percent equity financing.

So if we go to a hundred percent equity financing, what we should see is that the deal is in that case, um, gonna be diluted, right? Because we're gonna have, um, uh, a, a more significant amount of equity, uh, uh, greater amount of equity.

Um, we still do have, in this case, a little bit of debt.

And that's because I wired, remember, I, I kinda wired the, the, the debt so that it would be, it would be kind of used to pay back the stakeholders that wouldn't accept equity.

So there, there, there's always gonna be probably a little bit of cash or a little bit of debt sort of in, in, in these deals to, to take care of the, you know, the stakeholders that, that have to get taken care of, right? But in general, um, what we see here is that because of that, even that tiny little bit of debt that we have, it just makes this marginally accretive in year one just because of that.

Now, what I could do here is I could raise my cost of, of debt a little bit and we could see if that does it, my cost of debt is a little bit higher, and now all of a sudden we can see that the combination of using a lot of equity and uh, uh, you know, that little bit of more expensive debt would sort of push this into, into, you know, slightly dilutive territory.

And, and this is where, what, you know, what you might be able to do at this point is try to kind of figure out, okay, well what, what synergies do I need, you know, to make this break even? What synergies would I need to break this? Or, or would this effectively fly, you know, with the shareholders? Now the last thing I wanna do is just flip it the other way and I'll just do, um, I'll go back to the original debt financing assumption and I'll make the equity financing zero.

And with 0% equity financing, what we're saying here is that it's all gonna be funded by really cheap debt.

And when that's the case, when we're funding entirely with cash, or we're raising exclusively debt financing to, um, you know, to, to buy out a company, what is that gonna do? Well, it's almost always gonna be massively accretive, almost always.

Um, you, you will hear companies, CFOs, treasurers say that, that they, you know, they only do cash deals.

Now, I I I, I have a, uh, a client that I train at an m and a boutique that, that only, um, that only kind of advises, uh, uh, uh, a few clients on certain kinds of deals.

And they're all cash deals, right? They're all cash deals, no equity.

And yet they will still say, you know, we, you know, we do cash deals when they're accretive, only when they're accretive to, you know, to the shareholders.

And that's kind of to me a laugher, right? Because you, you know, I immediately as an analyst that you, you really can't do an all cash deal and have it be dilutive.

You, you really can't unless the, unless, unless what? Uh, I think it would be who, who had the comment earlier? Let me see who it was. What would make an all cash deal? Dilutive, uh, let's see, who was it who had that comment? It may, may, they may not even still be with us.

Uh, it was Max. Max. What, what would make an all cash deal? What could make an all cash deal potentially dilutive, if you're still with us, what could make an all the numerator? Uh, the denominator is staying the same.

Yeah. Yes, Shelby, uh, an all cash deal.

It's generally either cash from the balance sheet or some debt financing. Because, because, uh, you know, that's, that's typically still considered cash. You're not exchanging debt to the other, right? You're not giving them debt. You're going to, you're going to, it's like buying a house, right? You, you raise a mortgage, you, you get financing from the bank, but what do you give the owners? You give the, you give the, the current owners cash, right? Um, in, in, in m and a, you have a choice of giving them either cash, you know, or stock.

But if you're raising debt, debt is just like giving them cash because there's, there's nothing else to do with it except, you know, except take the cash and give it to, to the owners.

Um, so the only thing that you can do, um, to, uh, if you're paying with, with all, with all cash, meaning no new equity, and that denominator is not changing, the only thing you can do to possibly create a dilutive deal is to buy a company with negative earnings, in which case you've absorbed their losses.

And the combined or pro forma EPS is gonna be less, right? So here is a 100% debt deal, and if they, if we bought a company that had massive losses, then um, that could, that could possibly bring this down.

It'd have to bring it down by about, I guess, um, about 40 cents a share though, right? To get, to get this to be, to get this to be, uh, a dilutive deal.

So we'd have to figure out what that would be and, uh, you know, we could model it, but that's, that's just theory in theory.

Okay. Um, Shelby, does that clear up your concern? Any other questions? Please feel free.

We've got a couple of minutes. Um, I didn't get through some of the stuff on the bottom, which I think is, is, you know, is interesting. We've got, I'll put the solutions up there for you.

We've got the videos, um, pinging me if you wanna know how to do it.

Um, but as far as kind of getting through, I think the real core of accretion dilution analysis, that's, uh, that's I think what we covered, uh, you know, what we covered here today.

So if there are no other questions, and I'm gonna hang out for a minute, um, uh, thank you all and we've got one left if you wanna hear the wrap up. Come next week, I will cover new material.

It's not gonna be a review, but, um, I do want to tie together all the valuation stuff, um, and talk about the concept of a football field, which is what next week will be.

And there'll be a tiny bit of new material as well on transaction or precedent analysis to, so, um, if you've got one left before the holiday parties swallow you up, uh, would be, would be honored to have your presence here, uh, next week as well.

So I'll stick around for a couple minutes if anyone wants to stay on and ask a question, you can otherwise, uh, cheerio and have a good, uh, have a good evening.

And, uh, and thank you Yolanda as well for, for your.