My name's Maria Weber.

I'm one of the trainers at Financial Edge and I'm gonna be having a look at M&A fundamentals with you for the next roundabout hour, right? So let's talk about what is on the agenda for today.

So we are gonna look at a simple M&A model, but I think before we just launch into doing the Excel model, it's important to go over a few key concepts.

That's just going to frame what we are doing.

So we'll have an overview of some of those concepts.

I've got some slides that I will use to do that.

Then we're gonna start working on the simple M&A model.

And once we've done the initial part of the model, we'll then talk a bit about analyzing the deal simply.

Okay? Remember this is just fundamentals of M&A, but we'll have a look at calculating the impacts on earnings per share.

We'll have a look at the debt position of the business afterwards, because that's important to think about if there's gonna be any impact on the credit rating of the business.

We'll look at synergies.

And then finally we'll have a chat about ROIC, a return on invested capital When we are doing a deal, right? So we have identified a target that is obviously a very big part of the process, identifying which company we would like to acquire.

There's then two main decisions that need to be made.

First decision is what are we gonna pay for this target? And that is the valuation.

And then the second decision is how are we gonna pay? So that is the financing decision, starting first with the valuation.

So valuation in an M&A context is like valuation in any context, to be honest, except for the fact that this is in the context of a control transaction.

By control, I mean we are not just buying a small minority investment in another company, we are looking to acquire control because of that, we have to offer a price that is higher than the standalone, unaffected current share price of the business, right? And that's our control premium for acquiring control, convincing everybody to sell.

Also the fact that we are hoping to generate synergies normally when we do m and a.

So what we are gonna be looking at, instead of just the share price, we look at the offer price per share, then we apply that to the number of shares outstanding.

And that is the equity value.

Now we are buying shares, right? I'm buying shares in a business.

There are different ways of structuring an m and a transaction.

So for example, you could actually buy a division where you buy the assets and liabilities of the business.

The model that we are gonna be looking at, we buying shares, right? So that is the acquisition equity value.

It is then also very useful to calculate the acquisition enterprise value.

And we go over the bridge in order to do that.

So we add on the net debt to the equity value.

And that enterprise value is useful because firstly, it can help us to calculate an EV multiple and that we can compare to similar deals that have been done, right? So we could have an idea of what we wanna offer, but then we've got to see what's been done in the market recently.

Do we think that'll be acceptable to the target shareholders? So we can calculate some multiples and compare to recent deals.

And also things like calculating fees on the deal.

Normally that's done in the context of enterprise value.

Okay? So that's decision one, valuation price we're gonna be paying.

If we then move on to decision two, that is the funding.

Now we are gonna be doing a sources and uses of funds table when it comes to the use of funds.

We've already talked about that.

Okay, we need to buy the shares of this business.

So that is the amount of money I need.

Now we are gonna see in our model and in a couple of slides time that it's actually sometimes a little bit more complicated than that.

Hey, we'll deal with that in a moment.

But for now, okay, I need to pay X amount for the shares of this business.

How am I going to pay? Two main ways of paying.

One is to raise debt.

So the acquirer issues, debt, the target shareholders then get cash, right? Per share that is what the target shareholders get.

So target shareholders get cash per share.

An alternative to issuing debt or funding a deal with debt is to issue equity.

Now, normally what happens with equity issuance is the target shareholders, instead of getting cash per share, they actually get a number of shares in the now or after the deal combined enlarged business often for very big deals, you'll see a mixture of both.

Okay? And I'll show you some examples in a moment once we've gotten going a little bit more with our calculations.

So that is the sources of funds and there's pros and cons of each of these, right? I mean, I'm not going to go into all of that detail now, but we've gotta think of the cost of financing.

We've gotta think of things like dilution.

If we are issuing shares, if we are issuing shares to finance the deal, we would have what's called an exchange ratio.

We need to work out the number of new shares that are going to be issued.

One of the things we're gonna be doing to analyze the deal is calculating earnings per share.

Anytime I'm calculating earnings per share, I need the number of shares, right? So financing a deal with equity is going to impact the outstanding shares in the acquirer.

And the number of shares the acquirer has to issue is going to be driven by what they paying and their share price.

Okay? And if we then compare that to the number of shares that the acquirer is buying, that would give us an exchange ratio.

Okay? Last bit of introduction before we actually get going with the model is a little bit of a more complicated sources and uses of funds table.

So our previous sources and uses of funds, we said, okay, we need money just for the equity purchase price.

We are buying the shares. How are we gonna fund that? In reality, you're probably gonna need money for other things as well.

So equity purchase price, that's what we buy in.

But then we might need to or want to refinance the net debt of the target.

Maybe we have to refinance it very often in loan agreements for example, there would be a change of control clause, which says if the control of the business changes, it needs to be repaid.

So often we have to refinance the debt or we might want to refinance the debt because we think we can get a better rate on the debt.

So we would need money for that as well.

We also need money to pay transaction fees, lawyers, bankers, et cetera.

What we could also see, and we've got an example of this coming up, is an operating working capital adjustment.

If by the time the deal closes, the company is going to have a lot of working capital, we are gonna have to pay a little bit extra for that, right? And so we are gonna need extra money for that.

Now where do we get the money from? We've already talked about issuing debt or issuing equity, but now we've got two other potential sources of funds.

We could have some cash that we've built up over time as the acquirer, and we use that treasure chest of cash to acquire the target.

We also might want a revolving credit facility.

Now, revolving credit facilities is not typically a long-term financing instrument, right? But where an RCF is useful is to fund working capital because working capital, short-term fluctuations, and then the RCF would be used to fund that.

Okay? So we are gonna see this now coming up in our model.

Any questions as we go? Welcome to those of you that have just joined.

Please don't be shy.

Put them in the Q&A pod and you can always ask questions after the fact as well.

Okay? So let's get going with our Excel spreadsheet.

Those of you that have just joined under the resources section, there should be a link taking you to where you can find the resources, but it's under topics Felix live.

And then if you just navigate to today's session, you'll find it there.

I'm going to be using the empty file, you've got the full solution file, and I'm definitely not gonna be doing anything other than M&A cash deal one.

So if you just navigate to the fourth tab, we are in M&A cash deal one, you'll see M&A cash deal two is another opportunity for you to practice what we're gonna be looking at together.

Let's start first of all by just looking in M&A cash deal one, what the structure is and what we have got.

Oh, so I see someone has asked why are the operating working capital adjustments not part of the equity component? Great question, right? So the equity component is what we are paying for the shares, right? So that is what we are paying for the shares of the business.

Now I'm gonna come up with the value for those shares.

And if we look here at this example in front of us, the target share price currently trading at $4 per share and I'm going to pay, I think that's why it's in this light blue color, because it's an assumption 25% over that.

That is the equity value.

Now you are right in thinking, okay, well in order to come up with that share price, right? Surely that incorporates operating working capital.

But the issue is there's a time delay between when we announce the deal and when the deal actually closes, when we actually then have to hand over the cash.

All the agreements are executed, everything happens.

So if when we now work out these calculations, we look at say average operating working capital for a company over the year, right? That will be fed into the price.

But then if I'm buying this company, say, I don't know, in the summertime when they've got this massive buildup of inventory before the Christmas season, I would, when the deal closes, there'll be more working capital in that company.

And so I'll have to pay extra for that. That wasn't already built into my valuation.

So it's like buying a car where the gas tank is full, okay? You're gonna have to pay a little bit extra for that.

So does that clarify your question? Great. Perfect. Okay.

So I just want to say if I say answer live, I answer live. I just wanna clear these questions and then I can see any new ones coming up.

Brilliant. Okay. So coming to our model, we have got the acquisition assumptions and valuation to start off with.

So this, we are gonna look at what we paying and that is going to lead us if we go past the other assumptions. So we've got synergies, we've got how we financing the deal.

We then going to look at our sources and uses of funds.

We then also going to calculate because we are financing this deal partly with equity, okay, well what is the new number of shares going to be? Then we'll go and do some analysis on the deal. Simple analysis, EPS, synergies, debt, et cetera.

So let's start off with the first part, which is effectively the structuring of the deal.

So we've got the acquirer, we've got the share price of the acquirer and the share price of the target.

So we, assuming this target is listed, unlisted companies are bought and sold all the time as well.

We would probably then not be looking at, you know, a share price.

We would be looking at things like total equity value or enterprise value.

But here we have an observable share price.

And so we can apply a premium to that share price.

And we think based on deals that have been done recently, 25% should be good.

So we need to work out what is our acquisition price per share.

So it's gonna be the unaffected share price, which is before any rumors of a deal.

Okay? Traded share price we times by one plus the premium, and that gives us a share price, a deal share price, acquisition share price of $5 per share.

There's 31 million shares of the target outstanding.

We are aiming for 100 percent.

Yes, it is possible to get control of a business by not buying 100%, but we here are saying, right, we're buying 100 percent of the shares.

So that means 5 times the 31, we have got an equity value of 1.

Oh, sorry, I'm going getting too excited.

I'm already into the acquisition equity value. That's what I'm trying to do. But before we get there, we need the diluted shares outstanding.

Now this is something if you haven't seen before, I'm probably going to do it too quickly.

I don't wanna get distracted by focusing on this because the focus of today is M&A, but if you have not yet seen the dilution calculation, I want to refer you in Felix to the trading comps playlist.

So to look at the dilution, if you want to go to the trading comps playlist, and specifically in the trading comps playlist, it's video 7 to 11 on dilution.

Very briefly. Dilution happens when the company has stuff like convertible bonds or where they've got options that they've issued to their employees and those options are issued to their employees with a certain strike price.

So employees can buy shares for 3 instead of whatever the going rate for those shares are.

And that actually causes dilution because people are buying shares for less than what they are actually worth.

Now what often happens with M&A when there's change of control clauses, all of those outstanding options become immediately exercisable.

So not only do I have to buy the actual number of shares currently outstanding, which is 31, I also have to buy new shares that will now exist because of the exercise of those options.

And that is my dilution calculation.

So like I said, I'm probably going to go a little bit too quickly if you've never seen this before, but you can watch the trading comps video.

So to work out the dilution, we take the maximum of 0 and the acquisition price per share because that's now the new share price minus the strike price.

And the strike price is 3.

And I divide that by the acquisition price per share.

So this is the dilution bit, right? The part that people are would be getting for free because they're only paying three for something that's worth 5.

And then I multiply that by the number of options outstanding.

The reason I do the maximum of 0, and this is that if these options are not in the money, I don't want them to be included.

If they're not in the money, then I don't include them.

So that means in addition to the 31 shares that are currently outstanding, I'm also going to have to buy these additional shares.

And so the total number of diluted shares outstanding is the 31 plus that 2, which gives me 33.

Now I can get to the acquisition equity value, which is what I have to pay acquisition equity value, the diluted shares outstanding multiplied by the acquisition equity, price, acquisition share price.

So number of shares times that share price, and that gives me 165.

So that is what I need to pay.

What's also useful to see is the market cap not considering the deal.

So just looking at the moment for the acquirer and the target, what's the value of their businesses? So we have got, for the acquirer a share price of 18, we've got the diluted shares outstanding of 15.

So their market cap is 270, and if I just copy that to the right for the target, okay, we can see it's the 33 times 4 and that is 132.

That is not what I'm paying.

That is just standalone what the business is worth.

We've now got some more information on the company that we are buying on the target.

They've got net debt in the business of 40.

There's also a pension deficit adjustment that we need to make.

Now there could be things in an m and a context that crystallize that we need to pay.

So for example, if there is a pension scheme that is in deficit, the pensions regulator might say to us, okay, you need to as part of this acquisition, top up that pension scheme.

So here we need an additional 20 in order to top up the pension scheme as part of the deal.

This is not gonna happen in every deal, but it's built in into our deal in this case.

Now what I can do is I can work out the acquisition enterprise value acquisition enterprise value.

We know we need to go over the bridge from equity, we have to add the net debt, add any other financial liabilities, and that would then give us our enterprise value.

So I've got the acquisition equity value, I'm gonna add the net debt and I'm gonna add that pension deficit adjustment and I get an acquisition enterprise value of 225.

In addition to that, going back to the question that was asked earlier, by the time the deal closes, there's going to be more working capital in the business.

And so I'm also going to have to come up with an additional 10 to finance that working capital.

Okay? So if I have gone a little bit fast, remember you do have the solution. If you wanna follow along rather than the full file, please do so.

Any questions please ask.

Let's now move on to sources and uses of funds.

So first of all, we've got other assumptions with M&A very often, I mean there's ways of evaluating a deal. There's no one only way to evaluate whether a deal is good or not, right? So we've got a few ways here. We're going to look at earnings per share.

We are gonna look at the synergies versus the premium paid. We're going to look at return on capital employed in addition to those financial measures, there's also the softer factors, I want to say the qualitative factors.

So things like strategically, does it make sense, right? What are the synergies expected to be generated? So all of that stuff we would use to evaluate whether a deal is good or not.

And here we've got a quantifiable amount of synergies, which is 5, which we'll bring in later on.

We've then said, okay, we think we are going to finance the purchase of the shares with 30% equity financing.

So that percentage of equity financing is for the acquisition equity value, right? Not the enterprise value. Not everything that we are paying.

I'm looking at what I'm offering the shareholders, and I'm saying for the shareholders, 30% of what I give them is going to be in shares in equity and then the other 70% would be cash.

And I'll raise that, you know, through debt or maybe I have cash on hand already.

So that's an important point. That percentage of equity financing is for the acquisition equity value.

What are the targets shareholders going to get? And then given the cost of debt, so the cost of acquisition debt to finance the deal and the cost of existing debt, we'll see we need that when we are working out things like earnings per share, we've got a tax rate and then we've got fees as a percentage of enterprise value.

So this brings us on to our sources and uses of funds sources we'll do second, let's do uses of funds first.

So first of all, I need to finance the share purchase.

So acquisition equity value.

There we go in cell D12, that is acquisition equity value.

I then am refinancing the net debt, okay? So in addition to buying out the shareholders, I'm actually gonna repay the debt as well and I'm going to refinance that.

So I've gotta take existing net debt of 40, I need money for that as well.

I then also need money to top up the pension fund.

So that's another use of my funds.

And then as we said, by the time the deal closes, there's gonna be more working capital.

I need to actually pay for that as well.

So that's gonna be an extra 10.

And then I need money to pay for the fees.

And the fees we are told is half a percent of acquisition enterprise value.

So we've worked out the acquisition enterprise value in row 15.

And so we've got fees of 1.1 and the total amount of funds that we need is 236.1 million.

We now need to think, okay, how are we financing this? First of all, like I said, a revolving credit facility, we typically don't use for long-term things, right? Like buying a whole company or buying a big asset.

RCF is generally for temporary things and things that are short-term in nature like working capital.

So I'm gonna finance that extra working capital I need with the RCF.

Then the equity funding we've said is 30% and that 30% is being applied to equity value.

We are not taking the total uses of funds and saying, okay, 30% of that is gonna be equity.

I'm looking at what am I paying the shareholders? The shareholders are gonna get compensated 30% with shares in my company.

Okay? So that's the 165 times 30%, which is equity to the value of 49.5.

And then the debt funding is going to, in this case be the plug, right? So debt funding, I need total funds of 236.1.

I'm gonna use an RCF for 10 of that and I'm gonna use equity funding for 49.5 of that.

And so what I'm left with that needs to be financed with debt is 176.6.

And then if we calculate my total sources of funds, that is going to equal my total uses of funds of 236.1.

Now it might be that you first calculate the debt amount, you wanna get the maximum debt amount that you can get.

That's not going to affect your credit rating, for example.

And then whatever you can't finance with debt, the plug would be equity.

Okay? So there's different ways of approaching this, but the key point is your sources of funds has to equal your uses of funds.

Last thing we need to do here before we then move on to doing a bit of analysis is work out the number of shares that's now gonna be outstanding in the acquirer because the next thing we are gonna do is look at EPS of the acquirer before the deal and after the deal.

So at the moment, before any deal takes place, the acquirer shares that are outstanding is that 15 that we've been given, right? The diluted shares outstanding of 15.

I'm just gonna move this percentage to the right hand side.

Now we need to work out the new shares that they need to issue.

Now the new shares that they need to issue is going to be that value of equity funding.

I'm going to give the target shareholders value of 49.5 million.

So how many shares do I need to give them in order to make up a value of 49.5 million? Well, I'm gonna just divide that 49.5 by the value of one of my shares.

So I take that 49.5 and I divide it by the acquirer's share price.

So acquirer's share price up at the top is 18, and that is how many new shares the acquirer needs to issue to the targets shareholders.

So after the deal is done, we have got a total number of shares outstanding in the acquirer of 17.8.

Something the acquirer shareholders would also be interested in is what does this do to their percentage shareholding in the now combined business? Before the acquirer shareholders owned a hundred percent of their business, they were the only shareholders they owned a hundred percent.

Now we issuing shares to the target shareholders, they're now gonna become shareholders in this enlarged company.

So what does that do from a control perspective? So let's have a look after the deal.

The original acquirer shareholders would have 15 out of the 17.8 million shares, which if we change that to a percentage is 84.5%.

Okay? And then the target shareholders now part of the bigger company is gonna be the remaining 15.5% and that's something that the acquirer shareholders would look at.

So for example, it's just something to consider.

If you fall below 75%, you can't pass special resolutions without the cooperation of the other shareholders.

Or if you fall below 50%, that means actually you've lost control of the overall business. So that's something that we would look at as well.

Before we move on to doing the analysis, I just wanted to show you just the stuff that we are talking about here practically when deals are announced, this is the kind of thing that people want to know, right? So recently on Wednesday I think it was, we had an exciting deal anova, I dunno if anyone knows Kellanova, it used to be part of Kellogg, okay? But then it was spun off.

So they separated out the cereals, traditional breakfast cereals business that remained as Kellogg and then Anova became where the snacks sit.

Okay? I love a good snack, that's why I get so excited.

I've even got another example, which is also a snack example.

So Anova has things like Pringles, Pop Tarts, Rice Krispy treats, and it was announced on Wednesday that Mars is buying them out, right? So Mars is a family owned business not listed, so they didn't disclose as much information as you'll see for this other deal I wanna show you.

But if we just come to Felix, you can find, if we look at Anova. So Anova, if I look at the, there's lots of places you can find information, but if I look under proxy, so this is just information that's been given to shareholders of anova.

Well it's taking a while to open for me.

Let's try that again dear.

It was working perfectly earlier on.

I should have just left it open.

Okay, if I try another one, let's just see here.

Sorry guys, I don't wanna waste too much time on this example. Maybe I'll come back to it at the end. There we go. So that one is working, no. Oh, there we go.

Brilliant. Always making me sweet even more than I already am because it's so hot today.

Anyway, so here we have got, just to show you, this is a big deal, right? So Mars agree to acquire Anova for 83.5, her share in cash.

So in this case there was no shares being issued by Mars, okay? And typically an unlisted company can't really pay with their shares because I as the Anova shareholder, don't want to now become an owner and a private company.

So they're paying in cash and the total consideration is 35.9 billion.

They give what the premium was 44% premium to Kellogg's unaffected 30 day trading volume weighted average price.

And if you look at the high over the last 52 weeks, it's 33% premium.

And then they go on to calculate an acquisition multiple 16.4 times EV to LTM EBITDA.

And that you could then compare to recent deals that have been done.

And if you look at how they're financing this in the press release, they state that Mars had cash on hand and also debt financing in place, right? They get the cash, they pay the shareholders.

Another example of a deal is, I dunno if you've heard of JM Smucker and hostess Brands last year, JM Smucker, they do things like peanut butters, jams, also snacks, some pet foods.

And they bought hostess brands.

And Hostess brands sells Twinkies if anyone knows of a Twinky bar.

So they did a deal last year.

So one public company buying another public company and this was a mixed deal, so it was a mixed deal.

And under this deal they paid in a mixture of cash and shares.

Okay? So mixture of cash and shares.

If I just look here on Felix under the news section, there we go. There's the 8K press release, okay? And here they were paying 34.25 per share in cash and stock.

Again, they give us enterprise value, they talk about the net debt and they give us the multiple of 17.2 times.

If we then go down in terms of how it was being paid, cash of $30 per share and 0.3002 of a share in common stock in James Mucker.

Okay? So that is how it's being fund that's how it was being paid and how is it being funded? The cash portion, cash on hand and then bank loan long-term bonds.

Okay? Right? So just to show you the practical application, I think it's always nice to see, right? It feels sometimes like we're stuck in spreadsheets and we're doing all these calculations, but this is the kind of thing that happens in deals and that's disclosed and that you need to analyze.

Let's move on to doing some analysis now.

Now I've got some slides on this, but I don't actually want to use the slides because I feel, let's just get into doing the calculation.

Before we just launch into the calculation though, let's think about what we are doing here.

We want earnings per share, accretion or dilution.

So accretion simply means increase dilution simply means decrease.

And what I'm comparing is I'm comparing the earnings per share of the acquirer before the deal.

So if we go to row 62 acquirer's EPS, if there were no deal, if the acquirer just carried on as a standalone business didn't buy the target, what is their forecast earnings per share.

I then wanna compare that to the proforma earnings per share.

Now proforma means after the deal.

So I compare the acquirer's EPS if there's no deal versus the proforma EPS.

If we do a deal and I wanna see is the situation better or worse having done the deal.

So because I need earnings per share, I need two things.

I need total earnings and I need total number of shares and I've got that for the acquirer based on their forecasts.

I've got the acquirer's earnings per share forecast and I've got their weighted average shares outstanding. That's what WSO stands for.

Weighted average shares outstanding, right? So I've got the pre, I mean let's actually put this in right now.

Acquirer earnings per share.

If there's no deal acquirers earnings per share, if there's no deal, it's row 45.

Now what I need is the proforma earnings per share.

And to get the proforma earnings per share, I need two things.

Proforma earnings.

So combined earnings of both companies plus synergies after the deal.

And then I need proforma number of shares outstanding.

I've already got proforma number of shares outstanding.

That's what we worked out over here.

That's The 17.8.

If the acquirer funded this a hundred percent with debt or cash, the pro forma shares outstanding would be the same as the existing number of shares outstanding.

But anytime you're financing a portion of the acquisition with equity, you're gonna have more shares outstanding.

So there we go. Pro forma shares outstanding 17.8, just be sure to lock onto that to press F4 to get the dollar signs because that we're gonna copy to the right and we don't want that to increase, to move along and give us zeros.

The last thing we need to do now is to say, okay, well I know how many shares are going to be outstanding after the deal.

What are the earnings going to look like of the combined businesses after the deal? And there's effectively, I wanna say three things. We've gotta do one, take the standalone acquirers net income two, take the targets standalone net income.

So if there's no deal, we've got the acquirers, the targets, we're gonna add those two together in the combined business.

But then we've gotta take deal effects into account.

One of the deal effects is hopefully synergies.

So in m and a we are looking for synergies, okay? Unless it's not a strategic acquisition, but synergies we wanna incorporate.

And then if we are financing a deal with debt, if we are repaying some debt of the targets, we need to also work out the impact on interest because the acquirers need income and the targets need income.

It's on a standalone basis.

So if now all of a sudden I'm issuing more debt or I'm repaying debt or I'm using up some cash, I need to now adjust those earnings to reflect that.

So let's do that. I have got acquirer's net income and I can calculate that because I've got the acquirer's earnings per share and I've got the acquirer's number of shares.

So earnings per share times number of shares.

Ordinarily I would first do a whole year and then copy to the right, okay? But I think in this case, let's just copy each line because it's not that long.

We do exactly the same for the target.

So if there's no deal, okay, earnings per share of the target, if they carry on like there are standalone basis is 0.24 and their number of shares is 33.

And we copy that to the right as well.

So if there were no synergies, if this deal was not financed by debt, okay, we would say Okay, well then that's what the combined earnings are going to be the two added together.

But we've gotta take these deal impacts into account.

So first of all, let's take the synergies into account.

So synergies after tax, okay? We always need to work after tax, right? If I'm working on a net income line, it's not EBIT or ebitda, it's net income must be after tax.

So synergies after tax, let's have a look at what we've got.

We are told that we are expecting five of synergies.

I'm gonna lock onto that F4 because I want to copy it to the right and I don't want it to move and I'm gonna multiply by 1 minus the tax rate because I want it after tax.

And if I am paying, what is it this case, 30% tax at the end of the day, what's gonna make its way into my needs income is only 70% of those synergies.

So I multiply by 1 minus the tax rate and don't forget to lock.

So F4, you need those dollar signs to lock on to these numbers.

And so if you copy that to the right, we've got 3.5 of synergies.

Now, something you might be thinking, we are doing a simple model here, but guys synergies are not normally created from day one, right? Synergies are from things like streamlining the business, cutting costs, getting rid maybe of certain duplicate functions or departments.

That's not gonna happen from day one.

So this would be our run rate synergies when synergies are fully achieved and very often it takes about three years for those synergies to be achieved.

So maybe year one we achieve 20%. Year two we achieve 50%.

And then by year three we have the full synergies being achieved.

Okay? So here we've kept things very simple, same amount of synergy from the beginning, but in actual fact that would probably be built up over time.

Last thing we need to do is we need to then work out the impact of the interest.

So what is happening here? Okay, so what is happening is we're gonna have extra interest that we need to pay.

So I'm gonna have to go add whatever debt I'm bringing on as part of the deal.

So I'm adding the RCF and I'm gonna F4 lock onto that.

I'm gonna add the long-term date and I'm gonna F4 lock onto that.

So that's the date I'm adding in.

So I'm gonna be paying more interest because I'm adding in this date, but then I'm getting rid of the date of the target because I'm refinancing the date of the target target. So I'm going to subtract that existing net debt that is being refinanced.

And all of these have got dollar signs, right? Because we need to lock on to these amounts.

So I'm bringing on new debt, I'm gonna pay interest on the new debt, I'm repaying existing debt, I'm gonna save interest on that in my two figures above those earnings figures.

It's got interest as if this deal has not happened.

The debt stays there in the target acquirer doesn't take on new debt.

So I've gotta manually adjust. So that's the amount of debt.

And then I've gotta multiply by the interest rate, which is here we've got 5% interest rate lock onto that.

So another F4 and then I want this after tax, after tax times 1 minus the 30% tax rate and lock onto that.

So everything is locked because we want, we don't want this to move.

And then the final thing I'm gonna do is I'm gonna make this a negative because it's an interest expense, synergies are positive.

So I'm adding those on here.

I've got this interest expense of 5.1 and now I can work out pro forma net income, I've got the target plus acquirer plus synergies.

I subtract the extra interest because that's gonna make my earnings go down.

And so proforma net income is 24.3 in our first year.

And if I copy that to the right, you should end up with 31.1.

And Now I can do my EPS pro forma.

I can say pro forma earnings divided by pro forma number of shares outstanding.

So earnings per share, copy that to the right.

And then finally we wanna say, well is it expected to be better or worse if the company does the deal or if they remain standalone? So I take pro forma EPS divided by the acquirer's EPS. If there were no deal, I subtract one because I just want the increase or the decrease.

And I can see in this case the deal is accretive earnings per share is expected to be higher if the deal takes place than if the acquirer just is carries on on a standalone basis.

So I think acquirer shareholders would be very happy with that.

Realistically you might be seeing EPS dilution, especially in the first few years until the synergies hit the full run rate.

Okay? This isn't the be all and end all of a deal. There could be maybe very good strategic reasons for wanting to do a deal, but this is definitely something that shareholders would be interested in. What's gonna happen to my earnings per share? Because ultimately that affects dividends per share, okay? It affects valuation of your company.

Any questions before we finish up with the last couple of bits of analysis? Just while you're thinking if there's questions.

Public company, James Mucker buying hostess brands, they did talk about accretion or dilutive and they talked about aside from very good strategic reasons for buying the deal.

And if you look at that Anova one as well, I'm not gonna go there now in the interest of time, but that Anova look, it's so interesting to see reasons why they wanna do the deal and looking at all the documents that are being given to shareholders justifying the deal because shareholders have to ultimately approve the deal and vote on the deal.

They give lots of strategic reasons here.

We have got for the James Mucker and hostess brands, they tell us what run rate synergies are going to be a hundred million achieved within the first two years.

So not a hundred million from day one within the first two years and adjusted earnings per share is expected to be accretive in the first financial year.

So quite a good deal in that sense right from the beginning we're gonna see increase in earnings per share.

Okay, let's move on to the last couple of bits of analysis.

So we need to think about what's gonna happen to the credit rating of the acquirer if they finance a deal with debt.

Because what you would typically not want is for your credit rating to drop.

If your credit rating drops, your cost of financing becomes more expensive because your business is more risky.

So often acquirers would look in the market for comparable credits for comparable companies, right? What amount of debt to EBITDA is acceptable for a certain credit rating? Something they would definitely be interested in as well is the drop from investment grade to sub investment grade, right? If you go from triple B down to double B, you see quite a substantial increase in your cost of financing.

So what we need to think about is what is the proforma after the deal debt to EBITDA gonna look like And then we can say, okay, it's gonna be seven times.

Whoa, that's way too much. Unless we're doing something like a leveraged buyout, which is a different kind of deal, okay? In our industry it's say three times, okay? Normally for public companies it varies by industry, but three times debt to EBITDA for investment grade rating, okay? So we need this pro forma. So we need the pro forma EBITDA.

So I've got the acquirers EBITDA, I've got the targets EBITDA, don't forget here, I need to add in synergies.

And this is gonna be pre-tax because it's before interest in taxes and I don't have to worry about the interest because it's EBIT before interest, right? I'm looking at operational profits.

So I have got the acquirers EBITDA, the targets, EBITDA and then I'm gonna add on the synergies, pretax and synergies.

Pretax we've got up at the top of five, so that's gonna be 181 as the proforma EBITDA.

And then if I compare that to the debt after the deal, debt after the deal, we've gotta take the acquirer's existing debt plus the target's existing debt.

But then as soon as I add the target's existing debt, I'm gonna actually subtract it, right? Because we told that that is being refinanced, that's part of my uses of funds.

So I'm gonna subtract out that target's debt because it's going away, but then I'm bringing on more debt, I'm bringing on the RCF and I'm bringing on the debt funding.

So just like when we did our interest calculation, the debt part of it, this is exactly the same, right? We take away the targets debt, we bring in the new debt and so the debt is gonna be 486.6.

And now what I can do, oh dear, always love it when it copies down my annotations as well.

Okay? Now I can work out a debt to EBITDA proforma.

So I've got debt divided by EBITDA and that is 2.7 times.

So I can now analyze and say yes, if I look at other companies in my industry, they've got credit ratings of double A or A or whatever it is or a minus, okay? And I actually have very similar debt levels, so this should be okay, I shouldn't see a fall in my credit rating.

Now something that in the James Smucker deal they disclosed, which is also very relevant to what we are doing here.

Initially you might have a higher level of debt than you're comfortable with long term, right? Because of the acquisition.

And then part of your strategy is to try deliver a bit, right? And so that is one of the financial highlights of this James Mucker hostess brands deal is they said there's gonna be strong cash flow of the combined businesses to enable rapid de-leveraging because they know if you have a look here, proforma net debt okay is gonna be 8.6 billion and then the proforma net debt to EBITDA is gonna be 4.4 times and they feel maybe that's a bit high and so they're gonna delver rapidly afterwards.

Okay? So definitely important to consider you can't take on that much debt if it's going to really affect your credit rating.

Okay, we enter the final stretch.

If there are any questions, please don't be shy, I'm just keeping an eye on that Q&A pod.

Let's finish off with synergy versus premium analysis.

So if I want to work out is this deal expected to generate value for my shareholders from the perspective of the extra amount I'm paying over the current traded standalone value of the company, I wanna compare that to, okay, well what are the synergies that I'm expected to generate from this deal? And if the synergies are more than the premium you're paying, that feels like a good deal, right? So let's see what the situation is here.

So acquisition equity value, I'm looking at the shares, I'm buying acquisition equity value, we've got an acquisition equity value of 165 and I'm gonna compare that to the market cap just above standalone unaffected traded value is 132 so I can work out the total premium I'm paying, right? You could also do it on a per share basis and then multiply by the number of shares.

But I'm taking that 165, I'm comparing it to the 132.

And so the premium that we've paid not in percentage terms but rather in absolute terms is a premium of 33.

Now I wanna see, okay, well what are the synergies that are expected to be generated? And this is a valuation of the synergies.

I can't just go add up the synergies for the next three years.

I've gotta do a perpetuity valuation because those synergies, it's not gonna just be for the next three years, I'm now making these cost savings in the business and that's gonna continue into the future.

So I need to do a discounting calculation, I've got the wack and then I've got a risk premium.

Now this is a little bit tricky because we saying synergies are a bit more uncertain than other cash flows in the business, right? Because it's not certain that we are actually gonna realize those synergies that we actually gonna make them happen.

So here we've added on it's a bit of an arbitrary figure, just a risk premium to say, look, I would normally discount cash flows of this business at 7%, but actually these synergies are a bit more risky than the rest of the cash flows. They're more uncertain. And so I'm gonna discount buy in this case 10%.

An alternative way of doing it is rather to just do a bit of scenario analysis or take a bit of a haircut on the synergies because it's very hard to decide should that be 3%, 2%, 5%.

So rather playing around with the amount of the synergies applying a haircut or doing some kind of scenario analysis on that.

Now what I'm doing is because I've got the same amount of synergies each year, I'm just doing a perpetuity valuation from the beginning.

If it were different amounts of synergies building up year one, year two, year three, I would have to do like a normal DCF where you'd discount each individual year, separately, year one, year two, year three.

And then once you have a stable amount going forward, you do a perpetuity value and then discount that as well, okay? In this case I have got the same amount of synergies going forward.

And so we are doing from valuations, Gordon's growth formula.

Remember you take your cashflow, you times it by one plus growth and you divide it by your discount rate minus growth.

In our case we assuming no growth in synergies, okay? You might assume an inflationary growth in synergies, but we are assuming no growth.

So this whole part falls away, right? Because there's no growth.

The 1 plus G and the minus G fall away and it's just cash flow divided by WACC.

So the value of the post tax synergies, post tax synergies, we can pick up, we've got above, it's the 3.5.

So 3.5 is the post tax synergies and then present value of those post-tax synergies.

I just divide by the discount rate, okay? And I see that my annotations have started to go awry, which normally happens at this late stage.

So that formula does not look right and now I can say, okay, while I am paying 33 extra over the unaffected value of this company, but in exchange I'm expecting to extract synergies of 35.

And so from this metrics perspective, the deal again looks good because I am creating value of two.

If that were negative, we'd maybe have to go back to the drawing board and say okay, well look we need to either pay a lower premium if we think we can get away with that in the market or we need to try see where could we extract more synergies.

Final thing. And I'm very aware of the time, okay, we've only got five minutes left, but I think I can squeeze in a quick nopats not nopats ROIC calculation.

So ROIC, just to remind you very quickly, I've got my slides here.

If we just go down to ROIC, if we look at roic not in an M&A context, ROIC is nopats divided by invested capital, right? So we look at the operating profit after tax of the business relative to the capital that generates that operating profit, right? So it's all of your sources of financing minus cash or minus any assets that aren't operational.

So if you've got some financial investments for example, if we are looking at it in a deal context, we are looking at nopat of the target.

So nopat of the target plus synergies and then I'm gonna compare that to the deal enterprise value plus transaction costs effectively what has been invested in the deal.

But we do need to take the full enterprise value into account even if we are not refinancing the debt.

And then we compare that to the WACC of the target and hopefully we see a higher value because WACC is a required rate of return.

And we wanna see, okay, well based on this the heroic is gonna be higher than the minimum required rate of return.

So let's finish up our example with doing the ROIC for this deal.

So we've got the targets EBIT of 16 to get nopat, we are just gonna apply that after tax, right? So EBIT times 1 minus the tax rate and we've got our tax rate of 30% all the way up at the top.

Okay? So the targets nopat before synergies is 11.2 and then I've got my post-tax synergies. It's gotta be post-tax because we are looking at noad after tax, so post-tax synergies.

And so we get the adjusted nopat, so the targets nopat if there were no deal plus the synergies, which gives me 14.7.

And then finally I look at, okay, well what is effectively the enterprise value on the acquisition? It's what I'm putting into the deal.

Plus any net debt or any extra things that need to be refinanced.

I include fees as well because that is part of the deal.

So in effect here, it's our actual uses of funds, right? In effect it's our uses of funds, it's that equity value plus the net debt, plus the pension top up plus the working capital I need to put in pay for plus the fees.

So I've taken a bit of a shortcut by not calculating at all individually, it's just that uses of funds.

And so what is the ROIC looking at year one's earnings ROIC is going to be the nopat divided by the invested capital and that gives me 6.2% and I would compare that 6.2% to having a look at the whack of the target.

In this case it's 7%.

So by this metric this doesn't look like a great deal.

So I would be thinking, okay, potentially could I bring that investor capital down a little bit or could I bring the nopat up a little bit? So looking at synergies, so that is 959 my time, which means we have got one minute to spare.

I will stick around a little bit if anyone does have questions that you haven't yet asked.

But please, when you leave the meeting, you should get an automatic popup of a feedback form. Please do leave us feedback, let us know how you found the session.

If you have any questions, please do include your email address so that we can get back to you.

But other than that, I don't think there's anything more for me to say.

Do join us next week.

We are doing LBO fundamentals, so they're looking not at a strategic deal, looking at private equity style deals, so leverage buyouts. So do join us next week if you are interested in that.

Otherwise thank you very much and I hope you enjoy the rest of your days and that you have a lovely weekend.

So thanks very much and hopefully see you soon.