Okay, so welcome.

My name is Maria Weber.

I'm one of the trainers at Financial Edge and I am going to be talking to you today about m and a fundamentals.

I'm going to not, yeah, m and a, sorry.

I all of, I thought I said, uh, valuation fundamentals, which is the thing that I did um, in my last Rex live.

So m and a fundamentals is what we are going to be talking about.

I am gonna be using some materials.

I'm gonna be using a simple m and a model.

If you do have access to the chat, I'm just gonna copy and paste the link to that in the chat.

If you don't have access to the chat, um, you'll find that under topics in Felix, if you go to the Felix live topics.

And then you just have to scroll down to the bottom where we've got the upcoming sessions.

Um, so if you click on topics Felix live, you scroll quite a way down because we've got all the recordings at the top and then you'll see here coming soon m and A fundamentals Felix Live.

And if you click on that, you'll see in the bottom right hand corner there's two spreadsheets, M and a analysis workout empty, and then the answer file, which is m and a analysis workout full.

Please do make this interactive.

If you've got questions as we go, please do ask those questions.

We are gonna be keeping things quite basic, quite simple to give you an idea of what we're going to be doing.

We can't just launch into a model without having a bit of an overview of what we are trying to do and what the key concepts are. So I'm gonna start with an overview, high level of key concepts.

Then using the simple m and a model, we are gonna demonstrate that.

And then we are going to do a little bit of analysis.

I'm definitely gonna be doing EPS accretion or dilution because that is one important metric that people look at when analyzing an m and a deal.

And then that will probably take most of the hour.

If we've got time though, we can have a quick high level chat about some other performance measures.

However, next week's Felix live session, I'm doing that one again, I'm gonna be focusing on m and a analysis. We're gonna be looking at a bit of a more complex model and we are gonna be doing a lot more analysis on that.

Okay, so plan for today, high level introduction and then focusing on EPS accretion and dilution.

If you have any questions, you can put them in the chat or you can put them in the Q and a pod and I'll do my best to answer them as we go.

Let's start off with high level.

What are we talking about when we talk about m and a? We are talking about one company acquiring control of another company.

So we getting more than 50% of the shares. That's typically how we acquire control.

We are also thinking here about strategic acquisitions.

So one company buying another company, so Coca-Cola beverage company buying another beverages manufacturer.

Or recently in the news we saw Pepsi acquiring Poppy, um, uh, like digestive drinks.

So that's what we are thinking about.

We are not looking at leveraged buyouts.

Leveraged buyouts is where we use a lot of debt.

Also where there's private equity involved, it's a fund often buying the company.

And so there we are not so much focused on synergies all the time, okay? Although you can have synergies, but let's not go down that road.

So for now, strategic acquisition, one company acquiring control of another company, very important to make the strategic decision in terms of which companies are potentially good targets for my business to buy.

Once we've made that decision, we've then got two key things we have to assess.

The first is what am I going to pay? That is the valuation.

The second decision is how am I going to finance this? Where am I gonna get my funding from? If we start with the valuation, valuation in an m and a context is like valuation, I would say in any other context.

When we think of, think about things like equity value versus enterprise value.

That's what we covered in valuation fundamental sessions a few weeks, a few weeks back.

You can watch the recordings on that if you're not clear on the difference between equity value and enterprise value.

So conceptually it's the same, but the difference when we are looking at strategic m and a is that we need to pay a premium.

We need to pay a premium for acquiring control of the business.

I'm not just buying a little minority stake.

So I'm not doing a standalone traded valuation, I'm looking at acquiring control.

So we pay a premium.

Now if this is a listed company that we are buying, we can't just pay whatever the share price it's currently trading at is.

We need to pay a premium to that.

And the price we pay is called the offer price per share.

We've gotta multiply that by the number of shares that we are buying.

Like I said, more than 50%, very often we buy all of the shares and that gives us the acquisition equity value.

It's then also very useful to know the enterprise value of this deal that we are doing to work out the enterprise value from equity value.

Remember we add any other funding in the business, any other debt like instruments, and we subtract cash and financial investments.

So we take the equity value and we add on net debt. So that's same going over the bridge.

The reason having the acquisition EV is so useful is we can then work out what's the acquisition multiple.

We can compare that to other similar deals that have been done recently.

We also use enterprise value very often to calculate the fees.

So fees are often a percentage of the EV of the deal.

Okay, so decision one is what is the valuation decision Number two is, okay, now I know what I'm paying.

How am I gonna pay for this? The financing decision, and this is where we're gonna do a uses and sources of funds table under the uses of funds, we've got the equity purchase price.

That is what I'm paying.

Now we assuming here that you're buying the shares of the company, acquisitions can also be structured where you buy the assets and liabilities.

So say for example, you're buying just a division of a bigger company, you buy the assets and liabilities, okay, we are not gonna get into those complications.

Now we buying the shares.

So I need the price, I'm gonna pay to the targets shareholders.

That's the funding that I need.

I've got two main choices when it comes to raising money to pay for the acquisition.

The first one is debt.

So I take out a bank loan or I issue bonds.

If I take out debt as the acquirer, I get cash and the selling shareholders, the target shareholders get cash in exchange for their shares, they give me their shares, I buy them, they get cash and they walk away.

The other thing that I could do is I could use equity to pay for this acquisition.

Now we know equity means shares, right? So I'm gonna issue shares.

Typically what happens in an acquisition scenario though is instead of issuing those shares for cash and me then taking the cash and paying the sellers, I actually do what's known as a share for share exchange.

And that is where the sellers of their shares get shares in the now enlarged business.

That is called a share for share exchange.

Now, when you do a share for share exchange, you get something called an exchange ratio.

And I'll show you a practical example of this when we look at a deal announcement.

But that exchange ratio we just working out, okay, for every one share, the sellers are selling to me.

How many new shares am I giving them in my company? And remember, my company's now gonna own their company as well.

So that's a share for share exchange. Okay? Now very often if you have a big deal, you're gonna use a mixture of the two.

You're gonna use some debt and you're gonna use some equity.

Any questions guys, please do ask.

I had a good question coming out of the previous session.

Any question's? A good question, right? So please don't think about before you ask a question, is this good or bad? Any question is good. But a question from the previous session, someone said, okay, well what determines how much debt, how much equity you use? Now, ideally we'd want to use as much debt as we probably could because debt is cheaper than equity, right? From a required return perspective of the capital providers, they require a lower return on the debt.

We also get a tax deduction on the interest.

So debt is cheaper than equity, but we are constrained by something called debt capacity.

I can't just lever up super high because that then would have an impact on my credit rating.

The more risky my business becomes, the lower the credit rating, the higher the cost of my financing becomes.

And so one of the metrics we will consider is what happens to my debt And that we definitely gonna have a look at next week. So impact on your credit rating. Okay? So ideally you wanna try, use as much data as you can, but you're gonna be constrained and then you have to use equity.

Now in reality, and we're gonna see this in the model we're gonna look at now, which we'll move to in a minute, the sources and uses of funds table is a little bit more complex.

In addition to buying the shares, the equity purchase price that we've just seen, I need to buy the shareholders out.

I also need to think about whether I need to refinance the debt of the target.

Often loan agreements will have what's called change of control clauses, which means that if the ownership of the company changes, that loan has to be repaid.

So in an acquisition scenario, it often triggers those change of control clauses.

So not only do I need to come up with enough money to buy out the shareholders and pay the equity purchase price, I also need money to repay the debt.

And we say here, net debt, because remember that's debt minus cash.

So any cash in the target I could use to pay off the debt and then I can um, uh, come up with funds to repay the remainder.

Okay? I might also want to repay the debt because maybe I can raise financing at a cheaper rate.

I also need to pay transaction fees, lawyers, bankers, accountants.

There could be some other adjustments I need to make OWC operating working capital, we'll talk about when we look at our model.

And then there could be other things that I have to pay for, like if there's a pension deficit and we'll talk about that in our model in a moment.

So I need to come up with enough funding for this.

We've already said two types of funding equity or debt that we could use.

We also have to think about whether we as the buyer have a lot of cash lying around.

We could use existing cash that we have that's not earmarked for anything else.

And then a revolving credit facility is another kind of debt but that we would normally use for short term fluctuating things.

And we are gonna see this in our model right now.

So any questions please ask.

I'm just gonna copy and paste the link to the materials one more time in the chat.

Just 'cause if you have joined since I first posted it, you won't see that.

If anyone's having a problem navigating there, please just let me know.

But under Felix topics, Felix live and then you will find the um, m and a session for today.

And then at the bottom of that we've got m and a analysis workout empty.

The recording will be available.

Um, normally it's posted I think Monday, Monday morning, uh, UK time roundabout there. So the recording will be made available. Great.

And you'll find it in exactly the same place. Topics Felix live, all the recordings are there. Perfect.

Okay guys, solution file is there.

Let's have a look at what we've got loads of exercises.

You can work through them all to consolidate your knowledge, but I'm gonna work on the fourth tab here.

M and a cash deal.

So m and a cash deal and it's cash deal one, cash deal two's just got slightly different numbers as an opportunity to practice what we've seen before we launch in.

Let's just get a feel for what's going on here.

Up at the top we've got our acquisition assumptions and valuation, right? So remember we said decision number one, we have to work out how much we need to pay for this target.

So that's the top part.

If we navigate down, we've got some other assumptions like what are synergies, what's the tax rate, what's the financing cost? We've then got our sources and uses of funds table.

So what we were just talking about, I need X amount of money, how am I gonna raise that? Then we have got the analysis bit.

Next week I'm gonna focus on just the analysis, but let's at least today do EPS accretion or dilution EPS earnings per share.

I wanna compare if the buyer does not do the acquisition, what would the earnings per share be if we do the acquisition, what's the impact on earnings per share? And shareholders would like to see an increase in earnings per share.

Not always possible, okay? But we can do a little bit more analysis on that Next week.

Starting up at the top we have got the current share prices of the acquirer and the target that share price of four of the target that we are buying is what's called the unaffected share price in the market at the moment.

And we've estimated, and you can see this is an assumption, 25% premium is what we're gonna have to pay to convince, convince all those shareholders to sell and for us to gain control of the business.

That is not set in stone. That's why it's an assumption.

And that's one of the things that we'll flex and you know, do some sensitivity analysis around generally between 20 and 40% premiums are paid.

So we can work out what is the acquisition price per share, the unaffected price of four times one plus 25%.

I have got an acquisition price of $5 per share.

Now we've got a little bit of a complication on the right hand side.

On the right hand side, sure. Sorry guys, I've just seen um, the web link for the Excel workings.

If you don't have, um, sorry I've just clicked on it by mistake.

If you don't have access to the chat, let me just see if I can copy and paste this into the q and a pod.

I think if I type an answer to that, okay, so just let me know. Hopefully if you've ans asked that in the q and a pod, I've now got the link there as well.

So just let me know if that's not working.

We have got a little bit of a complication here now and I don't wanna get sidetracked by this because the purpose of today is m and a.

It's not working out diluted number of shares.

But on the right hand side we've got this dilution calculation.

I'm gonna do it really quickly.

For those of you that have seen it before, we can quickly do it, but if you haven't seen it before, you can just type the answer in this.

If you're interested. If you go to the trading comps playlist under valuations in Felix, this is gonna be videos seven to 11 if I'm not mistaken.

So if you wanna look at this dilution calc video, seven to 11 deals with this in trading comps.

What we are gonna do is we look and and say okay, at the moment in the company there's 31 million shares outstanding.

But we've gotta look, are there any employee stock options that are outstanding that are going to be um, in the money people gonna exercise them.

And so actually there's gonna be more shares outstanding.

This is my dilution calc.

So very quickly I know it's gonna be too quick for those of you that dunno what this is.

So just ignore me, okay? And you can just type in the answer.

I take the maximum of zero and the difference between the acquisition price of five, the strike price of three, I divide that by the acquisition price of five and I multiply it by the number of options outstanding.

And that gives me a dilution figure of two.

So like I've said, please don't panic if you didn't get that two, it is a round two so you could just type in two.

But what this effectively means is I'm gonna have to buy out not just the 31 million shares that are currently outstanding.

I'm also going to have to buy the two shares that are now going to be outstanding as a result of people exercising their stock options.

Okay, so the number of shares I need to buy is 33 million shares.

I can now work out the acquisition equity value.

I'm just gonna skip over this market cap line.

We don't need it for now.

So I am paying $5 per share, I'm gonna buy 33 million shares.

And so the acquisition equity value is 165.

So just going back to our slides, if we think where are we? What have we just done? We have just done this very first bit.

We have worked out acquisition equity value, we are gonna go over the EV bridge and work out what is the enterprise value.

So let's do that.

I'm told that in the target, the existing net debt is 40, whether I have to refinance that or not, it still goes into my EV calc because I'm gonna do a bit of analysis. Maybe I'm gonna say what's the EV multiple, I need the EV to work out the fees so that 40 goes into my bridge and then this pension deficit adjustment.

This is a debt like item.

Yes, it's not a loan like from a bank, but it is a financial debt obligation on the company.

They've got a shortfall in their defined benefit pension scheme, which means they actually are on the hook for more pension payments than the assets that they have.

So that's a debt obligation.

So going over the bridge, we've got the end, the equity value.

I add to that, any other financing items.

So the debt and the pension deficit and I would subtract cash, but I've already got net debt and I would subtract any financial assets which we don't have here.

So we have got acquisition enterprise value of 225.

Let's just take a minute to talk about this working capital adjustment.

When this company is being bought, we are expecting it to have at the time of closing when we actually execute the transaction to have more working capital than on average.

On average. I mean working capital fluctuates throughout the year. Think of something like um, inventory.

If you are a manufacturer, a retailer, you would have more inventory in the buildup to a holiday season.

So my valuation is based on like an average inventory level, but if when I actually execute the deal, there's more inventory there, I'm gonna have to pay for that as well. Well, so think of it, it's like buying a car, but you buy the car and the gas tank is full, there's some extra value there, right? Extra thing I have to pay for.

So that is the working capital adjustment.

This is relevant for my uses of funds table.

So let's have a look at that now please guys, don't be shy to ask questions either in the question an answer pod or in the chat if you have access.

So our other assumptions we're gonna skip over for now.

Let's have a look at our sources and uses of funds.

First things first, I definitely need money to buy out the shareholders.

Okay, so let's go get my acquisition equity value acquisition equity value from row 12 is the 1 65 that I'm gonna pay the shareholders to take them out.

We are assuming here that we are going to be refinancing the net debt.

That is often what happens.

So in addition to the 1 65, I need another 40 to pay the banks back.

What I also have to do is I have to top up the pension plan, the pension regulator as part of the deal. There's lots of approvals and stuff that you have to get.

They would say okay, this plan is in deficit.

You need to top that up.

Okay, so we are putting in another 20, we need money for that.

We then need money for this extra working capital.

So that was that 10 adjustment that we just spoke about.

And let's not forget the fees.

That's where the bankers come in, the lawyers, the accountants.

So the fees we are estimating, and you can see these are assumptions estimating at half a percent of acquisition enterprise value.

So acquisition enterprise value, I've got in row 15 and so my total uses of funds is 236.1 million.

So this ties in with the slide that we were looking at here.

The more complicated, more realistic version, equity purchase price, plus I'm refinancing the debt plus the transaction fees. Plus I've got an OWC adjustment and then I've got other claims on the business like that pension deficit that I'm gonna have to top up.

Let's now look at the right hand side.

Where am I gonna come up with this money? You could approach this by working out the amount of debt you can take on.

So you could approach this by saying okay, what's the maximum debt to EBITDA ratio I think this company can have? What do we have at the moment? So how much debt can I take on? And then the balancing figure would be equity.

Or you can say okay well I'm going gonna use 30% equity financing and the remain I'll finance with debt.

We'll obviously then have to check that that's within your debt capacity.

Now an important thing to note here is this 30% equity financing.

Remember we said this is where the seller's shareholders get given shares in exchange for the shares that they're giving up.

That 30% equity financing is only going to be applied to the equity acquisition value because I'm buying shares from the shareholders and I'm issuing shares in my company in exchange, I'm not gonna use that share for share exchange to pay back the banks to pay back the debt to pay the fees.

So that 30% applies to the equity price that I'm paying.

So let's work out the equity funding then equity funding is going to be 30% of that equity purchase price.

So that's 49.5 million.

Then I've got two types of debt here. I've got debt funding.

So you can think of this as long-term bank loans or bonds.

And then I've got an RCFA revolving credit facility is typically used for shorter term things, things that fluctuate because you use it, you repay it, you use it, et cetera.

So this RCF is going to be used for that working capital adjustment.

So the revolving credit facility, we've got the working capital adjustment being financed by the RCF and now we can work out the debt funding as being the remainder.

I need to come up with a total of 2, 3, 6 0.1.

I've already taken care of 49.5 of that.

I'm gonna give shares in exchange for that amount of value and I've taken care of 10 of that.

I'm gonna have an RCF that covers that.

So the amount of debt that I'm gonna take out is gonna be the 1 76 0.6, right? Any questions? Please don't be shy.

Before we go further with this, let's look at a real deal announcement.

Okay, so I mentioned for example, Pepsi buying that soda poppy.

Um, but the deal announcement unfortunately doesn't disclose a lot of information.

So a deal that I was previously looking at that I really like, um, is it's from the end of 2023.

I think it closed November 23.

Um, so not that old year and a bit um, JM Smucker company.

So JM Smucker, if we look at just what they do, for those of you that are not familiar with this, I think if you're in the US you probably would be familiar with their products.

JM Smucker, they do here a nice summary.

They manufacture and market branded food and beverages products, okay? They've also got a bit of pet food.

So branded food and beverages.

If you look at these brands, okay, they've got some coffee, they've got these spreads, the peanut butter, the jams, there's this pet food, this section over here, the Twinkies that they acquired in an acquisition.

So they bought Hostess brands and Hostess Brands was the maker of Twinkies.

Now Hostess Brands was a listed company and JM Smucker is also a listed company.

So if we look at their press releases we've got here, um, if I just go to when this deal was announced, there we go JM Smucker to acquire Hostess Brands.

Let's look at some of the language that's used, some of the things that we are looking at.

So first of all, there's lots of strategic reasons for them wanting to buy this, right? So the compelling strategic rationale, okay, we are not looking at that in detail now, but they are buying hostess brands for 34.25 per share.

And they financing this using a mixture of stock and cash.

They tell us this represents a total enterprise value of $5.6 billion and then there's 900 million of net debt.

They give us the multiple that's implied by this enterprise value. Looking at the EBITDA of hostess brands 17.2, we can then if we are doing those of you that have heard of transaction comps, if now I'm advising another company in the similar space that would be um, advising on this uh, kind of deal, I can look and say, okay, well a recent deal, 17.2 times, that's what it was done at, okay? Um, then we have got, I'll go back to the synergies in a moment.

Let's see that 34.25, how it's being paid, we said a mixture of cash and shares.

So each hostess, shareholder, hostess, branch shareholder for selling their shares, they're gonna get $30 of cash and then they're gonna be given Smucker shares to the value of $4 25.

And looking at what Smucker share price was when this was announced, we had a share for share exchange ratio of 0.3002 of Smucker shares for every one share that I'm selling.

So that's my exchange ratio.

How were they financing that cash portion? The cash portion funded through a combination of cash they had lying around cash on hand, a bank term loan and then bonds.

Okay? So they're getting that cash from debt and some cash they had lying around.

Sure, someone asked if I could share the link to this, I can do that.

You can find it in Felix.

But just for ease of reference, what I can do is I think if I click on that you should be able to even see my highlights.

So let me put that in the chat and then I'll put this in the Q and A pod as well just in case.

Let's see if that's gonna work. Great, that should work.

Let me know if it doesn't.

Okay, so this is very similar to what we seeing here, right? We're using a mixture of cash and shares and what we need to think about now guys, anytime you welcome, anytime we are issuing shares, we've gotta think about first of all, what's that going to do to the control in the business.

So here looking at ownership dilution and second of all, we definitely need to know how many shares are being issued because I need to work out earnings per share after the deal.

I need to work out what the EPS is post deal.

So let's have a look at how many shares would need to be issued and then how many shares are gonna be outstanding in total.

So the new shares that I need to issue, I am paying 49.5 million in value using my shares.

I'm JM Smucker, I'm paying hostess brands 49.5 million using my shares share. So how many shares do I need to give to the host, desperate and shareholders to make up a value of 49 and a half million? Well if the total value I need to give is 49 and a half million, I'm just gonna divide that by what my share price is now.

So total value of 49 and a half each of my JM Smucker shares are worth $18.

So that means I need to issue 2.8 million new shares.

That's for the share portion.

The remainder I'll give to them in cash to work out the total number of shares that are now outstanding in the acquirer.

The acquirer already has 15 million shares outstanding.

Those aren't going anywhere. James Mucker, that's their shares. 15 million shares outstanding.

In addition, they are now issuing two 2.8 million new shares to the old hostess brand shareholders.

So in total there's gonna be 17.8 million shares outstanding.

Something we would just wanna look at is what's the balance of existing shareholders in the acquirer versus the new shareholders we are letting in.

So existing shareholders have 15 million shares out of a total of 17.8 million.

So they own 84.5% of the now enlarged company and the new shareholders coming in, they own the balance which is 15.5%.

So that is something we would wanna keep an eye on because if that goes below 50%, then actually the existing shareholders are losing control of the business.

Okay? So we just keep an eye on those control percentages.

We also need this pro forma shares outstanding for the next section that we're gonna be doing, which is earnings per share, accretion or dilution.

Any questions please ask.

I'm gonna skip over relative PEs, but that's quite an interesting analysis to do.

I'll do that next week in our m and a analysis focus session.

Let's end off today 'cause I'm keeping an eye on the time as always, always for me flies by, but I think that's 'cause I'm just talking so much.

Maybe it doesn't go as quickly if you're listening but with our EPS accretion or dilution looks like a complicated calculation.

But big picture, if I wanna work out earnings per share, I need two things.

I need total earnings, net income and I need number of shares.

I wanna work out the proforma earnings per share.

Pro forma just means after the deal.

What is this gonna look like to work out after the deal pro forma earnings per share.

I need to know what is net income gonna look like after the deal.

And I also need to know the pro forma shares outstanding.

The good news is we've already got the pro forma shares outstanding.

We just worked out over here the buyer, I'm looking at this from the buyer's perspective.

So say in this case JM Smucker buying hostess brands after the deal, once they've paid for everything, they're issuing 2.8 million more new shares, they're gonna have 17.8 million shares outstanding in total.

So that's the proforma shares outstanding, the 17.8.

So let's put that in and I'm going to press F four or function F four to lock that because I want to copy this to the right because we're gonna do the EPS for all the forecast years up to year three.

So to make sure that when I copy to the right it doesn't move, I'm gonna lock it.

Okay, so we've already got the number of shares outstanding.

So now we need the pro forma net income, pro forma net income.

This is consolidations, right? The group after I buy the target is gonna consist of the buyer's net income as if they were standalone.

So JM Smucker standalone company, they're gonna carry on what would their net income be? I'm then gonna add to that, okay, now what is the targets net income? If they remain as a standalone company, what's their forecast? Net income? I'm gonna add the two of those together because now we are gonna be part of the same company effectively.

So let's start by doing that.

Acquirers net income, if you go up to row 44, I've got for the actual, so historic and then forecast year one, year two, year three, earnings per share and weighted average shares outstanding.

So number of shares and earnings per share.

So I can work out the total need income by saying earnings per share times the number of shares that's gonna give me total net income.

I'm just gonna copy that to the right and I do exactly the same for the target.

Therefore cost earnings per share. If they remain as a standalone business, this is what's expected to happen.

Their weighted average shares outstanding.

Let me multiply the two together to get the total net income for the target.

So part one of working out the pro forma net income, I take the buyer's net income and I take the target's net income, I'll copy this all to the right at the end.

Okay? So that's like consolidation.

One company plus another company.

Now we've got this enlarged net income, but what I also have to consider is what about the deal effects? These earnings forecasts that I've got here offer the two companies if they carry on operating separately.

Now I've gotta think about, okay, if I bring the two companies together, what's gonna change? There's hopefully gonna be synergies, right? Strategic acquisitions, I'm looking for synergies, cost savings, potentially revenue synergies.

So synergies I wanna bring in and you can see here, be careful we need to work after tax because net income is your very bottom line of the income statement after tax.

So synergies we've gotta make sure are after tax too.

Now I've got this assumption for synergies up at the top here we are assuming that synergies are going to be $5 million per year.

So that $5 million I wanna lock onto.

So I'm pressing F four but that's the synergies before tax.

I want the after tax synergies.

So I multiply by one minus the tax rate, okay? The tax rate that we have got is a tax rate, I think it was 30%.

I'm gonna press F four to lock onto that as well because we're gonna wanna copy to the right.

And so I have got after tax synergies of 3.5 million per year.

So 5 million is the synergies before tax.

I've gotta give 30% of my profits to the tax authority. So I'm left with 70% in my bottom line.

A question from the previous session, was we including the synergies from the start, is that realistic? The answer is no. We are keeping things very simple for now.

Next week we've got a model, if I remember correctly, that builds up the synergies because think about it, cost savings for example, you're not gonna buy the company.

And then day one, the cost savings are immediately realized.

It takes time for the synergies to be realized.

And so what we would normally have is a buildup to the full synergies.

Going back to our JM Smucker announcement, the Smucker announcement, if I just hide my annotations there, um, they talk about annual run rate, cost synergies, run rate cost synergies of a hundred million.

So run rate means fully achieved and they say it's gonna be achieved within the first two years.

Okay? So maybe, I don't know, 50% in year one and then the balance full run rate in year two.

Okay? So we normally see a bit of a buildup to synergies.

So we've got synergies that we are now adding because these two standalone companies, earnings forecasts didn't include that.

So let's add the synergies in and then we've gotta think about, okay, how are we financing this? Because if I'm using debt finance, I'm gonna pay more interest than what has been built into my standalone forecasts.

If I am repaying interest of the uh, repaying debt in the target, I'm gonna be saving interest.

So if I have a look at my financing bit, I've gotta build in that, okay, I'm gonna have an RCF of 10, I'm gonna have a long-term bank loan say of 1 76 0.6.

This is new date coming in to James Mucker, right? The acquirer and Gaza.

I'm using James M as an example. These are hypothetical numbers, right? It's not that exact deal, it's just the deal announcement that I use just to avoid any confusion.

Um, so I'm bringing on new debt, the 1 76 0.6 and the 10.

So more interest is gonna be paid than what I've currently got in my forecasts, but I am repaying the existing debt in the target.

So that is going to reduce the interest 'cause I've built into my forecast for the target, the debt of 40 that's not gonna be there anymore.

So I'm gonna net these two amounts off and then I'm gonna apply the interest rate which we've got, which is 5% and I need to take that after tax, okay? Because remember we working in net income.

Net income is after tax.

So let's do that, right? I'm gonna open my brackets, I need to press F four, get dollar signs for everything because we are gonna copy this to the right and we don't want it to move.

So let's go pick up the revolving credit facility F four onto that.

Plus we are gonna pick up the debt funding F four lock onto that.

So that's increasing the debt in the business, but I'm going to subtract the existing debt of the target 'cause that's going now.

So I'm not gonna be paying interest on that anymore.

F four lock onto that.

And then we want the interest on this debt.

So I'm multiply by the interest rate and if we go to our assumption section, I've got in row 21 the 5% that I'm gonna lock onto as well.

And then don't forget, we want the interest after tax.

I get a tax break on my interest expense tax is 30%.

So that means effectively I only actually pay 70%.

So my 30% tax rate, I'm gonna F four lock onto that as well.

And that gives me 5.1.

Now I've gotta do one more thing here because this is interest expense, right? I've got new debt, yes, I've repaid a little bit of debt, but on balance I've got more new debt coming on.

This is an interest expense so I need to make this a negative.

So I'm just gonna multiply that by minus one.

And now I've got my proforma net income. After the deal, after the deal the combined entity is gonna have the acquirer's net income, the target's net income.

And then because we're doing a deal we hadn't yet built in any synergies in those two lines above.

So I bring in the synergies and then I've also gotta look at the deal financing.

If I'm using debt, I've gotta look at what that that's doing to my interest in my income statements and I'm going to be paying 5.1 million more of interest every year.

So that gives me 24.3 million as my pro forma net income.

We've already worked out our pro forma shares outstanding, we've worked out that 17.8. So this is the second element of the financing impact.

If I pay with equity, I issue more shares.

So I've gotta take that into account, which I have.

And now my pro forma EPS is looking at the pro forma net income divided by the pro forma number of shares outstanding.

And that gives me 1 37 for the combined entity.

The reason I wanna do this is so that I can say, right, if we do this transaction on these terms, this is what the earnings per share is expected to be after the deal.

I'm gonna compare that to if we don't do the deal, if we don't do the deal, we carry on as we were, what is our earnings per share expected to be? And that comes from ROE 45 And I wanna see what's the difference.

Is there accretion, which I hope to see, which is an increase in the earnings per share or is there dilution a decrease in the earnings per share? I take EPS after the deal proforma divided by EPS before the deal or if there's no deal and I subtract one because I just want the percentage change uh, on top of the a hundred percent and that gives me a 14% increase.

Let's select everything and if we've done all of our locking of cells correctly, if we copy this to the right, you should hopefully be seeing the same numbers as me. Don't worry if you're not, you've got the full answer file. Hopefully I've done everything correctly and yep, I think that's looking good.

If we copy to the right, we can see that we've got 14% and then 18 point a half, 24% and 26%.

So by this metric, and to be very clear, this is just one way we will analyze a deal, but so far this is looking good, right? The buyer shareholders will be better off from an earnings per share perspective after the deal versus if there is no deal and for public companies, this is something that they very often disclose.

Okay? So we see here, if we go back to our James Mucker hostess brands deal announcement, they talk about adjusted earnings per share expected to be accretive in the first fiscal year.

Often it takes a while to become accretive.

If it becomes accretive because of that synergy buildup, right? We don't get synergies straight away from day one.

So what you might see in the first couple of years is a bit of dilution and then you could see the accretion.

Are there any questions on this before we, we've got 10 minutes or so.

We should maybe just look at the debt ratings and calculator debt multiple.

We can think about that. Any questions before we do that? Okay, if not, let's use our last 10 minutes and talk about proforma debt ratings.

So a typical debt metric that we look at is debt to ebitda. So it's a multiple, how many times higher than EBITDA is the date? The higher it is the more risky the company is because they have got more financial obligations.

So if we look pre-deal, the acquirer had EBITDA of 1 56, they had date of 300.

So debt divided by EBITDA is 1.9 times.

If we look at the target, what was their position looking like before the deal? They had that debt of 40 and they had EBITDA of 20.

So EBITDA, earnings before interest tax depreciation and amortization.

So they were at two times.

Let's look for the combined entity.

So pro forma, remember pro forma meaning after the deal we need to take the new data into account and we also need to look at the impact on the earnings as well, right? So if we first look at the ebitda, do we agree I'm going to have afterwards combined business acquirers EBITDA plus the targets EBITDA plus don't forget about our synergies, that's not built into the 1 56 and the 40.

So to go find our synergies, we go up to assumptions and that's five.

We don't take this after tax because remember EBIT is before interest and taxes.

So EBITDA before interest and taxes.

So that's 180 1 pro forma and we don't build in the interest either, right? Because it's before interest.

So that's the pro forma and then the pro forma debt.

Let's think from a consolidation perspective what's happening here.

So I've got the acquirer's debt of 300 plus the targets debt of 40.

But wait a minute, we said we are repaying the targets debt.

So I'm gonna go subtract that 40 that I'm repaying so that 40 just cancels out.

And then I've gotta add in the revolving credit facility and the debt funding that I'm bringing on.

And so the proforma debt is 4 86 0.6 and now we can look and say well after the deal, what's the leverage expected to be? The debt is 4 86 0.6, the EBITDA is 180 1 and that gives me 2.7 times.

We would need to do a little bit of analysis around that.

We would need to look and say, well at the moment the acquirer the buyer, 'cause normally it's the buyer that takes on the debt to fund the deal, it's done at the buyer level.

So they had 1.9 times. This is quite a big increase, right? They're going up almost by one.

So to 2.7 times, would that lead to a drop in their credit rating? And if so, would it go below investment grade? Because if it goes below investment grade, which is triple B, you see quite a sharp increase in your borrowing costs because you then much more risky if you sub investment grade.

So for this you need to do a little bit of, you know, credit analysis in terms of comparable companies.

You would also need to engage with the rating agencies as the buyer if you are going to be pushing your leverage up a lot.

Generally for like an industrial public company, three times debt to EBITDA roundabout there is fine for investment grade.

It obviously depends on the industry.

If you're more cash generative, you can afford a higher debt to ebitda. But the 2.7 times, but what you'll often see in announcements where debt is being used to fund the deal is something like this.

So here we see an emphasis. If you look at the financial highlights up at the top we see this emphasis on strong cash flow of the combined businesses to enable rapid de-leveraging.

And then at the bottom here we see for the hostess brands, James Mucker deal proforma total net debt estimated at the closing date will be 8.6 billion.

Pro forma debt to EBITDA ratio will be approximately 4.4 times.

That's pretty high. The company intends to maintain its balanced capital deployment model along with an investment grade credit rating.

So the rating agencies will often say, okay look, we know this is gonna be temporarily higher, but they'll keep an eye on you actually de-leveraging that.

So it's not to say, oh immediately now you're at 4.4 times you're gonna have a drop in credit rating.

It would be assessed and normally they give you, you know, if you are de-leveraging, they would take that into account.

Okay, so guys, that is um, one of the metrics to sum up.

I think I'm gonna leave this here.

Um, because to get into the synergies, I don't think we have enough time for that.

So let's just have a quick recap of what we have seen and what we've spoken about.

And if there's any questions then please do ask.

So first things first, we said we need two make two decisions.

One is the valuation decision and the other one is the financing decision.

But bigger than all of that for m and a is strategic rationale.

If you look at that James Mucker press release, you'll see the strategic rationale for the deal.

Okay? That is a very important part of it.

Financially though, yes, we've got the valuation and the financing decision.

We do a sources and uses of funds, table uses of funds, we gotta pay the shareholders out equity purchase price and then we also likely gonna have to refinance the debt, pay for transaction fees, maybe make OWC adjustments and other adjustments like pensions.

Where do we get the money from? We might have cash on hand that we can use.

James Mucker had some cash.

We might then have to take our debt for the remainder if we are paying cash to the target shareholders and RCF potentially for working capital.

And then equity, that's your share for share exchange.

And then from an analysis point of view, okay, we are not going to get into all of that.

The one thing we looked at is EPS accretion or dilution. We hope to see an increase in earnings per share as one of the metrics.

And then in next week's session we'll look at EPS again for a bit of a more complicated model and then we'll look at credit ratings, synergies and return on invested capital.

Okay? So I'm gonna leave things there.

I will be here for the next few minutes if anyone has any questions.

Otherwise, thank you very much for your attendance and please do get in touch if you have any follow on questions and I hope to see you next week.

So thanks very much and enjoy your weekends.