Hi everyone.

Welcome. Thank you for joining.

My name's Maria Weber, I'm one of the trainers at Financial Edge and I'm going to be taking today's session on m and a fundamentals.

So to get started, um, I'm gonna just talk through the plan for the session.

We've got an hour.

I definitely will not take longer than an hour, but we'll see how much we can get done in that time.

I am gonna be using an Excel exercise, so as is in the name, the purpose of today's session is to go through the basic principles of m and a.

We are not getting complex here.

We are going to start off with just giving an overview of the key concepts of m and a before we then dive into doing a simple m and a model.

Now, the reason we do an m and a model is to do some analysis on that model and we'll do as much of this analysis as time allows, but realistically we'll probably only be able to do EPS impact properly together.

I'll try have a look at the debt side of things as well.

And then you've got the solutions for synergies return on invested capital.

I did do a Felix live session, I think it was a few months ago now, specifically on analysis of m and a. So it was a bit more complex than today's session.

Um, but if you just go back to exactly the same place your topics Felix live and you scroll up, you'll find something called m and a, the analysis.

There we go. If you wanna go a bit deeper into the analysis, okay? But today we keeping things pretty high level, pretty basic, introducing fundamental concepts and doing a bit of the analysis.

Now before we dive into the details, let's be clear what we are talking about here.

We are talking about one company buying another company and obtaining control of that company.

So an example recently announced in the press, and I'll refer you to the presentation at the end of class. It makes for very interesting reading, Keurig, Dr. Pepper, big US beverages company.

They recently announced that they are buying pizzas, which is a coffee company, right? So one company buying another company.

So we would expect things like synergies, there's gonna be a strategic reason for the deal and then we do financial analysis around that to see does the deal financially seem to make sense? We are not talking about a private equity fund buying a company, right? We are not doing leveraged buyouts that we've got a session coming up on in the future.

Okay? So let's start off we're saying right? One company buying another company.

First decision you need to make is to identify a target, right? What's a suitable target? Does it fit our strategy, et cetera.

Then we've got two decisions we effectively need to make.

The first decision is how much we are going to pay for this company and that comes down to the valuation.

And then the second decision is, okay, how are we gonna pay for it? How are we gonna finance this because we can't make an offer for a company unless we can actually finance the deal.

Let's deal with the first of those two in concept and then we'll do our model.

So valuation in an m and a context is the same as valuation in a non M and a context, except we are looking at the price we are going to have to offer her share.

That is going to be different to the traded share price for a public company, right? We are going to have to offer a premium in order to convince all the shareholders to sell and we are going to have to pay more than the traded share price.

We are gaining control of the business.

We likely gonna get synergies and then we can do a bit of analysis to say how much premium are we paying versus the synergies we expect to get.

Okay? So first things first, we're gonna have to pay a premium to the standalone value of that company.

If we take the price we pay per share and the number of shares that gives us the acquisition equity value.

It's also very useful to know the enterprise value.

And so we go over the bridge here, you need a bit of valuation knowledge.

So to go from equity to enterprise value, we add on the debt, we subtract the cash and that gives us EV enterprise value is useful to have.

We often calculate fees on the basis of enterprise value.

As you're gonna see in our model.

Also with enterprise value, we can work out multiples.

What's the EV EBITDA multiple for the deal? How does that compare to recent deals that have been done looking at our transaction comps? Okay, so that's first thing valuation.

Second thing we need to think about is how are we gonna pay for this, right? So you always gonna do a sources and uses of funds table.

You'll see in the model we're gonna do in a minute, it does get more complicated than this, but let's just keep things simple for now.

On the left hand side, we've got the use of funds we are going to be buying the shares of the company.

Deals can be structured in different ways.

This is getting more complex and I think there's a session next week on some of these complexities, assets versus share purchases.

But let's keep it simple.

We are buying the shares of the company so we need to fund that, right? The equity purchase price, that's our use of funds.

How are we gonna fund that? Is our sources of funds? Two main ways we can pay.

First we can issue debt as the buyer, I'm going to take out a loan or issue a bond, I'm going to get cash.

So this means that the targets shareholders get cash for every share they sell to me.

Second way of paying for an acquisition is I can issue shares to do that.

Now, yes, I could issue shares, get the cash from having issued those shares and then give cash to the target shareholders.

But if you're a public company, what's more common, more efficient to do is actually just to give the target shareholders shares.

I don't get cash and then give them the cash.

I just do a share for share exchange.

I say you give me your shares and I will give you new shares in the now combined business.

Okay? So important to realize here, in most cases the target shareholders get shares.

Now there is some structuring decision making you need to make around here.

How much debt can we use, how much equity should we use? And this is where we start thinking about things like, okay, debt is generally cheaper than equity, but we have to realize companies have limited debt capacity, right? You can't just lever up as much as you want because that's gonna impact your credit rating.

And that's one of the things we need to think about.

We would not really wanna see a drop in credit rating for the buyer and specifically a drop below investment grade, right? Because then that makes all of our debt more expensive, pushes up the financing cost.

So you would have to manage, right, how much debt versus equity do we use? I said that it does get a bit more complicated just to prime us for the model that we're gonna be jumping into in a moment.

And guys, this is exactly in the model and I think this is the last slide I'm gonna be using.

Um, under the uses and sources of funds table, little bit more complex uses of funds, equity, purchase price we already spoke about, right? But what else might I need money for? Let's start with the fees.

The bankers, lawyers, advisors, we need to raise money to pay for that.

In a lot of cases we actually would also refinance the net debt in the company we are buying.

Often we have to pay back that debt because the loan agreements would have a change of control clause where it says if control of this company changes, you gotta repay the debt.

So we might have to repay the debt as the buyer or we might want to repay the debt if we can because maybe we can get the debt at a cheaper rate.

So we might also need to come up with money to pay off the targets debt, okay? Not always, but we would look at that.

Then there could be other adjustments we need to make. This is getting a little bit more technical, but just to briefly explain this OWC adjustment, operating working capital adjustment.

There's a delay between when we agree the deal and when we complete the deal.

Right? Now, if when we complete the deal, the operating working capital in the business, so think inventory, receivables, et cetera, if that's at a different level, say for example when I agree the deal, we agree on like an average level of working capital, but by the time we close the company has built up a lot of inventory or a lot of receivables, I'm gonna have to make an additional little payment for that, right? And I'm gonna need cash for that.

It's like, like buying a car, but you're buying the car with a gas tank already full, you're gonna pay a little bit extra for that.

So I might need some more money for that.

And then there could be other things like I maybe need to top up the pension fund.

So we need to take that into account as well.

Sources of funds, we've already mentioned these two.

Equity and debt.

A revolving credit facility is a short term form of financing.

So it would be unusual to kind of permanently finance your acquisition with a revolving credit facility that's typically used for your more day-to-day stuff like working capital.

So this RCF would typically be used for that operating working capital adjustment.

And then as the acquirer, we might also have some cash lying around that we can use as well.

Okay, so we are gonna move into our simple model.

Now for those of you that have just joined, I'll put the link in the chat again, okay? So that will lead you to the model.

I promise you we will get there.

But before we do, I wanna show you a recent deal announcement just to put this into context.

And if you're not already doing this, follow the news.

When you see a deal deal being announced, go have a look for the press release, read through that.

It gives you a very nice idea first of all of what's happening in the sectors that you're interested in.

And second of all the kinds of things you need to think about.

So if you go to Felix, you can find this yourself in Felix, but I'll put a link as well, um, to help you out.

But if you type in the analyze tab company called Union Pacific.

Union Pacific is a big rail company in the us okay? And they recently announced an acquisition of another quite big rail company, Norfolk Southern.

So if you look at the news announcements, the eight K, it's this one here from the 29th of July. There were rumors of a deal before that the companies responded to, and this is when they actually officially announced the deal.

So 29th of July this year.

If you click on that, you'll come to the press release.

I've just highlighted a few things, so if you want my highlights or if for some reason you can't find the links, I've just put that in the chat, okay? So if you click on that latest link there, it'll bring you to the document.

So let's just highlight a few key things here.

So first of all, I'm just gonna hide my annotations.

So Union Pacific and Norfolk Southern are gonna create America's first trans transcontinental railroad. And guys, this is actually a really big deal. It's a really exciting deal.

If you read about this from the bit of research that I did in the press, there is big regulatory hurdles to overcome here, okay? So it's not guaranteed. The deal will definitely get done, but it's definitely something interesting to follow.

So let's stick with the kind of financial stuff that we are looking at.

So first of all, we said you've gotta acquire a company at a premium.

If it's a listed company, you can observe that premium, right? Because they've got a share price.

How much are we paying above the share price for deals? It ranges, I mean 20% to 50%.

It'll depend on things like conditions in the market.

It'll depend on things like is the company you're buying maybe undervalued? Because if it's undervalued, then I'm gonna have to pay more because it's not actually trading at the price it should be trading at.

In any case, we can see here they're paying a 25% premium.

So that's the valuation element.

Second element, how they're gonna finance this guys.

Well, big deals, and this is a big deal.

If you look at the size of this, I think the enterprise value of the company being bought is $85 billion.

They're financing it with a mixture of stock and cash.

So the next question then becomes, okay, the cash element, how are they gonna pay for this? Do they have cash on hand? Are they gonna raise debt If we scroll down to the transaction details and financial impact, okay, it says if you look in the second paragraph, I highlighted the cash portion of the transaction will be funded by a combination of new debt and balance sheet cash.

But we are not just gonna go crazy.

We are conscious about credit ratings, leverage levels.

And so the very next sentence says we wanna have a strong balance sheet with a debt to EBITDA of approximately 3.3 times and looking to maintain an investment grade credit rating.

Okay, just going back up to the top here with a mixed deal, the shareholders are gonna get some shares.

So the Norfolk Southern shareholders are gonna get one share in the now enlarged Union Pacific and they're gonna get $88.82 in cash.

Okay? Something we also need to think about, which we're gonna see in our model in a minute, is if we are issuing shares, how much are the current shareholders of the buyer gonna be diluted by? How much are we actually giving away to these new shareholders? And we can see in this case it's 27%.

Last thing to just mention here, what we are gonna be focusing on in our model is the calculation of earnings per share.

So here they're saying this deal is expected to be accretive, which means good, it's gonna increase the earnings per share of Union Pacific.

They say it's gonna happen by year two, the second full year after closing, and then it's gonna rise to high single digit accretion after that.

Earnings per share is by no means the only thing we're gonna look at, but it is something that shareholders do pay attention to.

Then last thing to two things to mention, if you scroll up a little bit, we talk about synergies.

So they're expecting 2.75 billion in annual synergies per year.

And if you look at the sentence just before or just above, that equates to $30 billion of value because if it's 2.75 billion per year into the future present value that we get 30 billion.

Okay? And then lastly guys, you've got to have strategic rationale for doing the deal.

This deal announcement, I haven't seen a deal announcement lately that gives so much rationale for the deal, but I think this might be because they've gotta really prove that this is a good deal because of all the regulatory approvals that are needed.

But you can see they're going through here, why this would be good for America, why it would be good for safety, for service, et cetera. And then yes, we've got the financial elements as well.

Okay? So hopefully that brings what we are doing to life, puts things into context, and now we're gonna go do an Excel exercise.

It's unrelated to this example, okay? We've just got some token numbers in here to illustrate the principles.

Guys, any questions so far? Please do not be shy to come in the q and a pod or the chat.

Okay? To follow along with the Excel file, if you wanna just look at the answer, you can use the full file.

I'm going to use the empty file and there's loads of exercises. We've given you everything.

So afterwards you can go through and have a practice.

But the one that I'm gonna be looking at now is m and a cash deal one. So the fourth tab in Before, before we dive in, let's just see big picture.

What we are aiming for here, remember purpose of doing this is to do some analysis, but we've gotta start off with actually our assumptions.

So what are we gonna pay for this company? So we've got the share price, the premium, the number of shares. We are also then gonna calculate enterprise value.

Then we need to have some other assumptions like what are the synergies we are expecting? How are we gonna finance the deal? Equity versus debt costs, interest costs, et cetera, tax rates.

Then we've got our all important sources and uses of funds table.

And once we've got all of that, we can start doing our analysis.

So looking at how many shares we have to issue, if we are issuing shares, what the ownership dilution is gonna be, relative PE analysis, I'm gonna leave for now it's but more complex.

Then we are gonna focus on calculating this EPS, accretion and dilution.

If we've got time, we'll look at the pro forma debt numbers and then synergy versus premium return on investor capital.

We'll see, but I always am over ambitious in terms of what we will get to, but definitely to the end of EPS.

Okay, so let's get started with the valuation aspect.

I have got the acquirer on the left hand side target on the right hand side.

So Target is a listed company, their share price is $4 share premium.

We think we're gonna have to pay 25%.

You can see by the formatting of that 25%.

That is an assumption.

That is something we would do some some sensitivity analysis around and say, look, what if we actually had to pay 28%? Would the deal still make financial sense? Okay? Now that 25%, like I said, will be based on things like recent deals, whatever recent deals been done at working out, backing out a EV to EBITDA multiple for this deal versus other similar deals.

Okay? So that is definitely an assumption, but let's work with 25% for now.

So unaffected share price at the moment, standalone target is four.

If I'm gonna be paying 25% on top of that four, I'm gonna multiply by 1.25 and that gives me an acquisition share price of five.

Next thing I need is I'm gonna say, okay, well if I'm paying five per share, how many shares are there? Now the number of shares outstanding at the moment in the target is 31 million, but I've gotta take dilution into account.

Now, I don't wanna get derailed by this because this is going into more valuation territory.

Um, if you are interested, we'll do the dilution calc very quickly.

But if you are interested in learning more about this, you can find it in Felix.

If you go to investment banking and valuation, so investment banking valuation and you go to trading comparables.

So in the trading comparables playlist, you could also just search for dilution.

But in the trading comps playlist, you can see here in video number seven, we start talking about dilution.

Okay, so video seven, we talking about dilution, I'll go through it very quickly.

Now someone's just asked for a link to the Excel.

Let me do this, just let me know if this doesn't work for some reason, I've just put it in the chat, okay, hopefully you can access that, but let me know F not, okay.

So with dilution, don't get confused. This is not in terms of percentage ownership.

This is looking at things like stock options.

And this is looking at those things that are stock options issued by the company.

They gonna become shares effectively and normally that's triggered on an acquisition.

So we are actually gonna not have to buy just the 31 million shares, we are gonna have to buy some more shares as well.

Okay? So I saw someone had raised a hand for a second, but just let me know in the chat or in the q and a part if you have any questions.

Okay, so I'm gonna quickly do this calc, like I said, I don't wanna get too derailed by it. For those of you that know it, let's quickly test your knowledge. If you don't know it, you could literally just type in the answer two because the answer to this is two.

But what I do is I take the maximum of zero and the difference between the share price and now the share price I'm using is the acquisition share price.

I subtract the strike price of the options and I divide that by the share price, okay? And I multiply that by the number of options and that gives me the two.

Okay? So like I said, not the focus of today, okay? If you know how to do dilution and you've got the two brilliant, if you don't know, you can watch that video and please get in touch via ask an instructor on Felix if you do have any questions.

Okay? So we are going to say the diluted number of shares outstanding is the 31 that are actually outstanding plus an additional two because of these stock options.

Okay? So that gives us 33.

Now the reason we are doing all of this is so that we can work out sources and uses of funds.

How much am I gonna have to pay to buy all of these shares? I'm gonna skip over row 11 for now. We don't need it.

I wanna know. Acquisition equity value.

I am gonna be paying five per share and I'm gonna be buying 33 million shares.

And so the amount of money I need to buy the shares is 165 million.

I've also got some other information like existing net debt in the target.

I've got a pension deficit in the target.

So this is a financial obligation that the target has, okay? There's a hole in their pension fund.

So we are gonna top that up effectively.

So let's work out the acquisition enterprise value.

So we need to go over the bridge, we've got equity value to the equity value, I add the net debt, I add that pension adjustment, and I get to 225 million enterprise value.

I could now work out an enterprise value to EBITDA multiple, compare that with recent deals, et cetera.

And then we've also got this additional payment we're gonna have to make of 10 for the working capital adjustment by the time the deal closes.

Okay? Hopefully everyone is all right, the person that asked for the Excel, hopefully you've got that now. But do let me know if not, and any other questions, please don't be shy.

Okay, great. So let's now look at some of these other assumptions and let's go build our sources and uses of funds table.

Let's start with getting the total use of funds.

And this is the more complicated diagram I spoke about, right? So going back here, it's this one, okay? So what you saw on the screen here, this is what we are going to be doing.

First things first, I need money to buy the shares.

I'm buying the shares of the company to pay all of those shareholders.

I need 165 million, okay? That is the acquisition enterprise value.

That's how I'm gonna get control of the company.

I'm gonna buy all of the shares here. We are assuming a 100% acquisition, you could also buy 70% of the shares, 80% of the shares.

Hey, but ultimately we are aiming for a hundred percent and we are working with that here.

So I need 1 65 in. This is in this scenario, we are assuming that you are going to refinance the targets net debt, okay? So either because you have to, there's a change of control clause or maybe we want to, now we look at net debt because if the target has got excess cash, it makes sense to use that cash to pay down whatever debt is there.

And then what additional funding do we need? Well, we can see they've got net debt of 40, so we have to come up with another 40 because we wanna pay off that debt as well.

We then have to take into account this pension fund deficit pension fund top up, okay? Often the pension regulator will say, yes, the deal can go ahead, but you do need to top up the pension.

So we've got that 20 there, and then we've got this working capital adjustment.

By the time the deal closes, there's gonna be more working capital in the business.

And so we are paying an additional 10.

So my total need for funding is 235 million.

And actually no, I am jumping the gun. Very excited, okay? Because I haven't taken fees into account, which is how bankers, lawyers, everyone else gets paid.

So let's take the fees into account and the fees are half a percent of enterprise value, right? So based on acquisition enterprise value, the bigger the deal, okay? The more money you're gonna get.

I mean looking at that Union Pacific, we just looked at, I think they said enterprise value of 85 billion, big, big deal.

So we are taking half a percent, okay, let's just unbolt that.

And now I've got my total need for funding of 236.1 million.

How am I gonna finance this? The revolving credit facility, as I said earlier, it would be unusual long term to finance a deal exclusively using an RCF, right? So here we are saying this RCF, we are gonna assume they're using for that working capital adjustment, okay? So revolving credit facility, we're gonna arrange and draw down 10 of that facility debt funding.

In this case, we don't know how much debt funding we are gonna use, but we've made an assumption on the amount of equity financing we are gonna use, the amount of equity financing we are going to use is in row 20.

Now we saying 30% is gonna be financed with equity.

Very important to realize here that that 30% is talking about how we are going to pay for the shares.

I'm not going to take 30% of the total need for funding, right? I'm not gonna do that because I'm looking at financing the actual purchase of the shares.

We are talking about this deal where like with Union Pacific, we said, oh, they're gonna get one share, right? They're gonna get one Union Pacific share and 88.2 in cash for each share the target is selling, okay? So I'm applying that 30% to the value of the shares that I'm buying.

So let's get that equity funding in there.

So 30% of the equity purchase price is gonna be financed through a share for share exchange.

So that accounts for then 49.5 million of the value that I need.

And so the debt funding will then plug that gap that I've got.

I need a total of 2, 3, 6 0.1.

I've already got 10 taken care of through the RCF.

I've got 49 and a half taken care of through using my shares.

And so the remainder that I need through debt is 1 76 0.6.

Now, we would have to do some analysis around this to see can the company actually handle that level of debt or will it push up our debt to EBITDA multiple very high, which could result in a drop in credit rating and specifically drop below investment grade.

So we would need to do analysis around that.

Another way to approach it could be to do the debt bit first to say, look, I think after the deal, the combined business could support three and a half times debt to ebitda.

So what would that equate to in terms of additional debt I can take on? And then equity could be your balancing figure. Okay? So different approaches to follow.

Bottom line is it's not just a free for all when it comes to debt, you've gotta check the capacity of the company.

Let's just double check that our total sources of funds does add up to the uses of funds, otherwise we have made a mistake somewhere and it does 23 or 2, 3 6 0.1.

Great. Any questions? Please don't hesitate to ask. If I don't have chance to answer them now, I will stick around and answer them at the end.

Okay? So now we can start doing some analysis.

Okay, we've got what we paying, how much money we need and how we financing it.

So first thing I'm gonna do is have a look at share issuance and ownership dilution.

The acquirer, the buyer already has 18, no 15 million shares outstanding in row 10, right? 15 million shares are outstanding at the moment and they're gonna have to issue more shares because they are giving the targets shareholders, shareholders shares in the company to the value of 49 and a half million in total.

So how many shares does this equate to? Well, if I tell you I'm going to give you a total value of 49.5 billion, here's individual shares in total they're worth 49.5 billion.

How many shares do I have to give you? Well, I'm gonna divide it by what one of my shares is worth.

And the buyer's shares are currently worth 18, right? So if I've gotta give you a total of 49 point a half million in value and each of my shares is worth 18, that means I need to issue 2.8 million shares in total.

That then allows us to calculate how many shares we are going to have in issue from the buyer's perspective.

Remember the buyer's like swallowed up the target now.

So the buyer has got 17.8 million shares outstanding.

So let's work out the percentage shareholding that the original shareholders have.

So they own 15 before they owned 15 out of 15 they owned a hundred percent of the business.

Now we've issued shares to new shareholders.

So they own 15 out of 17.8 and that is 84.5% and the remainder is owned by the old targets shareholders and that is 15.5% and we've got a total of a hundred percent.

So this ownership dilution, we just wanna keep an eye on these percentages.

So for example, if we have to issue so many shares to finance this deal, say I'm a small company and I'm trying to buy a huge company, it could actually end up being a reverse takeover because I might have to issue so many shares that my original shareholders end up owning less than 50% of the business, okay? Or we would look at things like, is this gonna go below 75%? Because in a lot of jurisdictions, 75% can pass special resolutions.

So that's something that you would have a look at this to just equate it to ideal for Union Pacific, that's that 27% that they're talking about there, right? Because they are issuing one share for every share they're buying.

How many new shares are they issuing relative to the shares at at the moment? So 27% is gonna be given to the targets shareholders.

Okay? Now we can start doing a bit of analysis.

Like I said, I'm gonna skip over the relative PEs, but guys, if you're interested, if you just scroll back up the Felix live page, go back through the recordings, you'll see one called M and a, the analysis, okay? In that m and a, the analysis, I did it a while ago, I used a more difficult model.

So it might be nice after the session to look at a more difficult one.

And you can also focus a bit more on analysis specifically.

And they are looked at relative PEs.

Let's focus on earnings per share.

This looks like quite a big calculation here.

So for us not to get lost, let's go down to the bottom and figure out what the purpose of this is.

I want to compare the proforma earnings per share.

By proforma we mean after the deal, it's red is a little bit jarring.

Let's maybe use softer color, right? So after the deal, what is the earnings per share of the buyer? Because remember the buyer's the one buying this other company.

Then I'm gonna compare that to if there is no deal and the buyer just carries on as they are, what's their forecast earnings per share expected to be? And I'm then gonna compare the two.

If we see earnings per share after the deal has increased or is expected to increase, that's accretion good.

And if it is lower, if we do the deal than if we don't do the deal, that's not great.

That is dilution.

If I want to work out earnings per share, I need two things.

I need total earnings, net income, bottom line of the income statement, and I need number of shares, right? Earnings per share. We have just worked out the first part of that.

Pro forma shares outstanding.

If we do the deal and finance it using 30% of equity, how many shares are now gonna be outstanding after the deal? And that is 17.8 the acquirer based on this structuring.

And we can change those assumptions and our model will update.

But 17.8 million shares is the number of shares. So let's go put that in. So long, I'm not interested in actual column I'm forecasting. So I'm looking at your 1, 2, 3 in the future.

So we're gonna go pick up that 17.8 in row 36.

I'm gonna press F four to get those dollar signs because I wanna lock onto this because I'm gonna be copying this to the right for all years.

So locking onto that, I've got the 17.8, I'm just gonna do it for year one just so you can see my formulae.

And then we'll copy everything to the left after that.

Now what we need is total earnings.

I've got total number of shares after the deal.

So what is total earnings after the deal? We've gotta do consolidation, accounting, consolidation accounting.

We take the acquirers standalone, what's their total earnings plus the target standalone, what's their total earnings? So we are consolidating the two companies. Let's do that.

If you scroll up a little bit, we've got, if there's no deal, things carry on as usual.

There's the targets forecast, earnings per share, there's the forecast number of shares.

WSO just states for weighted average shares outstanding.

So that's number of shares. So I can work out.

Net income in total is gonna be earnings per share times number of shares.

Let's just copy that to the right.

So that's for the acquirer standalone.

Let's do exactly the same thing for the target on a standalone basis, target has expected earnings per share of 0.28 in the first year.

Number of shares of 33.

Let's copy that to the right. Okay? So that is step one.

Just add the two companies earnings together.

So coming down to row 55, I'm just gonna do the first year, then we can copy everything later.

The acquirer's bottom line, net income year one, standalone 18.9.

And for the target that is 9.2.

But now we need to realize that as a result of the deal, these forecast earnings that we have are gonna be different because these forecast earnings offer two businesses on a standalone basis.

They don't take synergy into account.

So let's go bring in the synergies. Synergies. We need to make an assumption on the synergies before we do the calc. Important to realize guys, net income is after tax, right? It's the very bottom line of the income statement. It's what belongs to shareholders.

So if I now wanna add in the synergies, I've gotta make sure that those synergies are done on an after tax basis.

So typically synergies would come from cost savings.

You can also have revenue synergies.

Those are above the tax line.

So I just need to make sure that when I am adjusting for synergies, when I'm adjusting for interest, which we'll do next, you're gonna multiply by one minus the tax rate to make sure you are in an after tax environment.

Net income. Let's go pick up the synergies from our assumptions, we are assuming that we are going to have 5 million in synergies per year.

So five times one minus the tax rate.

I have to give 30% of my taxable income to the tax authorities.

So that means that after tax I'm gonna be left with only 70%.

Now before I press enter, I just need to make sure that I put my dollar signs around these numbers because I'm gonna be copying to the right.

So I just wanna lock onto the tax rate.

I wanna lock onto the synergy.

So we get 3.5 and that's locked.

It's gonna be the same every year.

This model is a little bit simplistic in the sense that guys, you usually don't have full synergy realization in the very first year after an acquisition.

Synergies often take some time to be realized.

If you think about cost savings overnight, you're not just gonna save costs, you've gotta restructure things, et cetera.

So when you hear people talk about the run rate synergies, run rate synergies are the fully achieved synergies, but it normally takes a couple of years, say two to three years to build up to that.

So here we've just said it's gonna be 5 million every single year into the future before tax.

But what you might say is actually year one we are only really gonna achieve 20% of that 5 million.

By year two we would've achieved 50% of the 5 million.

And then by year three we would've achieved the full 5 million.

Okay? So you could see that ramping up.

We've just kept things simple here, okay? And we've seen the synergies expected once they are fully realized in this Union Pacific deal, 2.75 billion annual synergies.

Last thing we need to do before we can calculate this proforma net income is we need to say what is the financing implication on the income statement? Because if I'm issuing more debt, there's gonna be more interest.

If I'm repaying debt, there's gonna be less interest.

These numbers of 18.9 million for the buyer guys, that is, if the deal doesn't happen, the buyer carries on as usual, that does not take into account the new debt that's issued to finance the deal.

This targets net income forecast into the future.

That's as if no deal is happening.

But guys, in our example, if we do the deal, we are refinancing the targets debt, we are getting rid of that targets debt and then we bringing on the deal debt.

Okay? So that's what we now have to adjust for and say okay, new debt's gonna mean more interest, repaying the targets debt means some interest in that 9.2 is gonna go away.

So let's do that. Okay? We are gonna need lots of dollar signs here because we fixing everything to copy it to the right.

So let's first go pick up the debt numbers.

If we go back to our sources of funds, RCF of 10, I'm gonna F four to lock onto that.

Plus we taking out the long term debt of 1 76 0.6, I'm gonna F four to lock onto that.

So that's gonna mean more interest that's not yet accounted for in the acquirer's standalone numbers.

So F four to lock onto that.

But then we are going to get rid of the targets net debt.

So I'm subtracting that we're gonna have to pay less interest because I'm getting rid of that net debt.

I'm refinancing it with this new debt that I'm bringing on.

So I press F four to lock onto that.

So that's just the change in debt amount for the income statement.

I want the interest impact of this.

So I need to multiply by the interest rate and we've got an assumption here, interest rate on all debt, okay, we've kept it simple guys.

This is intro to m and a, all debt, the interest rate is 5%.

If the target's existing debt was at a different interest rate, we couldn't just do this all in one calculation, right? Say the targets debt was at 7%, I would then have to say, okay, well that 40, I'm gonna save 7% interest.

And then on the 10 and 1 7 6, I'm gonna pay 5% interest.

I'd have to split it out here, keep it simple, everything's at 5%.

Lock onto that. And then the final thing is to say I've gotta take the interest off the tax.

So I'm gonna multiply by one minus the tax rate and that is a tax rate of 30%.

And again, we're gonna have to lock onto that tax rate.

So if four, and we are not quite finished because look at the sign guys, I'm raising more debt than I'm repaying, which means I'm gonna have to pay more interest.

And so this should be a negative, more interest is gonna be paid.

That's not taken into account in those standalone numbers.

So that's minus 5.1.

And now we can work out the proforma net income.

I've got the standalone acquirer standalone target.

I've adjusted it to take synergy into account and I've adjusted it for the debt financing and the repayment of the target's debt.

So if I add all of that up, I get 26.5 million for the first projected year, I've got 17.8 million pro forma shares outstanding.

So my pro forma earnings per share is the 26.5 divided by 17.8 and that gives me 1.49 per share.

What I need to do now is to compare this to the acquirers earnings per share.

If the deal doesn't happen.

So I go back up to row 45 acquirers forecast standalone earnings per share is 1 26.

And then I compare if we do the deal, we expecting EPS of 1.49 versus if we don't do the deal 1.26 subtract one because I just want the percentage change and that gives me 18.5% accretion.

Let's just copy this to the right to see if you've got your numbers correct.

Don't stress if you haven't got your numbers correct, it's probably because you just haven't locked onto a cell.

But you do have the full solution file to guide you.

But if you are ending up with 26% accretion, well done.

That is correct. So guys on this metric on earnings per share, it is something that shareholders look at.

It's relatively easy to calculate.

As you can see, we would generally like to see an increase in earnings per share.

In a lot of cases it's not accretive immediately from the beginning because of what I said about the synergies taking time to come through.

So you might see a dilution in the first year, maybe second year, then it starts being accretive.

And the final thing to say on earnings per share is guys, this isn't the only metric.

Just because something is accretive doesn't necessarily mean it's a good deal.

We do need to consider the quality of the earnings.

We need to consider the premium and versus the synergy.

So the other analysis that you can do as well.

Okay guys, any questions please ask.

I don't wanna pause for too long in case there are no questions and I'm aware we only have 13 minutes left and there's still a couple of things I wanna show you, but please do type away in the background if you have a question.

Okay, we've got time to quickly do this calculation of um, the debt to ebitda.

'cause remember we said we've just used debt as the balancing figure.

But what is that as a ratio? Is it gonna be too highly geared? So we've got here acquire a standalone EBITDA, acquire a standalone debt at the moment of 300.

So debt to EBITDA is the 300 divided by 1 56. That's 1.9 times we can copy this calculation to the right for the target.

We can see the target similarly geared slightly higher, but two times what's important is to say okay, the buyer had leverage of 1.9 times before the deal.

What is that gonna be after the deal if it is a dramatic increase that could result in a ratings downgrade.

So let's see. So I want the pro forma after the deal ebitda, bear in mind here that EBITDA is pre-tax.

So when I add the synergies on, I don't have to worry about taking it after tax.

So we have got the acquirers standalone EBITDA, I've got the targets standalone EBITDA.

But if we do the deal, we expecting synergies, cost savings, maybe additional revenues and we go back up and pick up that five from our assumptions.

What we don't need to worry about the interest impact like we did for earnings per share because EBIT before interest, right? So I'm not worrying about the interest impact debt.

Let's think about what's gonna exist in the combined consolidated business afterwards.

Consolidation, you take the one company's debt plus the other company's debt.

But then guys, we've gotta look at the deal impact.

This isn't gonna stay the same.

We are taking on additional debt on top of that 300 that we already have in the acquirer.

We are taking on an additional 10 plus the 1 7, 6 0.6 and we are getting rid of the 40.

So yes, I've added that 40 in 'cause I'm consolidating.

But actually that 40 is gonna be repaid because I'm gonna take out new debt to repay that 40.

So I add in the new debt and I take out that 40.

So you could have just left that 40 out from the beginning.

I've added it and then subtracted it just for completeness sake.

So we can see here debt to EBITDA after the deal is 2.7 times.

So that is quite a big increase.

What you would need to have a look at there is you would need to do some credit comp analysis.

Look at similar companies in the industry, what are their leverage levels? Also, if you can convince the rating agencies that you will pay down the debt relatively quickly and dele, okay, then they could maintain your credit rating.

Okay? But to be honest, that doesn't look anything crazy, right? Generally, I mean it's different for different industries but for a public company below three is okay, but I'm, that is a sweeping generalization, okay? There are other bits of analysis that we can do.

But what I would like to do, I'm just checking my notes if there was anything that I forgot to show you, I do not think so.

One thing that I do want to quickly show you is the um, another interesting deal announcement. So I'll copy the link in Felix again.

Um, but this time I'm looking at Keurig Dr. Pepper.

So I mentioned right up at the start Keurig Dr. Pepper, big drinks company.

They recently announced that they're buying Pete's coffee.

Okay? So if you go to Keurig, Dr. Pepper and then I'm not looking at the press release.

What's actually really interesting to look at is the slides.

They had a call I think um, where they went through the steal announcement.

So if you come to transcripts and slides and look at those slides, okay, I'll give you the link.

I just highlighted a few things so let me just copy that link.

So I've put that in the chat if you wanna have a look through.

So the reason this is interesting and it's something to watch is because what's happening here is Keurig Dr. Pepper drinks company in the US in 2018 I think it was.

It was created by combining Dr. Pepper Snapple soft drinks business with Keurig coffee company.

So coffee and soft drinks came together to form this big Keurig Dr. Pepper. Recently you can see this is from August, KDP announced that they are buying Pete's coffee.

So that's the merger or the acquisition.

But then they're going to spin off the coffee business.

So they're effectively undoing the merger that happened back in 2018.

They now see there's more value in actually running a separate soft drinks, energy drinks, beverages, business and a separate coffee business.

And to bolster that coffee business, they're buying pizzas.

So this is a really interesting one 'cause it's an acquisition and then after the acquisition there's gonna be a demerger effectively or spinoff.

Now just to show you some of the things, I mean I'm not obviously gonna read through this whole presentation with you.

You can look at it. Um, but it starts off with talking about the acquisition, first of all, transaction overview.

So it gives, you know, the rational why they wanna do it the right time, the right target, the right transaction.

So giving some motivation there.

They talk about from a strategic perspective why pizzas is a good idea.

And then we talk financial metrics.

So they're gonna unlock cost synergies. They're seeing 400 million in expected cost savings.

And if you scroll down a bit further, you'll see where that is expected to come from.

And look what we just calculated generates strong earnings per share.

Accretion, immediate shareholder value creation. So they're expecting to see EPS accretion from the start.

Hey, if you scroll down a little bit further, they'd go lots into the strategy, et cetera.

And then what I want to jump to, they start talking about why they wanna split the businesses. So this is like a combined um, presentation on the D merger as well as the acquisition.

But I'm just jumping down to page 24.

So on page 24, key acquisition terms, they're paying 31.85 euro per share because Pete's is actually based um, holding company is based in Europe.

That's paid for in cash. Okay? So they're buying this for cash enterprise value, $23 billion.

They then give EV multiples.

So you can look at that compared to recent deals that have been done 12.9 times excluding synergy.

And then look at this financing overview guys, it's not just about doing the deal.

They are committed to an investment grade rating at acquisition and for both entities, how is this gonna be financed? New senior unsecured and junior subordinated debt and cash that they have on hand.

Okay? Then cost synergies. Where do they think they're gonna get this from? Portfolio efficiency, SGNA logistics, et cetera.

And then remember, like I said, if you can kind of prove to the rating agencies that you are committed to de-leveraging, yes, we are taking on a lot of debt to do the deal, but we are gonna pay that debt off relatively quickly.

Here they're showing you, that was the big merger that created the group in 2018. Their leverage went up to six times and then by 2021 they bought that down to 2.9 times and now it's sitting at 3.3 because they did an acquisition of an energy drinks company and it's gonna be 5.2 times after the acquisition. So quite high. So let's see what happens with their rating if they manage to keep that investment grade rating.

Okay, so and then they're going to the separation, why that's a good deal, et cetera.

Okay guys, I am going to leave things there.

We've only got four minutes left. Unfortunately, not enough time to do the rest of the analysis, but you do have the full solution file, right? Full solution file is there, m and SM and a analysis work out full.

Please do look through that. Do get in touch.

If you have got any questions, you can contact us on Felix through this.

Ask an instructor button. Okay? I'll stick around now for a couple of minutes if anybody does have any questions.

Otherwise, thank you very much for joining and I hope you have a wonderful weekend and hope to see you again soon on another one of these sessions.

Thanks very much.