For those that are new here.

My name's Maria Weber, I'm one of the trainers at Financial Edge and I'm gonna be doing today's session on M&A analysis.

The session that I ran last week was on introduction to M&A.

So if you are new to M&A and you didn't attend that last session, I would recommend watching the recording for it today is gonna be quite a bit more advanced and we are only gonna be focusing on the analysis aspect.

So by all means, don't just log off now and think, oh no, you're new to M&A, you're not gonna attend.

I'm sure you'll be able to still pick some things up, but the pace is maybe gonna be a little bit faster than last week.

And we are looking at a more complicated model.

And you'll see here we've got three files.

Because this model is so huge, there's no way in an hour we are gonna be able to do the whole thing.

Um, so there's an empty version.

If you do want to try from the beginning doing the consolidation sources and uses of funds, all of that business, you've got Thet version, you've also got the full version.

And then what I'm gonna be using in class if you wanna work along with me is the middle one, the part complete model.

So I filled in bits of it and then we are gonna fill in some other parts together.

If you are not very comfortable with m and a, maybe you just wanna follow along in the solution file.

Okay? I'll also refer you to some videos on Felix where this actual model has gone through step by step.

So if you do wanna go back and look at it from the beginning, you've got those videos to help you.

Right? So before we just launch into the model, I'm not gonna really be using slides today, but I do want to put into context why we are doing the things that we are doing when we do an M&A model.

The end result of the model is to analyze it.

So what do investors care about? The deal announcement that I've picked is a little bit of an older one. So it's from 2023, but one of the companies was in the news yesterday, so that made me think of it.

So the deal was Tapestry. Tapestry.

If people aren't familiar with them, if I just look at their business overview, it's a fashion company.

Brands that I'm sure you might recognize, coach Kate Spade Tapestry.

Were buying Capri Holdings.

And Capri Holdings is also a fashion company and their brands are Versai, Jimmy Chu, Michael Kors.

If we go to the tapestry deal announcement, okay, so I'm just going to the eight k. Their press releases this, like I said was from 2023, so a bit of an older deal. There we go. So oh 8 10 23.

Okay, so Tapestry announces an agreement to acquire Capri.

So this was in towards the end of 2023.

They're both uh, listed companies.

You'll see here the stuff that we talked about last week.

Things like what is the enterprise value being paid $8.5 billion.

What are the selling shareholders receiving Capri shareholders we're receiving $57 per share in cash.

Okay? So that was the kind of stuff we talked about last week.

And then we also said it's not just about the financial analysis of the deal, it's about looking at the strategic rationale as well with M&A. We are not just trying to like financially engineer a return, right? So we are not just looking for EPS secretion because we financed it in a clever way.

There's gotta be a strategic reason for the deal.

So here we've got the strategic rationale.

I'm not gonna read through all of this obviously in the limited time we've got, but here then we start seeing the financials coming through synergies.

As we mentioned last week in our simple model, we had synergies coming in from day one.

In reality they take a while to achieve.

Here we've got 200 million in run rate synergies once they fully achieved that is going to be achieved within three years after closing.

We then got some other things being disclosed.

But the next thing I wanna talk about is shareholder returns.

We see the first line, strong double digit EPS accretion and a compelling heroic return on invested capital.

The second bit that I've highlighted here is talking about dividends.

Something shareholders might be a bit concerned about of the acquirer is if they're used to receiving a good cash dividend from the company, if they now do an acquisition, first of all they could be using a lot of cash in their acquisition and second of all, if they're acquiring maybe a company that's not as cash generative going forward, they're not gonna be generating as much cash.

And if they're issuing more shares as part of the deal, then that's also more shares outstanding, more of a dividend to be paid.

So something in this price announcement, they reassure the shareholders that they're still going to be maintaining their dividend and in fact, um, increasing their dividend per share.

Then this is the stuff we talked about last week.

How do you finance the deal here? This is $57 being paid in cash.

The premium is 59% to the weighted average price.

It's being funded by debt, right? So senior notes, term loans and then they had some cash.

And then finally whenever we are using debt, we've got to think about credit metrics.

We can't just lever up the company.

This isn't a leveraged buyout, this is a strategic M&A.

So we've gotta be conscious of the gearing levels and what that might mean for our credit rating.

And you can see that they talk about post deal.

They are going to have an increase, okay in their debt to ebitda, but they are looking to bring that below two and a half times within 24 months because they want to maintain the investment grade credit rating.

So hopefully this sets the scene for why we are doing what we are doing, right? If we look at the things that we're gonna cover, we're gonna briefly talk about accretion dilution because we saw that last week.

But we're gonna do another little CU on that.

We are gonna do some ratios and credit metrics.

We are gonna look at the present value of synergies versus premium paid and then if we've got time we'll talk about roic have already part completed stuff. So hopefully we can get through as much as possible.

Just um, out of interest that deal didn't end up happening because the FTC blocked it on the basis of competition.

So I think specifically if I remember correctly, it was something to do with the handbags. They said it was going to reduce competition too much.

So I think it actually even went to court and then the two companies called off the deal, if you go further up into tapestries announcements, um, they decided to call off the deal.

But the reason they're back in the news is because Capri Holdings that who was gonna be the seller, they are selling one of their brands.

Versace, they're selling Versace to Prada. So this was in the FT yesterday and what's interesting as well is given what's been happening in the markets and the uncertainty around the tariffs and everything else, the purchase price actually got lowered apparently by $200 million.

Okay? So just interesting to see how, you know, obviously Capri was looking or sale or they were good target and here they are, um, getting rid of as such.

'cause they wanna focus on I think Michael cause anyway, okay, let's not get too tied up in that deal.

Let's go look at our spreadsheet. For those of you that have just joined, welcome.

I'm just gonna copy the link into the chat one more time so you can access the materials before we can do the analysis. Unfortunately we need to spend a little bit of time understanding how this model works, right? Because to do the analysis we need to know what the acquirer's financials look like, targets, financials, combined synergies, et cetera.

So let's take a few minutes to just walk through the model on the first info tab.

Nothing for us that's too important there. Model intro.

Only thing I wanna draw your attention to here is we do have a circular switch in row nine.

That circular switch is because we've got interest in the model on the debt and on the cash and because we're using average balances that causes a circular reference, we wanna be able to work with iterations turned off and so we need to switch the interest off so that switches off for now.

Okay then all important assumptions page.

We've got the buyer, the acquirer, which is German company buyer.

We've got their share price.

Note that their currency is euro because they're a European company.

We've then got the target which is Monsanto, Monsanto US company.

So we've got their share price, we've got the offer premium, all the stuff we talked about last week.

But take note that this is all in US dollars.

If we scroll a little bit down, we've got the FX rate, so we need that right? $1 equals 0.95 euro.

Then we've got the acquisition terms.

So we've got things like the fees we've got how this is gonna be financed.

So we've got equity issuance including convertible bonds.

I wanna highlight this secondary issue in row 23.

That is a little switch.

It's not the same as a circular switch. Just a little switch. I don't wanna spend time talking about it now, but we will when we do our analysis.

So for now, just highlight row 23. We've got a little switch there.

Now the reason we need all of these assumptions is so that we can do our sources and uses of funds table like we spoke about last week.

Under the uses of funds, we gotta buy the shares, we gotta refinance the net debt, we've got all of our fees and then under our sources of cash, this is our financing, right? So we are issuing equity for 15, we're using a little bit of excess cash and then the vast majority of this deal is being funded by debt.

So big amount of debt being added on to finance this deal.

We don't wanna be working in US dollars, we wanna be working in euros because the buyer is a Euro based company.

So we've got an extra little step here to convert all of these US dollar numbers into Euro using the exchange rate.

We've got some other stuff below on the spreadsheet that I'm not gonna go into detail on.

But for those of you that are familiar with consolidation accounting, you would know about goodwill, you would know about step ups of assets and liabilities and step downs.

So that's what's happening over here to enable us to do the consolidation.

And then we have also got other assumptions like tax rates, et cetera.

Okay? So that is obviously crucial to driving our model, which is then gonna drive the analysis.

Next tab we've got is the acquirer tab.

So this is the buyer. We've got a forecast, three statement model, income statement, balance sheet cashflow on a standalone basis.

We can see it is in Euro and the buyer, their year end is 31st of December.

Next tab we've got the target which is Monsanto.

Now we already know Monsanto reports in US dollars, but what we also see here is they have a different year end to the acquirer.

They've got a year end of 31st of August.

Now when we do consolidation, we need to bring the two companies financials together.

I can't have two different year ends.

So what I do is I need to calendarize, if you are not familiar with Calendarization, we've got a video two or three on this.

I'll show you at the end the exact playlist where you can find um, calendarization.

So all we are doing here is we are changing the year end of the target from that August year end to a December year end so that it agrees with the acquirer.

And what we are also doing here is we are changing the currency from US dollars to Euro.

So the name of this tab calendar.

So that means calendarization target financials and it's in the acquirers currency so it's in euro.

Now we can do our consolidation, right? Because we've got two sets of euro financials with the December year end.

That is what we have started doing on the next tab, which is the opening balance sheet.

Opening balance sheet, what is it gonna look like immediately after the deal? This is consolidation accounting.

If you're not familiar with it, you wanna learn more about it.

This would be under our accounting playlists.

So if you go to topics accounting, there's something called introduction to full consolidation, you will find out about goodwill et cetera. Everything there In short, what we do is we take the acquirers balance sheet, we take the targets balance sheet and we add the two of them together.

But then we've gotta recognize as a result of the deal we are going to have different financing in place.

So we repay the old financing in the target, we issue debt, we issue equity, we've also gotta do consolidation entries like step up and step downs. We've gotta put in the goodwill.

So this is detailed consolidation.

On the next tab we have got the calculations.

So we are gonna be using a lot of this because you can see the very first thing we've got is synergy assumptions.

We'll be linking to this in a moment.

We've got a few other cults further down.

And then finally before we get to do our analysis, we have got the combined entities financials forecast, income statement, balance sheet and cashflow statement in Euro with a December year end.

And this is the consolidation.

So last week we, when we were doing like EPS secretion and dilution, we said to work hard EPS, you need the earnings of the target earnings of the acquirer synergies, financing impact from having extra interest if you're issue a debt number of shares.

That's what we are doing on this tab because you can see if I just take revenue for an example, we take buyer's revenue, we add Monsanto's revenue, so two standalones and then we've got revenue synergies, okay? And we would consolidate on the basis for everything. Okay? So NewCo is the combined pro forma.

Remember we talked about pro forma last week, what things are gonna look like after the deal.

Okay guys, please don't be shy to ask questions.

I know we do have a lot to get through.

So if I don't answer your question immediately, I'll stick around at the end and answer it.

But please either in the chat, if you've got access to the chat or the q and a pod, please put your questions in there as we go.

Okay, I'm just gonna paste this link one more time in the chat just in case anyone has joined late and can't access the materials. But please speak up in the chat or q and a if you're having any issues.

Let's get going with our analysis.

So I'm on this analysis tab.

So we are working in millions of euro and you can see I've got four costs for 20 17, 18, 19 and 20.

The deal is expected to happen end of 2016, right? If you look at that consolidated balance sheet, that's done end of 2016.

So going forward we are looking 2017 onwards.

First thing we're gonna look at and we said we have got our here list, we are gonna look at accretion and dilution.

Okay, so we did this last week.

I've pulled in the numbers already.

You can go follow through where these numbers come from, but we know in order to work out the EPS of the NewCo, by NewCo we just mean proforma consolidated after the transaction.

I need the earnings of the NewCo and I need the number of shares, the earnings we've got from our three statement model.

This is pulling through from the NewCo tab.

We go pick up the earnings.

But something that we didn't talk about last week that's new here is we've got this thing called cash net income.

Now that cash, I'm gonna put in inverted commas because it's not really cash, pure cash net income.

All that's happening here is as a result of consolidation accounting, one of the things that happens is the assets and liabilities that are being purchased.

You gotta look at the fair value of them.

Now often you bring brands onto the balance sheet that weren't recognized before, okay? Because you can't recognize internally generated brands, you revalue the property plant and equipment.

If there's an increase in value, there's gonna be increased depreciation and amortization.

Now that is purely as a result of just the accounting for the consolidation because we use that to work out the goodwill, et cetera.

So what we do here and what some companies, if you look in their press announcements, they disclose like a cash net income or a cash earnings per share figure.

All we do is we just reverse out the extra depreciation and amortization as a result of the step ups on consolidation.

And the reason we do that is we say look, that's just an accounting entry as a result of consolidation accounting.

I wanna look at the trend in EPS.

I wanna compare with the standalone company before and this is almost like just a distortion because of the M&A.

So that's why we've added back and you can follow through.

I'm not gonna go there now in the interest of time, but on the calcs tab it's the additional depreciation it we work after tax because remember we are looking at net income.

So bottom line, so what I've got is the net income of the combined entity.

I've just adjusted for the extra DNA, I've got the number of shares outstanding.

So the acquirer's, existing shares plus any shares that they're gonna issue as part of the deal.

And so I get this cash EPS for the combined entity, remember that we then compare that to the standalone buyer and this comes through from the acquirer tab, standalone forecasts and then the accretion or dilution is simply looking at proforma divided by standalone minus one.

'cause I just want the change. Do you agree that looks too good to be true? Okay, and generally in life when things look too good to be true, they probably are too good to be true.

We are forgetting a very important thing here guys.

This deal is being financed by a lot of debt, okay? We are working with the interest turned off and generally when you working on a model, you work with iterations off. So you warned if you create a circular, so we switch the interest off, but when you're analyzing once you've finished, we need to put interest on so we can see interest running through.

So let's go switch interest on to see what would happen to the EPS.

So if I go to the model intro tab, model intro tab, circular switch in row nine, I'm gonna turn that to a one.

So if I turn that to a one, I get an error message.

You might or might not, depending on whether iterations have been on or off on your computer.

If you get this error message, what you need to do is you need to go to file options.

So alt ft if you are using your accelerator keys not on a Mac and then you need to go to formulas and see that enable iterative calculation, you need to turn that on.

If you're interested in this, if you've never seen this before, guys in our modeling playlists under modeling, financial modeling, we talk about iterations.

Okay? So you can go have a look at that if you are not familiar with it.

The point is now we've turned the switch on.

So interest is now running through the model.

Let's go back to our analysis tab and now we see a more realistic looking EPS accretion.

We see we have got dilution in the first year and guys that's to be expected, right? As synergies come through, they don't all get realized immediately, but we can see then as we go further into the future, we see this uplift in EPS.

So on this metric things are looking good.

Let's do a bit of extra analysis now. So last week we never did this. Let's talk about this.

I'm just gonna take these colors off so we don't get confused by things looking too busy.

Let's have a look now at the additional synergies required to break even.

What's useful to do is if you have EPS dilution, don't just say oh we've got EPS dilution.

You wanna go and make a suggestion and say okay well if you don't want this to be dilutive, you need to find extra synergies.

Let's see how much synergies you need to have no dilution. That's what we mean by break even break even instead of that being minus 5.4%, just to make that 0%.

So what I'm gonna do here is I'm gonna say okay, well free deal the buyer's EPS is five post deal, it's expected to be 4.8.

So do we agree I'm 0.2 per share diluted short, I want this in total.

So I need to multiply by the total number of shares and that gives me to six 8.1.

Now that is the additional synergies I need on a post-tax basis because remember that's looking at net income EPS, that's after tax.

I've gotta earn synergies pre-tax, right? So then once the tax comes off, I'm left with this 2 6, 8 0.1.

So all I'm gonna do to get that pre-tax is I need to divide it.

Remember to get post-tax you multiply by one minus the tax rate.

So to get pre-tax, I'm gonna divide by one minus the tax rate and I'm gonna find the tax rate on my assumptions tab.

And on the assumptions tab you've just gotta go all the way to the bottom.

I think it's row 43 and we wanna F four to lock onto that because we're gonna be copying this formula to the right.

So F four to lock on and we get pre-tax synergies that we need of 383.

Okay? So that's quite useful. You can then go and say, well how realistic is it to get this? If you copy this to the right, you can see it's actually not meaningful because it becomes, we already ACC creative.

So you could wrap this function in a max function.

So maximum of zero.

And so it just gives you an answer if there is a positive, okay? This effectively means the negatives. Oh we've got synergies to spare, we can afford to lose synergies, right? But I mean that we wanna just know, okay, if we dilute it, how much more synergies do we need? Okay, so I'm just gonna undo that.

I'll leave the original formula there.

Next thing that I wanna have a look at is I wanna look at, and I'm again just gonna delete the colors relative PE analysis.

This is useful just as a kind of sense check as an indicator of whether this deal is expected to be accretive or dilutive to earnings per share.

Let's see how it works. So hopefully people are familiar with a PE ratio.

So a multiple price to earnings multiple.

What I'm gonna compare is I'm gonna compare the transaction price to earnings multiple with the buyer's price to earnings multiple, the transaction price to earnings multiple, okay? We've gotta go all the way to our assumptions tab and we are going to be locking on and bear in mind because we are gonna be copying to the right. So we need to lock if we um, going to one cell.

Bear in mind also that we are working in euros now, right? So let's go find the PE multiple.

We are gonna go up to the assumptions tab, top of the assumptions tab there. I've got my target, I've got the standalone share price unaffected, I've got the offer premium.

There we go. I've got that offer price, that's the P in my PE right? I'm gonna F four to lock onto that C 13.

This is in US dollars, I want it in euro.

So I'm gonna multiply that by the exchange rate.

Now you'll notice in the formula bar that just comes up as fx fx, it's a named cell so I don't need to lock a reference that will always be stuck on C 18.

Okay? So that's the P, the price element then divided by the E, the earnings per share, I want the earnings per share of the target in euro.

So we are gonna go to this calendar target acquirer FX model, the three statement model.

And I'm gonna navigate my way down the income statement to their earnings per share.

So in row 30, no sorry, row 36 is earnings per share.

And we are going into column G because we are looking for 2017, right? So 2017 I'm going into column G and I've got the EPS and that gives me 29.4 times.

So that's the acquisition equity share price divided by the targets EPS, that's the PE ratio for the deal.

I compare that to the acquirer's standalone pe.

So we do exactly the same calculation just using the acquirer's details.

So I'm gonna go back to that assumptions tab.

I'm gonna go this time to buyer get their share price, it's already in euro so I don't need to convert IF four to lock onto that and I wanna divide it by their forecast EPS, which is gonna be here on our acquirers tab.

So acquirer again in my income statement it's row 36 for the diluted earnings per share and we in 2017, so column GI divide by the EPS in column G and I get 19.9 times.

So what exactly does this mean? This means if I were to finance this deal using just equity to buy the target, just equity and we don't consider synergies.

So no synergies and I'm just using equity to finance this deal.

This deal would be dilutive.

The reason is I am using my shares as a currency to pay for the target.

My currency is worth 19.9 whereas what I'm buying is actually more valuable.

So I'm gonna have to issue proportionally more shares to acquire those earnings.

And so that is why it's expected to be dilutive, right? If we were financing this deal just with equity, I'm using my equity and I'm paying for the target.

Think of this in terms of like value of your currency.

I've got a relatively weaker currency and I'm buying something that's more expensive.

And so I would expect to see EPS dilution, okay? If this was just financed with equity, let's have a look if this were financed with debt.

Now the concept of a debt PE is quite hard to understand.

What's easier I think to do is look at it from a cost of debt perspective.

So let's go get our after tax cost of debt that we're gonna use to finance this transaction.

That's gonna be on the assumptions page.

So I'm gonna go back up to assumptions and I'm going to go to row 32.

So 5% that's pre-tax and I'm gonna multiply by one minus the tax rate.

And the tax rate is in row 43 I think there we go to get the after tax cost of debt comes up as zero, don't panic, we just need to change it to a percentage and that's three and a half percent.

Okay? So I've just taken the 5% cost of debt times one minus the tax rate and that gives me a three and half percent cost of debt.

Now all the debt PE is, it's just the inverse of this.

It's just one divided by the cost of debt.

That is the debt pe, okay? Price is a hundred and we divide by the cost of debt.

So if I do that here, one divided by cost of debt after tax, I'm gonna lock onto that.

Let's do a four because we wanna copy this to the right.

I get 28.6 times.

So what does this mean? Okay, now I'm looking at comparing the transaction PE with the debt pe.

So I'm comparing the 29.4 with the 28.6.

If I were to finance this deal purely with debt and there's no synergies, this deal would be expected to be slightly dilutive in the first year, right? Because I'm paying with something that's got a PE of 28.6 and I'm buying something that's 29.4.

Now it's helpful to me to actually look at the inverse of this.

So let's just copy this to the right and then I'll show you what I mean by looking at the inverse.

Just double checking my numbers as I go. Yep.

And those are all looking good.

Last thing to say on this PE business is what's more intuitive I think is to look at it from a yield perspective.

If I take the inverse of the pe, PE is price divided by earnings.

The inverse of that is earnings divided by price.

That's the earnings yield, right? So if I just for all of these numbers take the PE or not actually the pe, I've got one divided by the PE 'cause I want the inverse, right? So one divided by the PE and change that into a percentage.

So alt hp if you're not on a Mac, otherwise your percentage button.

If I then copy this down and copy this to the right, I've now got percentages which I think make a little bit more sense.

If we talk about, first of all, if we were to finance this deal just using debt, if I just use debt, the cost of that debt is 3.5%.

Okay? The yield of the company that I'm buying is 3.4% in the first year.

But then you can see it increases as the earnings increase.

So actually the deal would be accretive if I financed it with debt because I'm paying 3.5% on the financing, but I'm earning 3.8% on what I've invested it in.

Okay? So that would expect, we would expect accretion if we now take that color off and compare instead the, if I finance this just with equity, if I finance this just with equity, I now compare the acquirer's earnings yield.

At the moment they're earning 5%, 5.3, 5.5 and they're gonna be investing in something that's earning a lower amount.

And that's why we would see this dilution. Okay? So guys in this case it's just, it's, you can see you need to do a proper model to see what's actually gonna happen, right? So to see that you need to do the full model that we've got.

But this gives you a very useful just sense check because think of it, in our case, we are seeing small dilution in the first year then accretion.

First of all, we've got synergies included which our PE analysis doesn't consider.

And secondly, we are financing most of this deal with debt and we saw debt looks good, right? Because the cost of debt is cheaper than the earnings yield.

And so it makes sense that we then see some accretion coming through.

So that is an analysis that we saw in the, if you wanna go back to last week's little model that we looked at, we skipped over this bit, okay? But hopefully that makes sense if not guys please questions in the pod or in the chat, Right? Let's move on to one of the things we said last week was if you are paying with equity, you would wanna see what is the percentage of the combined company that the target shareholders would own after the deal.

'cause you'd wanna be conscious, are they actually gonna be more than 50% so now they control the business or are they maybe gonna be more than, um, are you going to lose 75% threshold? Okay, so maybe now you're gonna be 70%, the target's got 30% 'cause then they could block special resolutions.

For example here, what might look odd to you is equity ownership after the deal buyer has got a hundred percent of the shares, Monsanto's got no shares, but we said we are using equity to finance this deal.

So have we made a mistake here? The answer is no.

And this is where that switch comes into play.

If we go back to the assumptions tab or the model, no it's the assumptions tab, not the model intro. There we go. Row 23.

So assumptions tab row 23, secondary issue question mark.

The note says if that is one, we are doing a secondary issue.

If that is zero, we are issuing shares directly to the target.

Last week we said generally speaking, when equities used to finance a deal, the equity not issued to shareholders for cash and then cash used to buy the company instead there's a share for share exchange you give shares directly to the target shareholders.

A secondary issue however, is where you issue shares for cash.

So the target shareholders do not get shares in the acquirer.

The target shareholders get cash.

And that's why the switch was on one.

We had a hundred percent buyer ownership.

Monsanto had nothing.

If we were to change that to zero, now we saying okay, we are not issuing shares for cash, we're doing a share for share exchange that will flow through our model properly.

And if we now go to our analysis tab, what you'll see is now Monsanto shareholders have 14.6% of the combined entity because it's not a secondary equity issuance.

They getting shares in Monsanto.

Okay, so just to explain that, I just wanna go back and turn the switch back off just in case anyone is following in the solution and you've maybe joined a bit late, I don't want things to look too different.

Okay, so that is what that switch was all about.

Okay, so we have done our accretion dilution analysis. We've already looked at some ratios, the pe, let's look at some credit metrics, credit metrics I've already pulled through from the relevant models to save us some time.

We wanna work out total debt.

So I go to the proforma balance sheet, the new co balance sheet and I add up the debt, short-term debt, long-term debt, add that all up. So this is after the deal, I've got it at 2016 and then into the future I do the same for non-controlling interest.

So the acquirer and the target in the two standalone balance sheets they had NCI because they've got subsidiaries they don't own a hundred percent of.

So when you consolidate, there's NCI, right? So that's NCI, it's part of the funding.

Then we've got book value of equity from the balance sheet combined balance sheet and then we've got the total capitalization.

We've then got cash and cash equivalence, which NZI is quite small and zero for future years.

Let's have a look at leverage.

We said one of the things we need to keep an eye on is this debt to EBITDA ratio.

I want the pro forma consolidated debt to ebitda.

So I've got N row 27, the total debt.

I'm gonna divide that by the EBITDA of the combined entities.

So I'm gonna go to the new co tab to the income statement, find EBITDA row 19.

I'm working in the 2016 year.

Can you see how important setting up your model well is model integrity on every tab where I've got a model 2016 is column F.

2017 is column G.

So if I'm confused, what year am I looking at? I've got the debt from column F, so I need the earnings from column F as well.

Okay, so I've got 4.9 times debt to ebitda.

That is your leverage ratio. Let's do a coverage ratio.

Coverage ratio, probably not as important as the debt, uh, the leverage but obviously we still need to make sure we can cover the interest.

That's EBITDA over interest expense comes straight from the new co income statement.

Ebitda, same line.

So row 19 column F we're doing 2016 and I divide that by the interest expense and you'll see that that is in row 28.

Now it's not ideal 'cause this is net interest expense which is interest income minus interest expense.

Ideally we just want the interest expense on its own, okay? But you can see going forward the company doesn't have lots of cash anyway, so it doesn't make a huge difference here.

That looks a bit weird being a negative.

So let's change it to a positive.

So that's pretty healthy coverage, right? You can cover your interest 13.3 times.

Let's look at the percentage of debt out of the total percent out of the total capital, what percent of the capital is made up of debt.

I've got that all on this tab.

I've got in row 27 the debt as a percentage of the total capital in row 30, it's north 0.6.

You could change that to a percent if you want.

You can change that to 60%.

Notice that we use book value of equity here.

I know very often we are looking market values of equity but for credit purposes credit is focused on downside risk.

If something goes wrong in the business that equity's not gonna have the market value it's got now.

Okay, so we look at book value of equity generally for credit.

Let's copy this to the right and see what this looks like.

We've got one additional calculation here. FFO to debt.

FFO stands for funds from operations.

Now the definition of that can vary depending on the rating agency that's doing the analysis or the modeler.

For our purposes we've basically said let's look at cash net income, right? So def definitely different definitions of funds from operations, okay, we don't have a historic cashflow statement so we are just doing this for 2017 forward.

But if I go to the funds from operations calc, I go to NewCo, I go to the cashflow statement and on the cashflow statement you can see there I've got net income for 2017.

I'm just gonna add to that the depreciation and amortization.

Okay? So like I said, this isn't a detailed credit analysis definition of funds from operations.

We've just said let's take net income, but let's add back DNA.

So that is the funds from operations.

I'm just gonna put that all in brackets and then I'm gonna divide by the debt and my debt is in row 27.

So I can see north 0.1 probably more useful to see this as a percentage, 14.8%.

Okay, let's have a quick think about what this means.

Total debt to EBITDA that's leverage.

The higher this is, the more risky the business is, right? So you can see it goes up massive.

It's 4.9 times for an investment grade company, a normal industrial investment grade three, three and a half times squishing it, right? So this makes me uncomfortable to see it go all the way up to four.

Yes the company is de-leveraging, but is that quick enough? That's like what the um, tapestry announcement was talking about, right? Then we've got the EBITDA to interest expense, the coverage, yeah, it dips a little bit but that still seems okay.

This also makes me a little bit uncomfortable guys. We've got more than 50% of the total funds coming from debt and then funds from operations.

The higher this is the better, right? Because this is a safety measure and we can see quite low in the beginning and then it increases.

Now it's not just enough to look at this on its own.

What you've gotta look at is what was the buyer before this? So if I look at the standalone buyer, you can see there is gonna be a significant increase in the debt level, right? So 4.9 versus 1.7 bond holders are probably not gonna be happy with that, right? If you have a drop in your credit rating, it's not just about going below investment grade but a drop in your credit rating, even if it's from you know, a minus to triple B plus that changes the cost of your funding bond holders lose value.

Okay? So the conclusion for this deal based on what we've seen so far is yes, EPS accretion looks very good but we probably using too much debt.

So we would need to go back to our assumptions, increase the amount of equity.

Yes we're gonna sacrifice a bit of EPS accretion, but you can't just be worried about shareholders, you've gotta worry about your debt holders as well.

Remember you're gonna keep going back to the market in future to raise more financing and you don't wanna have burned your debt holders, right? By doing a massive deal and everyone sees their value drop, okay? So this, I mean you will definitely engage with the rating agencies, you don't wanna see a drop in your rating.

So if they'll allow you, and guys I know we don't have time, I must actually um, move on to synergies.

But for those of you that were in class last week, um, JM Smucker deal that we looked at, I actually found their rating agency report and they said straight after the deal they revised the outlook to negative.

They didn't change the rating, they just said negative outlook because if they don't deliver over the next I think two years, then they would drop the rating.

Okay? So they said they expect to to reduce below four within two years and they said they've got a good track record as a company of doing that and that's why they're not actually dropping the credit rating.

Okay? Very conscious of the time guys.

I'm gonna move on to the next tab quickly so we can at least do synergies.

Okay? I didn't have time for ROI in the first session so it looks like I'm not gonna have time for it either in this session, but I'll show you videos where you can find that.

Let's just do the synergy analysis.

So on the value creation tab with synergies, you can get synergies from different sources.

Here we've got revenue synergies, so selling more as a combined group than we would if we just continued, you know, separately.

So new markets, maybe cross-selling of products, then cost synergies.

These are relatively more certain than revenue synergies because it's easier to model, right? I know head count, I know how many people I could cut.

Okay, so cost synergies.

One that we didn't see last week is CapEx synergies.

If there's potential for using common machinery to do stuff, then I don't need to spend as much on CapEx as if there were just two companies operating separately.

So we've got a saving in CapEx spending.

Now if I spend less on CapEx, I'm also gonna have less depreciation right now.

Synergies don't come for free, they don't just happen by magic.

It costs money to extract these synergies, right? So what's the costs of this restructuring? Thinking of things like, I dunno, redundancy payments, consulting fees, whatever we've got restructuring costs.

So there's the total, we've got tax worked out on all of this and the tax, we don't look at the tax on the CapEx synergies 'cause that's not an income item.

The income impact is the DNA and we've got that included in our tax calc.

All of these synergy numbers have pulled through from the calcs tab.

And you can see in this calcs tab we have got the buildup to the full synergies.

So someone asked about that last week here we've got 25, 50, 75, so building up and then by year four we've reached full synergies.

Now what we wanna do with these synergies is we wanna value them.

I wanna get the present value of these synergies and I'm gonna do a discounted cashflow calculation for those of you that are new to discounted cashflow.

Okay, this is gonna be too fast.

I recommend watching, I think two weeks back there was an intro to DCF Felix Live, but for those of you that are familiar, let's quickly go through.

First thing I need to do is get cashflow revenue synergies.

I'm just pulling from above that will increase my cash flow as will cost synergies and cap X synergies.

One we just need to be careful about is this reduction in DNA as the note says, we are gonna have less depreciation as an add back to our cashflow.

When you start a cashflow statement, you start with net income and then you add back depreciation, right? Adding back depreciation, then that makes your cashflow higher.

If I'm not doing as much CapEx, I'm not gonna have as much depreciation and so I'm not gonna be adding back as much depreciation and so that actually reduces my cashflow.

So the sign for this one here should be a negative.

So that 15 of reduced depreciation, that actually reduces my cashflow because I'm adding back less to my net income.

Then restructuring costs definitely are the cash impact and then the tax I need to pay.

Also cash impact.

So we've got our total cash flows of 2 53 for the first forecast year.

And guys this name can be fancy.

Sometimes delta just means change.

This is my change in cash flow, this is my increase in cash flow as a result of synergies.

I'm gonna copy this to the right because I need to now discount all of this back to the present value.

Let's just keep an eye that my numbers haven't gone astray.

Yep. So those are looking good.

This part pure DCF.

Okay, so I've got a discount rate.

This would usually be the targets whack.

You can see we've included a risk premium.

That's debatable because how much of a risk premium do you include? We'd maybe do more sensitivity analysis around the synergies, but here we've said, okay, we're just going to increase the discount rate a little bit because synergies are uncertain, right? So we are using 8% and then we've got a terminal growth rate of 1%.

So this part guys just sit back if you don't know DCF yet, but for those of you that do know it, let's work out our terminal value of synergies.

I take the final year, multiply it by one plus growth, divide that by WAC minus growth and that gives me 17 5 0 9 in value that represents the value of all of the synergies going into the future, right? So that is the 17 5 0 9.

Now I want each of these synergy amounts in your 1, 2, 3, 4 to be discounted back to the present value.

Normally what we would do is we would have a discount factor for each year, multiply the two together, get the present value for each year, add it all up as a shortcut.

What we've done in this model is we are just gonna do an NPV calc, right? So I'm just doing it all in one between normally like to see each year discounted individually.

But all I'm gonna do is I'm gonna say give me the NPV, you put your discount rate first, comma, you select your cash flows.

And so what that represents is the present value of each of those cash flows present, valued, and added together.

I now need to get the present value of this terminal value because that terminal value is sitting at the end of year four.

We were standing at the end of year four looking forward and saying what are we gonna earn into the future? So that's 17 5 0 9 needs to be brought back to today as well.

So I'm gonna discount that for four years.

I take the terminal value divided by one plus the WAC to the power of four 'cause that is four years into the future.

And now I've got the total net present value of synergies of 15 2 0 7 0.8.

To finish off this analysis, you could say, okay, but what does that mean? How do I know if this is good or bad? Okay, so you're generating 15.2 of synergies in value, but how do I know if this is good? One of the things we can do is we can compare the present value of the synergies to the premium.

We pay for the target.

Remember last week we said you pay a premium to gain control.

Once you've gained control, you can do whatever you want in the company and you extract the synergies.

So how much are we paying for that control? We need to go back to our assumptions tab and remember that we are working in euros here.

So last calc we're gonna do, let's go to our assumptions tab.

I'm gonna open brackets 'cause I know I'm gonna be doing subtraction.

So in the assumptions tab, if I look at the premium, I'm paying for the target in dollars, I'm offering 1 28 per share.

That's the price I'm paying minus the standalone unaffected traded price of 89.

So per share, I've got the premium I'm paying, I want the total premium.

So I need to multiply by the number of shares, which is in row 15.

And then the final thing to remember is this is all in US dollars.

I'm working in Euro, my synergy analysis was in Euro.

Do not make the mistake of just leaving this in US dollars 'cause the comparison obviously doesn't make sense.

I multiply by the exchange rate and I get 16 4, 8 5.

And then what I can do is I can compare these two things.

I can say, okay, well I have paid whoops and my arrows are going in the wrong place and now my eraser is not working.

Okay, let's see if I can do that right? So I can say I have paid a premium of 16, 4 8 5 to get control of this business.

Once I've got control, I'm gonna extract synergies to the value of 15 207.

So have I created or destroyed value for my shareholders? In this case, I've destroyed value for my shareholders, right? Because I'm paying 16.485 and all I'm gonna be generating for that control is 15 2 0 7.

So on this metric it's not looking great.

However, one thing to just bear in mind though is what happens if Monsanto was undervalued? What happens if that share price of 89 was too low? Do you agree? Then I'm gonna be paying a very high premium because not all of it's actually premium.

Some of what I'm paying is actually to get up to the fair value of Monsanto and then there's a premium on top of that.

So it could be that Monsanto good company, but for whatever reason it was slightly undervalued in the market.

And so yes, it looks like I'm paying a high premium, but I can't say that I'm destroying value because it's not really fair to say that's all premium that I'm paying.

So you can see how nuanced this is guys, you can see how you need to know the companies that you're working with, but these are the tools that you can use to do your analysis.

Unfortunately, I'm gonna have to stop there.

This return on invested capital, I'd already filled out some of the numbers for you, but what I would suggest is you've got the full solution file, okay? Also, if you wanna have a look at this particular model, if you go to your topics and you go to corporate finance and M&A, so topics, corporate finance, M&A this topic is advanced M&A modeling.

Yeah, so advanced M&A modeling.

This takes you through using the same model that we've just seen all the steps. There's your calendarization videos, you then go through building the combined income statement, balance sheet, et cetera.

And then right at the end you've got your return on invested capital at the end.

Okay? So guys, I'm going to leave it there.

Hope that you found that useful and that you have a good rest of your day and a good weekend.

I'm gonna stop the recording, but I am here if anyone has any questions.

So thanks very much and hope to see you again in another session soon.