M&A Guide: Part 17 - Merger Model

Eduard Grigoryan

International Legal Counsel (PQE 7) | Ph.D. in Law Candidate | LL.M. in International Private Law | SQE Candidate | Aspiring Solicitor of England and Wales

Published Dec 25, 2023

The merger model is a critical tool in investment banking, particularly in the mergers and acquisitions (M&A) sector. It's used to analyze the financial impact of a merger or acquisition on the acquiring company's earnings per share (EPS). This model helps determine whether a deal will be accretive (increase EPS) or dilutive (decrease EPS) post-transaction.

Here’s a detailed guide on understanding and building a merger model:

🔍 What is a Merger Model?

Definition: A merger model calculates the expected accretion (increase) or dilution (decrease) in the acquirer’s EPS resulting from an M&A transaction.
Application: Used in both sell-side and buy-side M&A advisory services.
Sell-Side M&A: Advising the selling company or owner.
Buy-Side M&A: Advising the purchasing entity.

🔨 Building a Merger Model: Key Steps

Determine Offer Value Per Share and Total Offer Value: Calculate how much the acquirer should offer for each share and the total value of the offer.
Structure Purchase Consideration: Decide the composition of the offer in terms of cash, stock, or a combination of both.
Estimate Financial Details: Calculate financing fee, interest expense, number of new shares to be issued, possible synergies, and transaction fees.
Perform Purchase Price Accounting (PPA): Calculate goodwill and incremental depreciation and amortization (D&A).
Calculate Standalone Earnings Before Taxes (EBT): Determine the EBT for the acquiring company without the merger.
Consolidate EBT to Pro Forma Net Income: Combine the EBTs of the acquirer and target, and adjust for the transaction's impact.
Calculate Pro Forma EPS: Divide the pro forma net income by the pro forma diluted shares outstanding.
Estimate Accretive or Dilutive Impact: Determine the final impact on the pro forma EPS.

📈📉 Accretion / Dilution Analysis

A. Purpose: Primarily relevant for publicly traded companies to understand market valuation implications post-merger.

B. Interpretation:

· Accretive Merger: Indicates a positive market response, suggesting the acquirer didn’t overpay.

· Dilutive Merger: Can be perceived negatively, hinting the acquirer might have overpaid.

🏭 Scenario Overview

A. Acquirer Company: Let's call it "Company A."

Share Price: $40.00
Total Shares: 600 million
Market Value (Equity Value): $24 billion (calculated as $40.00 per share times 600 million shares)
Earnings Per Share (EPS): $4.00

B. Target Company: Let's call it "Company B."

Share Price: $16.00
Total Shares: 200 million
Market Value: $3.2 billion (calculated as $16.00 per share times 200 million shares)
EPS: $2.00

The Deal

A. Offer Price: Company A offers to buy Company B.

They propose a 25% premium on Company B’s share price.
Company B's share price is $16.00, so the offer price per share becomes $20.00 (25% of $16.00 is $4.00, added to the original $16.00).

B. Financing the Acquisition:

Company A decides to use a mix of 50% cash and 50% stock.
The cash will be borrowed (debt).

Key Assumptions

Synergies: Expected savings or extra revenue from combining the companies.
Transaction Fees: Costs for lawyers, bankers, etc.
Purchase Price Accounting (PPA): Adjusting asset values and accounting for goodwill (intangible value) after the merger.
Tax and Depreciation/Amortization Impact: Changes in taxes and asset value reduction over time due to the merger.

Final Analysis

A. Calculate Post-Merger EPS for Company A:

Determine the new earnings (profit) and the new total number of shares after the merger.
New EPS = New Total Earnings / New Total Shares

B. Compare Pre-Merger and Post-Merger EPS:

If Post-Merger EPS is higher than Pre-Merger EPS ($4.00), the merger is accretive (good).
If Post-Merger EPS is lower, the merger is dilutive (not as good).

🤝 Conclusion

The merger model is a complex yet essential analysis tool in M&A transactions. It ensures a comprehensive understanding of the financial impact of a merger or acquisition, guiding investment bankers and companies in making informed decisions.

Also check the previous series of posts!

Part 1 - Corporate Takeover

Part 2 - Traditional Merger vs. Tender Offer

Part 3 - Hostile Takeover

Part 4 - Horizontal Integration

Part 5 - Vertical Integration

Part 6 - Reverse Merger

Part 7 - Conglomerate Merger

Part 8 - Divestitures

Part 9 - Spin-Off

Part 10: Forward Integration

Part 11: Backwards Integration