Question

What are Mergers and Acquisitions? Name 5 things to consider when undertaking the Merger and Acquisitions process? Explain one valuation method. Describe the leveraged Buyout analysis.

Answer 1

Mergers and Acquisitions refer to the consolidation of companies or assets via various type of financial transactions.

Mergers and Acquisitions are connected and often used together but have different meanings.

Mergers occur when two firms merge together and form a new entity.

On the other hand, acquisition is a form of financial transaction where one company takes over another entity , known as target company and the acquiring entity estabillishes itself as the new owner.

5 things to consider when undertaking Merger and Acquisition Process:

1. Reasonable Rationale Behind Acquisition.

There must be reasonable rationale behing the financial transaction such that the firm can benefit from the financial transaction. The combined values of the 2 firms should be greater than value of either firm. Reasonable rationale can be access to new technology , markets, expansion in product lines, etc.

2. Significant Research

Significant amount of research needs to be undertaken on business operations of target entity and all alternatives must be researched upon.

3. Impact on Financials and Fair Valuation of target

The impact on financials i.e. P&L, Balance Sheet and Cash Flows should be positive. It should not result in large cash outflows threatening the business continiuation of the acquiring firm.

4. Analysing both Pros and Cons of Merger or Acquisition

Equal weightage should be given to analyse both pros and cons of merger or acquistion.

5. Focus on Human Capital

Human capital is the one of the most precious asset in most financial transactions. The impact of employees on future goals should be considered, especially that of the target. Management Experience is important to make mergers and acquisitions successful.

Valuation Method in M&A process:

Price To Earnings Ratio

The Price to Earnings Ratio is the ratio of the company’s market share price currently to its per-share earnings.

P/E Ratio = Market Value of Share / Earnings per Share (EPS)

A higher P/E ratio indicates an expectation by investors (acquiring entity) for a high growth of earnings in future in comparison to those companies which have a lower P/E ratio.

P/E ratio is compared with other firms in the industry or sector or against the same company's historical P/E Ratio.

It implies how much investors (acquiring entity) are willing to spend per dollar of earnings.

Leverage Buyout Analysis

A leverage buyout is a type of acquisition where one company acquires another with use of debt (Leverage) i.e. borrowed funds are used to meet the cost of acquistion. It leads to a very high debt to equity ratio. The primary reasons for LBO are for Taking a public company private.