Merger Models

yedlu, Winter 2024

Key Components

Definition: Goodwill is the excess purchase price over the fair value of net identifiable assets.
Steps to Calculate:
1. Determine the purchase price (offer price × target diluted shares).
2. Write up tangible and intangible assets to their fair values.
3. Calculate Deferred Tax Liability (DTL) on asset write-ups.
4. Goodwill = Residual amount after adjustments.
Write-Ups:
- Tangible: PP&E adjusted to market value.
- Intangible: Brand names, patents, customer relationships (unrecorded in the target’s books).
Example:
Purchase price = $600M, fair value of net identifiable assets = $450M, write-ups = $50M, tax rate = 40%.
\[\text{Goodwill} = 600 - (450 + 50 - (50 \times 0.4)) = 130M\]
Impairment: Goodwill is tested annually for impairment and not amortized. Losses reduce the goodwill account and affect the income statement.

Definition: DTL arises from differences between book values (after fair value write-ups) and tax bases of assets.
\[\text{DTL} = \text{Asset Write-Up} \times \text{Tax Rate}\]
Impact:
- Creates a liability on the opening balance sheet.
- Reduces over time as the gap between tax depreciation and book depreciation narrows.
- Reverses fully by the end of the depreciation period.
Example:
If the write-up is $50M and the tax rate is 40%,
\[\text{DTL} = 50 \times 0.4 = 20\]
Relevance:
DTL increases goodwill, as it represents a liability assumed in the transaction.

Adjustments:
- Consolidate the acquirer’s and target’s balance sheets.
- Write up target’s assets to fair value.
- Add goodwill and DTL.
- Record transaction financing (e.g., new debt issuance).
Steps:
1. Start with standalone balance sheets.
2. Add purchase price allocation:
  - Write-ups for tangible/intangible assets.
  - Goodwill creation.
  - DTL adjustment.
3. Include transaction fees and financing adjustments.
Example:
Acquirer pays $300M in cash and issues $200M in stock. Target assets: $250M, liabilities: $50M, write-ups: $30M.
\[\text{Goodwill} = 500 - (250 + 30 - 20) = 240\]

Purpose: Details the financing sources and allocation of funds in the transaction.

Key Questions:
- How is the deal funded (cash, stock, or debt)?
- Are transaction and financing fees included?
- How much debt is refinanced or repaid?
Example:
For a $1,000M transaction:
- Sources: $500M debt, $300M stock, $200M existing cash.
- Uses: $900M purchase price, $50M target debt repayment, $50M fees.

Definition: Measures the impact of the transaction on acquirer’s Earnings Per Share (EPS).
Pro-Forma EPS:
\[\text{Pro-Forma EPS} = \frac{\text{Pro-Forma Net Income}}{\text{Pro-Forma Shares Outstanding}}\]
Steps:
1. Combine standalone net incomes of acquirer and target.
2. Adjust for synergies, depreciation, amortization, and new debt interest.
3. Subtract taxes to calculate pro-forma net income.
4. Calculate pro-forma shares outstanding (including newly issued shares).
5. Compare pro-forma EPS with standalone EPS.
Result:
- Accretive: Pro-forma EPS > Standalone EPS.
- Dilutive: Pro-forma EPS < Standalone EPS.
Example:
Acquirer standalone EPS = $3.50, pro-forma EPS = $3.80.
Result: Accretive by $0.30 per share.