Introduction
As we know, a Merger is a situation where two companies come together to form a new, single entity. Now, what is a merger model? A merger model represents the combination of two companies that come together through the merger process. Statements of the buyer and the seller in the acquisition process reflect their financial position arising from the combination.
Businesses often opt for mergers and acquisitions in a competitive market. This is why it becomes important for the company to analyse the financial implications of such a deal by calculating the combined value of the two companies.
Importance of the Merger Model in M&A Decisions
The merger model plays a crucial role in deciding whether or not to acquire the target company. This analysis of financial modeling helps the company make informed decisions by showing whether the day is worth it or not. It helps the party determine the best financing options, secure shareholders’ approvals on the deal, and sell on a viable purchase price for both parties.
How do we build a Merger Model?
Let us understand the process of building a merger model, which consists of the following steps,
1. Making assumptions
The first and foremost step in building a merger model is to make acquisition assumptions. In this step, the buyer creates an assumption for the acquisition of the target company. This assumption can include the form of consideration, which can be whether in cash or the number of shares and the offer value per share. Other assumptions in this step will include the purchase price, number of new shares to be issued, synergies from the combination of the two businesses, integration costs, financial projections, financial adjustments, value of cash that should be paid with the target company, etc.
If the buyer’s stock is undervalued, it may decide to use cash instead of equity, but the target company might want to receive the consideration in the form of equity. This can be a crucial part of striking a deal or a merger.
2. Projecting the financial statements
The next step is to make projections in a merger model, which is similar to making projections in a DCF model or any other financial model. The buyer’s merger and acquisition team will use the data from the two businesses’ income statement, balance sheet and cash flow statement to generate a financial projection for the upcoming proposal that is of the merger.
This process is also known as building a three-statement financial model, which includes the income statement, cash flow statement, and balance sheet. In this step, the analyst makes assumptions about the margins, capital structure, fixed cost, variable cost, revenue growth, capital expenditure, etc.
3. Valuation
Step 3 is to value the business. The valuation of the business can be done by using the assumptions made in the previous two steps. The evolution will be made by the discounted cash flow (DCF) model using the comparable company analysis and precedent transaction method.
The steps here will include performing the comparable company analysis, building a DCF model, determining the weighted average cost of capital, and calculating the terminal value of the business.
4. Key financial metrics
The financial model built by the buyer for the merger and acquisition includes the estimation of key financial metrics. This Matrix includes financing fees, cash flow, synergies, integration cost, interest expenses, transaction fees, standalone earnings, and debt-related aspects.
5. Business combination
One of the most important steps in building the merger model is the combination of the two businesses. This Temple includes the combination of the balance sheet, income statement, calculation of synergies, calculation of cash flow, debt repayments, ratios, determining the value of goodwill, the value of stock shares, the form of consideration, and the purchase price allocation.
Calculation of goodwill resulting from the acquisition is an important step in building a merger model. Goodwill arises when the buyer requires the target for a price greater than the share market value of the net tangible assets of the target company’s balance sheet.
6. Deal accretion or dilution
The last and final step in building a merger model is analyzing the deal. The purpose of accretion or dilution analysis is to determine the deal’s after-effects on the buyer’s pro forma earnings per share.
A transaction can be accretive if the buyer’s earnings per share increases after in the company. However, if the buyer’s EPS declines after the merger, the transaction is viewed as dilutive.
Conclusion
The M&A model evaluates the financial feasibility and the result of such a merger or acquisition. The M&A model is considered one of the core financial models in investment banking and corporate development.
It helps to analyze factors such as potential savings from acquisition, cost of acquisition, projected revenue growth, earnings per share, the effect on cash flow, and the overall return on investment.