Identifying Opportunities for

M&A- Buy Side and Sell

Side
Chapter 5
Why look for opportunities
• For growth and maximization of shareholders’ wealth, cos on lookout
for growth options
• Organic and Inorganic
• Investment banks help by identifying, assessing, evaluating and
pursuing opportunities
• Buy side advisory- when helping client identify and acquire right
target
• Sell side advisory- when helping client identify opportunities to sell
off, divest or connect with buyer
Buy side advisory activities
• Identify tentative potential targets for acquisition
• Preliminary due diligence for proposed targets
• Select best feasible option for buyer
• Complete financial due diligence for selected target
• Write and fix pre-purchase agreement
• Negotiate with target firms and close deal
Role of advisor
• Prepare initial report having detailed analysis, planning, resource
allocation and expertise to integrate resources- also called due
diligence report
• Strategic, legal and financial due diligence
• Contents of report
• Selection of target and engagement
• Preliminary due diligence, valuation and indication of interest
• Comprehensive due diligence and PPA
• Final due diligence, DPA draft, completion of deal, including integration
Financing options for Buyer
• Stock/Equity
• Usually costlier than debt financing
• Useful in large and expensive purchases
• Flexibility-no interest, capital repayment, compulsion on capital structure
• Exchange ratio: x= Pt / Pa,
• Where x= exchange ratio, Pt= price of target firm before deal announcement, Pa= price
of acquiring firm before deal announcement
• Acquirer would want exchange ratio to be minimum, target would want
maximum
• If share prices not acceptable, then minimum exchange ratio
X=FVt / FVa
• Where FVt= fundamental value of target per share, Fva= fundamental value of acquirer
per share
• DCF can be used to calculate fundamental value

• Maximum exchange ratio:

(FVt+AP)/ FVa
• Where AP= acquisition premium per share paid to target shareholders
Financing Options for buyers (contd)
• Cash on hand
• Debt financing
• Bridge loan- interim loan taken from bank consortium, later converted into
long term debt
• Bonds and debentures raised from market- long term, coupons
• Senior debt notes-term loans by banks, priority for payment and repayment,
liquidation, less risky
• Junior debt notes/ junk bonds- subordinated debt, low priority for payment,
repayment, liquidation, mezzanine debt which carries option to buy shares
• Line of credit- interest on amount actually used, used for short term gaps and
shortages
• Fairness Opinion
• Opinion letter by advisor claiming and authenticating the fairness and
justification of valuation
• Before signing PPA and deal announcement
• Professional assessment of financial due diligence
• FO required for filing with regulators and courts of law

• Definitive Agreement
• Purchase agreement signed by buyer and target firms
• Consists of valuation and consideration, representations by buyer and target,
warranties, treatment of options if any, termination fee, break up clause, etc.
• Signed after all covenants covered, terms and conditions agreed upon, final
stages
Buy Side Valuation and Deal Analysis
• Football field graph
• valuation done using different methods such as DCF, market multiples, market
capitalization, EVA, etc.
• These methods provide a range of values.
• This graph helps plot different values and arrive at ideal outcome
• EPS accretion/ dilution analysis
• Pre-deal analysis
• Accretion: Combined EPS > Acquirer’s EPS
• Dilution: Combined EPS < Acquirer’s EPS
• Breakeven: No impact on Acquirer’s EPS
Accretion/ Dilution calculation
• Pro-forma income of combined firm estimated
• Adjustments made to combined incomes to reflect M&A effects
• Synergies-operational and financial eg. differential revenues from cross-selling
of products/ cannibalization, economies of scale, etc.
• Change in interest expense due to debt effect of M&A
• Amortization of intangible assets created due to M&A
• Depreciation due to write-up of assets post M&A
• Find out new shares of combined firm
• Calculate EPS by dividing estimated net income by new share total
Example 5.2
• An acquirer wants to purchase 100% of a target firm by issuing
additional stocks against the shares of the target firm. If no premium
is paid, calculate accretion/ dilution of EPS

Acquirer Target
Market price per share 30 65
P/E ratio 6 10.8
Shares outstanding 5000 1500
• In pure stock deal, always dilutive when target PE ratio greater than
acquirer’s PE ratio, and vice versa
• Because PE ratio reflects cost of earnings- higher the PE ratio, higher
the cost of earnings and more expensive is firm
Sell-Side M&A
• Advisory Procedure:
• Target business’ comprehensive due diligence
• Strategic vision of target firm (pre and post merger)
• Identifying potential buyers
• Establishing strategic fit
• Inviting best valuations, bids and intents
• Negotiation of terms and closing deal
• Factors affecting sell-side M&A
• Company specific variables-why sell?
• Existing market conditions-valuations
• Synergy opportunities
Sell-side process
• Preparing business for review-
• presale due diligence,
• define objectives,
• review processes and operations,
• pre-purchase DD report
• Preparing target for sale-
• key selling points,
• evaluate buyers,
• final buyers list,
• management presentation,
• prepare for field visit from buyers
• Marketing the target-
• select buyers for final round,
• confidential report for buyers,
• evaluate buyer’s financial capacity,
• first round of auction and bid selection process,
• prepare for second round
• Due diligence and selection-
• select final list of buyers,
• negotiate on finer aspects,
• arrange for visits and financial analysis,
• evaluate price, structure, cash and stock components
• Negotiation and closing-
• final selection of buyer,
• finalizing deal value and structure,
• negotiate for final valuation and mode of payment,
• final definitive agreement, sign and close deal
Financial Buyers
• Investors interested in the return they can achieve by buying a business
• They are interested in the cash flow generated by a business and the future
exit opportunities from the business. They are typically individuals or
companies with money to invest, and who are willing to look at many
different types of businesses or industries.
• Their goals may include growing cash flow through revenue enhancement,
expense reductions, or creating economies of scale by acquiring other similar
companies.
• Their exit plans may include an IPO (initial public offering), where the business
is “taken public” (hopefully at a higher multiple of earnings than paid at
acquisitions), or selling the company at a future date.
• Financial buyers will carefully scrutinize the financial statements of the
company.
• The transactions of financial buyers are often leveraged. It is common to see
financial buyers use as much as 80% or more debt to finance an acquisition. By
using high leverage, the financial buyer is effectively partnering with someone
who is willing to accept a level of return that is generally lower than that
required by financial buyers.
• In layman’s terms, financial buyers are buying exactly what the company has to
offer. They are buying the expected future earnings of the company as they are
perceived to exist at the time of the acquisition.
• While financial buyers may see the potential for expanding cash flow beyond
what the company has achieved on its own, they are generally not willing to
pay for that potential. They are much more likely to keep the current personnel
in place than strategic buyers. However, if their intent is to grow the business
and eventually sell to a strategic buyer, the retention of personnel may be
temporary.
Strategic Buyers
• Interested in a company’s fit into their own long-term business plans.
• Interest in acquiring a company may include vertical expansion (toward
the customer or supplier), horizontal expansion (into new geographic
markets or product lines), eliminating competition, or enhancing some of
its own key weaknesses (technology, marketing, distribution, research and
development, etc.).
• Strategic buyers are often willing and able to pay more for a company than
financial buyers. There are two main reasons for this. First, strategic
buyers may be able to realize synergistic benefits almost immediately due
to economies of scale that may exist through the combined purchasing
power of the new entity and the elimination of duplicate functions. The
better the fit (i.e., the more realizable the synergies are), the more they
will want the business and the greater the premium they will pay.
• Second, strategic buyers are generally larger companies with better
access to capital. They often have another currency available to them
in the form of stock. Strategic buyers often offer stock, cash, or a
combination of the two in payment of the purchase price.
• In short, the strategic buyer is buying the company in light of how it
will enhance their existing operations.
• They are often willing to pay for readily realizable synergies, and many
times will pay for speculative synergies, particularly if the target
company is being marketed to other competitors (through some type
of “auction”). Strategic buyers are much less likely to retain all of the
current personnel.