Chapter 15 FIGURE 15.1 ADDING VALUE IN AN ACQUISITION FIGURE 15.2FINANCING ACQUISITIONS WORKING INSIGHT 15.1SYNERGY CHECKLIST WORKING INSIGHT 15.3 RELATIONSHIP BETWEEN BIDDER AND TARGET P/E AND EPS DILUTION WORKING INSIGHT 15.4USING DEBT FINANCE TO ENHANCE EPS WORKING INSIGHT 15.6, 15.7FEATURES OF AN EARN OUT

FIGURE 15.1 ADDING VALUE IN AN ACQUISITION Value to Vendor Increased sales Cost efficiencies Value to Acquirer Deal costs Working capital Maximum to pay Zone of negotiation

FIGURE 15.2FINANCING ACQUISITIONS Cash Buyer raises Shares Debt Equity Buyer cannot afford debt, and seller does not want risk of shares, so rights issue or sale in market to fund deal, or cash underwritten offer Seller gains from synergies and shares all risks. Buyer’s gearing is reduced No further relationship between buyer and seller. No risk to seller. Buyer is geared Unlikely Target shareholders receive

WORKING INSIGHT 15.1 SYNERGY CHECKLIST Does the deal… 1.increase sales growth? 2.improve profit margins? 3.reduce tax rates? 4.mean that we can save on capital expenditure? 5.mean that our working capital management will improve? 6.extend our period of competitive advantage? 7.reduce our cost of capital? Why? Over what period? By how much?

WORKING INSIGHT 15.3 RELATIONSHIP BETWEEN BIDDER AND TARGET P/E AND EPS DILUTION (1 of 2) BidderTarget Number of shares1,000 Share price£10 Market capitalisation£10,000 Profit after tax£1,000£500 Eps pre-deal£1£0.50 P/E ratio10x20x Bidder buys Target for £10,000, issuing 1,000 new shares Number of shares post-deal2,000 Profit after tax post-deal£1,500 Eps post-deal £1500/2000 = 75pLower eps post-deal

WORKING INSIGHT 15.3 RELATIONSHIP BETWEEN BIDDER AND TARGET P/E AND EPS DILUTION (2 of 2) BidderTarget Number of shares1,000 Share price£10 Market capitalisation£10,000 Profit after tax£1,000£500 Eps pre-deal£1£0.50 P/E ratio10x20x Target buys Bidder for £10,000, issuing 1,000 new shares Number of shares post-deal2,000 Profit after tax post-deal£1,500 Eps post-dealHigher eps post-deal £1500/2000 = 75p

WORKING INSIGHT 15.4 USING DEBT FINANCE TO ENHANCE EPS BidderTarget Number of shares1,000 Share price£10 Market capitalisation£10,000 Profit after tax£1,000£500 Eps pre-deal£1£0.50 P/E ratio10x20x Bidder buys Target for £10,000 cash, raising debt at 6.25% pre-tax. After tax of 20%, debt cost is 5%. 5% is inverse of Target P/E of 20x Number of shares post-deal1,000 Interest charge (net of 20% tax)£500 Profit after tax post-deal£1,000 Eps post-deal£1 Extra interest exactly cancels out increased profits

WORKING INSIGHT 15.6, 15.7 FEATURES OF AN EARN OUT AdvantagesDisadvantages Only pay for what is achieved. Delays the issue of equity, retaining control longer. Delays the issue of debt. Retains seller management for a period. Difficult to achieve synergies. Earn out management have an incentive to act for short term gain. Problems if own share price falls during the period. Potential to get a higher price. Tax advantages. Retains involvement in the business. New owners may change nature of business. Delays payment. Reliant on financial stability of buyer. Retains involvement in the business. To the Buyer To the Seller