Never imagine that building a merger model in Excel is either easy, quick, or guaranteed to be accurate. On the contrary, those who have benefited both from merger modelling training and who have practical experience will tell you that every deal is different and every model needs to be bespoke. Some truths are unassailable, however – the accuracy of the model will depend on the assumptions that are made, especially for the sales, costs and therefore operating incomes of the two companies.
How to Build a Merger Model
A DCF model for both companies must be built, with all the usual problems of subjectivity, poor forecasting techniques, and difficulties in assessing comparative costs of capital. However well done, this process is inevitably subjective. When combined with analysis of comparables, recent deals and merger premia, the DCF will generate the relative valuations of the companies. This in turn will determine the modelled cash, or quantity of shares, to be paid in consideration, as whether or not the deal really is a merger rather than an acquisition in disguise, like Disney’s takeover of 21st Century Fox, it is usual either for cash to be paid, or, more rarely, for one company’s shares to be replaced by the other; even in a merger of equals, such as Daimler-Benz and Chrysler, where a new company altogether is to be created, there is a need to determine relative valuation. The evidence of what actually happened at Dixons and Carphone, however, as opposed to the financial model that generated an approximately equal valuation back in 2014, is an example of where DCFs can be rapidly overtaken by events. Care is needed in attending to warranties and share options, as these can dilute value very quickly, fees payable, and goodwill, as it can unbalance a deal equally quickly. Any potential replacement debt is introduced into the model at this point as well as additional equity or some combination of both, the planned financing mechanisms – different debt/equity ratios and cost of capital generated by a model can excite investors about a deal, but the model is equally useful in highlighting the financial engineering that will be required to make it succeed.
Synergy is Crucial
The next crucial forecast is synergy. Any merger model can be made to look attractive if the synergies are projected sufficiently highly, so cost savings must be balanced against integration expenses in a defensible way, not just in quantity but timing as well. The financials of both companies will need attention, reflecting different accounting practices. This is especially so when the merger is between part of one company and another, as the restructuring process – asset disposals, reorganisation of equity, differently structured debt – that will be required after the merger must all be modelled. IFRS merger accounting is almost constantly changing, so it is vital to ensure that the latest Standards are incorporated.
Whilst there is no absolute rule on what the worksheets of a merger model must be, sheets for assumptions, the raw financial data, the DCFs for each company which will show a contribution analysis and therefore justify the purchase price or share exchange values, the synergies and therefore combined income statements, combined income statements, balance sheets and cashflow statements, the debt schedules, and tax implications, and risk analysis driven by either or both of sensitivity and scenario analysis are all usual components.
The model can now start to generate answers, such as what will happen to Earnings Per Share (EPS) of the combined entity by comparison to its two predecessors. If EPS is projected to fall, the model is already indicating that the deal may fail. All of this, and indeed every aspect of the model, is rendered more difficult when the acquirer is launching a hostile bid, as companies will not part with information readily, as the bid for Qualcomm demonstrated. A difficult task, and one that really requires specialist training.