Description

In a merger model, you combine the financial statements of the buyer and seller in an acquisition, reflecting the effects of the acquisition. Such as interest paid on new debt and new shares issued, and calculate the combined Earnings per Share (EPS) of the new entity to determine whether or not the deal is viable.

You can build a fairly simple merger model that takes 30-60 minutes (or even less time). Or one that takes hours or days to complete, depending on the complexity and requirements.

In this tutorial and walkthrough, we’ll look at one small part of a moderately complex merger model. One that might take a few hours to build. If you already have a template and much of the data filled in.

Specifically, we’ll walk through the Income Statement combination in a merger model here. Since it’s one of the most important steps in the entire process.

Broadly speaking, companies want deals to be EPS-accretive because it’s easier to win approval for such deals. And shareholders tend to react better when the deal is expected to increase the company’s EPS.

EPS is a key metric in M&A because it’s the only quick-to-calculate number that reflects all the primary effects of the acquisition: Foregone Interest on Cash, Interest Paid on New Debt, and New Shares Issued.

Of course, EPS does not tell the whole story.

Plenty of deals could be accretive to the Buyer’s EPS but still, be terrible deals!

You can use the analysis as supporting evidence for or against deals. But no company ever “decides” to make an acquisition just because it’s likely to be EPS-accretive.

You might also look at the Contribution Analysis. The Value Creation Analysis, or a simple DCF-based valuation of the Seller to judge the quantitative merits of the deal.

We prefer to start the Combined Income Statement at the bottom of the Combined Cash Flow Statement. Or the “Combined Cash Flow Projections” if you lack a full Cash Flow Statement for both companies.

We do this because if Debt is used to fund the deal. It’s helpful to track required principal repayments to determine. How that New Debt balance changes over time (since it will affect the Interest Expense as well).

If there are no principal repayments, the New Debt only allows for optional repayments. Then you can skip this step and return after you’ve finished the Combined Income Statement:

 

We could have skipped this complex formula and used a much simpler version that assumed a 1% principal repayment of the original balance each year as well.

The Income Statement combination is fairly simple: we add together the corresponding line items, such as Revenue, COGS, and SG&A, for the Buyer and Seller.