Mergers or acquisitions exist when other groups or companies look to acquire another company in the same field, merge with a competitor, or when an organization wants a financial institution to acquire the company as a whole. When the leadership/owners of a sufficiently sized company are pitched a merger or acquisition proposal, the company needs to take into consideration the financial impact that the transaction may have on the potential buyer’s financial position.
In order to fully analyze the consequences, the company owners must compare the stand-alone acquirer to the newly combined business. An effective way of doing this is through EPS accretion/dilution. This is a simple test that shows whether the proposed deal will increase or decrease the post-transaction earnings per share (EPS) for the buyer. In order to obtain a break-even impact to EPS, pre-tax synergies are required. However, this analysis must also be performed in conjunction with other valuation methods, as there are transactional effects that can increase EPS artificially without actually increasing firm value.
The acquiring company must calculate possible future earnings to plan for the transition of ownership. This is done via pro forma calculations, which include hypothetical amounts or estimates. They are made ready before a planned acquisition or merger to anticipate the result of the transaction. These pro forma statements indicate the projected financial position of the potential buyer to ensure that the decision to merge will be leveraged, using borrowed capital for an investment and expecting the profits made to be greater than the interest payable.
Using pro forma calculations to estimate the leverage of a merger or acquisition is important as it allows the acquirer to determine what price he is willing/ able to pay. Beyond the amount that he is willing to pay is the form of consideration that they are able to use in order to pay for the transition of ownership (cash, stock, other securities, or a combination). All of this then ties into how the deal will be structured and what type of tax considerations will be taken/given. Taxes on stocks will be very different than those on assets.
Not only does the acquirer (buyer) need to analyze the consequences of a merger, but the seller must also determine if it makes sense to him. Will merging the company be good for business both financially and credibility wise? Will acquiring the company allow the seller to get out of debt or make a reasonable profit?
When these types of “take overs” happen, everyone involved must be in a win-win situation.