{"id":22067,"date":"2020-03-04T00:50:06","date_gmt":"2020-03-04T05:50:06","guid":{"rendered":"https:\/\/breakingintowallstreet.com\/biws\/?post_type=biws_kb&#038;p=22067"},"modified":"2024-09-11T07:06:18","modified_gmt":"2024-09-11T12:06:18","slug":"merger-model-template","status":"publish","type":"biws_kb","link":"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/merger-model-template\/","title":{"rendered":"Merger Model: Cash, Debt, and Stock Mix (19:58)"},"content":{"rendered":"<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_81 counter-flat ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Merger Model: Cash, Debt, and Stock Mix<\/p>\n<span class=\"ez-toc-title-toggle\"><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/merger-model-template\/#How_Do_You_Determine_the_Cash_Stock_Debt_Mix_in_an_M_A_Deal\">How Do You Determine the Cash \/ Stock \/ Debt Mix in an M&amp;A Deal?<\/a><\/li><li class='ez-toc-page-1'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/breakingintowallstreet.com\/kb\/ma-and-merger-models\/merger-model-template\/#Summary\">Summary<\/a><\/li><\/ul><\/nav><\/div>\n\n<style>.enteremail__large--inline{margin:60px auto!important}<\/style>\n<h2><span class=\"ez-toc-section\" id=\"How_Do_You_Determine_the_Cash_Stock_Debt_Mix_in_an_M_A_Deal\"><\/span>How Do You Determine the Cash \/ Stock \/ Debt Mix in an M&amp;A Deal?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Very common interview question, and you also need to know it for what you do on the job.<\/p>\n<p>3 ways to fund a company, and to fund acquisitions of other companies: use cash on-hand, borrow the money from other entities (debt), or issue equity (stock) to new investors.<\/p>\n<p>But how does a buyer in an M&amp;A deal decide whether it should use\u2026<\/p>\n<p>50% debt and 50% stock vs.<br \/>\n33% debt, 33% stock, and 33% cash vs.<br \/>\n50% cash and 50% debt vs\u2026.<\/p>\n<p>And the list goes on.<\/p>\n<p>Easiest: Think about the &#8220;cost&#8221; of each method, start with the cheapest method, use the most of THAT method that you can, and then move to the next cheapest method, and continue like that.<\/p>\n<div class='code-block code-block-2' style='margin: 8px 0; clear: both;'>\n<div class=\"kb-adinsert-modal\">\n    <div class=\"kb-adinsert-top\">\n      <div class=\"media\">\n          <img decoding=\"async\" class=\"alignnone size-full wp-image-28448\" src=\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2024\/04\/24164120\/adv-fm-tile.png\" alt=\"PowerPoint Pro\" width=\"128\" height=\"128\" \/>\n      <\/div>\n      <div class=\"content\">\n          <h3>Master Financial Modeling for Investment Banking With <strong>BIWS Core Financial Modeling<\/strong><\/h3>\n      <\/div>\n    <\/div>\n    \n    <div class=\"full_text\">\n    \t<ul>\n        \t<li>\n            \t<h4>Become a financial modeling pro<\/h4>\n              <p>158 videos, detailed written guides, Excel files, quizzes, and more<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Complete 10+ detailed global case studies<\/h4>\n            <p>These include both the theory and the practical applications<\/p>\n\t\t\t    <\/li>\n          <li>\n          \t<h4>Prepare for your internship or full-time job<\/h4>\n            <p>Gain the skills you need to \u201chit the ground running\u201d on Day 1\n\n<\/p>\n\t\t\t  <\/li>\n      <\/ul>\n        \n      <a class=\"cta-link orange-button-medium\" href=\"https:\/\/breakingintowallstreet.com\/core-financial-modeling\/\" target=\"_blank\">Full Details<\/a>\n      \n      <a class=\"cta-link orange-button-medium bg-blue\" href=\"https:\/\/biws-support.s3.us-east-1.amazonaws.com\/Course-Outlines\/Core-Financial-Modeling-Course-Outline.pdf\" target=\"_blank\" rel=\"noopener\">Short Outline<\/a>\n    <\/div>\n<\/div><\/div>\n\n<h3>GENERALLY:<\/h3>\n<p>Cheapest: Cash, since interest rates on cash are lower than interest rates on debt, and tend to be low in general.<\/p>\n<p>Next Cheapest: Debt, since it is still cheaper than equity and since interest paid on debt is tax-deductible.<\/p>\n<p>Most Expensive: Stock, since the Cost of Equity tends to exceed the Cost of Debt\u2026 in theory and in practice.<\/p>\n<p>To Compare Them: Look at the &#8220;After-Tax Yields&#8221;\u2026 for debt and cash, just take the Interest Rate and multiply by (1 &#8211; Buyer&#8217;s Tax Rate).<\/p>\n<p>Stock: Take the buyer&#8217;s Net Income and divide by its Equity Value (or &#8220;flip&#8221; its P \/ E multiple).<\/p>\n<p>SO: Always start with cash, use the most you can, then move to debt, use the most you can, and finish up with stock.<\/p>\n<h3>Cash &#8211; How Much is &#8220;The Most You Can?&#8221;<\/h3>\n<p>Easy: Company has minimal cash and can&#8217;t use anything, or it has a huge cash balance and can use all of it.<\/p>\n<p>More Common Case: Look at the company&#8217;s &#8220;minimum&#8221; cash balance and use the excess cash above that to fund the deal.<\/p>\n<p>EX: Company has $500 million in cash right now, but its minimum cash balance to keep operating is $200 million\u2026<\/p>\n<p>So it can use $300 million of its cash to fund the deal.<\/p>\n<p>How to Determine: Can be tough, but sometimes companies disclose it\u2026<\/p>\n<p>&#8230;or you can look back at historical cash balances and make a guesstimate based on that (what was its lowest cash balance in past years?).<\/p>\n<h3>Debt &#8211; How Much Can You Use?<\/h3>\n<p>So let&#8217;s say you&#8217;ve now used $300 million of cash to fund the deal\u2026 but it&#8217;s a deal for $1 billion total.<\/p>\n<p>How much debt can you use to fund the remainder? $700 million? $300 million? $500 million?<\/p>\n<p>Easiest Method: Calculate the key credit stats and ratios for the combined company &#8211; for example:<\/p>\n<p>Total Debt \/ EBITDA<br \/>\nNet Debt \/ EBITDA<br \/>\nEBITDA \/ Interest Expense<\/p>\n<p>And see what amount of debt makes these look &#8220;reasonable&#8221;, in line with historical figures and also figures for comparable companies.<\/p>\n<p>EX: Let&#8217;s say that if the company uses $500 million of debt, its Debt \/ EBITDA is 4x.<\/p>\n<p>Historically, it has been around 2-3x, and no peer company is levered at more than 3.5x.<\/p>\n<p>If that&#8217;s the case, we&#8217;d say that 3.5x &#8211; 4.0x is probably the &#8220;maximum&#8221; (whatever amount of debt that means).<\/p>\n<p>Here: We have the Debt \/ EBITDA and other ratios for the Men&#8217;s Wearhouse \/ Jos. A. Bank peer companies.<\/p>\n<h3>Stock &#8211; Now What?<\/h3>\n<p>Often used as the &#8220;method of last resort&#8221; because:<\/p>\n<p>A) It tends to be the most expensive method for most companies.<\/p>\n<p>B) Most acquirers don&#8217;t like giving up ownership and diluting existing shareholders unless absolutely necessary.<\/p>\n<p>So in this example, if we&#8217;ve used $300 million of cash and $500 million of debt, we&#8217;re still not quite at $1 billion&#8230; need an extra $200 million, which we can get by issuing stock.<\/p>\n<p># of Shares = $200 million \/ Buyer&#8217;s Share Price.<\/p>\n<p>Technically, there&#8217;s no real &#8220;limit,&#8221; but it would be very odd for a company to give up more than, say, 50% ownership to another company\u2026 unless they&#8217;re very close in size.<\/p>\n<h3>Exceptions:<\/h3>\n<p>Buyer has an exceptionally high P \/ E multiple (Amazon) &#8211; stock might be the cheapest!<\/p>\n<p>Buyer wants to do a tax-free deal (Google \/ YouTube) and it&#8217;s much bigger anyway, so won&#8217;t make a difference.<\/p>\n<p>Companies are similarly sized &#8211; stock might always be necessary because cash\/debt are implausible (mergers of equals).<\/p>\n<h2><span class=\"ez-toc-section\" id=\"Summary\"><\/span>Summary<span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p>Which purchase method do you use?<\/p>\n<p>MOST relevant when companies are closer in size\u2026 doesn&#8217;t make much difference when the buyer is 100x or 1000x bigger than the seller.<\/p>\n<p>Order:<\/p>\n<p>1. Cash &#8211; Any excess cash above the company&#8217;s minimum cash balance.<\/p>\n<p>2. Debt &#8211; To the upper range of the Debt \/ EBITDA of comparables (and other metrics).<\/p>\n<p>3. Stock &#8211; For any remaining funding that&#8217;s required; ideally give up well under 50% ownership.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>In this merger model lesson, you&#8217;ll learn how a company might decide what mix of cash, debt, and stock it might use to fund&#8230;<\/p>\n","protected":false},"featured_media":22068,"template":"","class_list":["post-22067","biws_kb","type-biws_kb","status-publish","has-post-thumbnail","hentry","kb_category-ma-and-merger-models"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/22067","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media\/22068"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=22067"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}