What is a Merger Model - Example, Components, and More

When two companies merge, the purchase price dynamics usually impact the acquirer's earnings per share. The acquirer typically builds a merger model to measure the extent of this impact and decide whether the deal is ideal.

In this guide, we'll explore how a merger model determines the deal's effect on the earnings per share of the consolidated entity and how this can impact your M&A transaction.

You'll want to be well-informed to improve the chances of a successful exit.

At Exitwise, we can help you work with the best M&A experts, such as investment bankers and business appraisers, who can help you with merger modeling for an optimized exit. Reach out to us today to maximize your business exit!

What is Financial Modeling, and Why Does it Matter?

Financial modeling in M&A is an abstract analysis of a real target company that helps a buyer project the company's future cash flows, valuation, and financing requirements to determine whether to buy it.

M&A financial modeling is important for the following reasons:

• Determining Deal Viability: Financial modeling can help buyers determine whether a deal is worth it. A deal with a positive future income projection can be worth investing in. Modeling also shows the justification of the company's valuation and the viability of the proposed purchase price.

• Decision-Making: If the deal is viable or the risks are lower, the buyer can decide to buy your business or company.

• Determining Financing Options: Financial modeling helps the buyer determine the most viable way to finance the purchase, choosing the one with the lowest cost. A cash basis can be better for you for a smoother exit.

• Negotiation Tool: Financial modeling helps the acquirer support their proposed deal terms and valuation using data, which can help you sell sooner. You can agree with the deal if it's good enough or negotiate for better terms.

What is a Merger Model?

A merger model is a type of financial modeling that combines the buyer's and seller's financial statements to show the effects of the acquisition or merger on the combined earnings per share (EPS) of the new entity to determine if the deal is worth it.

Merger models, also called M&A models or accretion/dilution models, are ideal for showing the effect of the cost of the deal on the acquirer's EPS.

Some key cost metrics include the foregone interest on cash if the buyer pays you in cash, the interest paid on new debt if the buyer uses debt to finance the purchase, and the new shares issued.

While they are mainly scientific because of the calculations, merger models are also partially artistic because of the various involved.

Merger Model Example

Below is a hypothetical acquisition model based on pre-calculated financial metrics:

Role of a Merger Model in M&A Decisions

M&A financial modeling helps with informed decision-making in the following ways:

• Showing Whether or Not the Deal is Worth It: If the buyer sees that the deal is likely to boost their EPS, they may choose to proceed with the merger or acquisition.

• Determine the Best Financing Options: Since the cost of financing often reduces the EPS before the acquirer realizes synergies or gains target earnings, they typically choose the financing option with the least cost. As the seller, a cash payment is ideal, but you may negotiate for a stock payment if you see it as more valuable in the long term than cash.

• Securing Shareholders’ Approval: If the model shows that the buyer's EPS will improve, the shareholders may agree to the deal, and you could sell your company sooner.

• Settling on a Viable Purchase Price: M&A modeling helps both you and the buyer agree on a suitable range for the purchase price.

How to Interpret Accretion/Dilution Analysis

Determining the accretion or dilution of the acquirer's earnings per share involves combining the net incomes of the two companies and dividing the new shares outstanding.

EPS = Net Income ÷ Shares Outstanding

EPS Accretion/Dilution = (Pro Forma EPS ÷ Standalone EPS) - 1 (Where pro forma EPS represents the EPS minus non-recurring costs)

For example, if the acquirer's standalone EPS is $2.00 and it increases to $2.10 after the acquisition,

EPS Accretion/Dilution = ($2.10 - $2.00) - 1 = 0.05 (= 5%)

The EPS is 5% accretive, thus showing a projection of a $0.05 increase in EPS. 

The EPS is accretive (increasing value) when the combined EPS is greater than the buyer's standalone EPS before you close the deal.

If the EPS is lower after you've combined the two companies’ EPS, the EPS is dilutive (decreasing value).

A dilutive EPS doesn't have to break the deal. The buyer may have paid excessively for your company, or the costs of the deal may have caused a short-term dilution.

Short-term dilutions often resolve once the new entity realizes synergies or hits its target revenue earnings.

Key Components of a Merger Model

As a business seller, you can build a merger model to put yourself in the buyer's shoes. Below are critical components to look out for:

• Projected Financial Statements: At the minimum, a merger acquisition model carries the forecasted income statements of both companies. The balance sheets and cash flow statements are also typically included.

• Estimated Purchase Price and Payment Form: For a private company, you may agree with the buyer on an estimated purchase price based on agreed valuation calculations.

You can also agree on payment forms such as cash, stock, debt, or combinations of these three. Check out our free valuation calculator to estimate how much you can sell your company for.

• Valuation of the Acquiring Company: Mergers and acquisitions modeling also includes valuing the buyer's company using the same valuation methods used for your company.

• Accretion/Dilution Calculations: The acquisition model computes the accretion or dilution figures based on the combined income statements of the two merging companies.

• Sensitivity Tables: While these are optional, acquisition models usually include them for assessing the EPS dilution or accretion under different scenarios. They may show scenarios such as different synergy realization levels and lower or higher purchase prices.

How to Build a Merger Model

Merger models are typically built by the buy side to evaluate the worthiness of your target company. You don't have to build the model yourself, but it's important to learn how one's created using the steps below:

1. Creating Assumptions: The buyer creates assumptions for the acquisition of your company, such as the cash they'll pay you, the number of shares they'll give you, or the offer value per share.

2. Making Projections: The buyer's M&A team uses the data from the two businesses' income statements, cash flow statements, and balance sheets to generate a financial projection for the proposed merger.

3. Valuing Each Company: Using the discounted cash flow method, the assumptions, and the available data, the buyer estimates the valuation of their company and yours.

Your buyer can also estimate the amount of money they need to invest in your company after the purchase to achieve the projected returns.

4. Estimating Key Financial Metrics: The buyer's M&A financial model typically includes estimates of key financial metrics. These include interest expense, cash flow, financing fees, synergies, integration costs, standalone earnings before interest, transaction fees, and debt-related aspects.

5. Purchase Price Accounting: At this level, the buyer calculates the goodwill and conducts purchase price allocation. They also determine the incremental depreciation and amortization, where applicable.

6. Combining Balance Sheets: The buy-side combines the items of your company's balance sheet with their company's, making adjustments such as synergies, accounting practices between the merging businesses, goodwill, and purchase price.

7. Analyzing Accretion/Dilution: Before the deal closes, the buyer estimates the effect of the deal on their pro forma earnings per share. They may simulate different scenarios based on varying proposed purchase prices and different levels of post-deal cost savings or revenue increments.

Find Your M&A Expert With Exitwise

Notably, mergers and acquisitions modeling can be daunting. You'll need the help of various M&A experts, such as business appraisers and investment bankers.

At Exitwise, we follow a proven three-step process to help you find the best M&A experts:

1. Initial Consultation

When you contact us, we answer any questions you have about selling your business. You tell us about your business's history, management team, and financial performance.

We listen to your requirements and thoughts about the sale to find you the best industry-specific M&A experts.

2. Connecting You With Top M&A Experts

Once you are ready, we introduce you to top-performing M&A experts in your industry who will help you manage the sale. We show you their transaction history, fee structure, and estimated valuations for your company.

We also take you to the pros and cons of each expert to help you make the best decision.

3. Helping You Hire and Manage

Lastly, we help you interview and hire each M&A expert, from investment bankers and wealth advisors to business appraisers and M&A attorneys to tax accountants and brokers.

We also negotiate the best fees, engagement letters, and terms on your behalf. Once you've selected your dream team, we collect the necessary signatures, get everyone to work, and help you manage them throughout the sale.

We at Exitwise know what needs to be done and how to keep everyone motivated for an optimal outcome. Let us help you find your dream M&A experts today!

Frequently Asked Questions (FAQs)

Let's end the guide with common questions about M&A modeling:

What is the Difference Between the Merger Model and the LBO Model?

An LBO or leveraged buyout is a model usually used by private equity companies when evaluating and acquiring a target company.

The leverage reference is used because debt is typically the largest option for paying the purchase price. An LBO also involves an exit valuation, as, at the time, the private equity hopes to sell the acquired company.

On the other hand, unlike ROI-focused private equity, M&A deals usually have a strategic buyer who focuses more on the deal's internal return rate.

The debt repayment tracking in an LBO makes the calculations more complex than in an M&A model, even if the latter includes debt financing.

What is the Williamson Merger Model?

A Williamson merger model refers to a situation in which a horizontal merger simultaneously results in cost savings from realized efficiencies and increased prices from the realized greater market power.

If the objective is to optimize consumer welfare, Williamson suggests that the law should only allow a merger if it can result in efficiencies that do not increase the price.

What is Purchase Price Accounting (PPA)?

Purchase price accounting refers to the process by which the acquirer reevaluates the acquired assets and adjusts them to fair value after the deal closes.

The process also includes both you and the buyer reporting the allocation of the purchase price on your annual tax returns. For you, PPA helps determine how is goodwill taxed.

When you work with us at Exitwise, we can ensure the M&A experts you work with help you properly conduct purchase price allocation and accounting to optimize your take-home amount.

Conclusion

A merger model can be helpful for both you and the buyer when negotiating a potential transaction because it can help you agree sooner.

We at Exitwise can help you hire and manage an industry-specific M&A team to help you create an M&A model to simulate the buyer’s. Consult with our team today to find the best experts to protect your interests and secure an optimal exit.