Prior to an acquisition or merger, a merger model (a type of financial modeling) will be used to analyze the combination of the two companies in a proposed deal. The primary objective of M&A modeling is to determine how the acquisition may impact the earnings per share (EPS) of the acquiring company, and how this EPS would compare with others in the same industry. However, M&A models can offer deeper financial insights in any given deal. The financial insights and projections arrived at within the model can help inform whether or not to proceed with a merger or acquisition.
Most financial models will include financial statements, a forecast projection, and additional analysis to help evaluate the most meaningful data for the potential merger or acquisition. This comprehensive analysis of each business’ financial health and how they may work in conjunction is a great resource to aid in the decision-making process. Financial modeling has become an essential skill for many investment bankers, and when done properly it has the potential to effectively predict success and outcomes for a variety of M&A scenarios.
As many assumptions and estimations about future performance must be made within the construction of an M&A model, the process of financial modeling is not an exact science. The assumptions that are made within the M&A model can greatly influence the valuation of a company and the viability of any deal, making financial modeling an incredibly important exercise that carries significant implications.
Here are the primary steps for building out a merger model to help determine a viable range for the purchase price. Creating an operating forecast for both companies is necessary during this phase.
The accretion/dilution analysis and the associated effect on the EPS is largely influenced by how any given M&A deal is financed. There are three primary methods for financing an M&A deal, and these financing costs tend to reduce EPS prior to the company realizing any gains from target earnings or realized synergies:
The responsibility of building out financial models for mergers or acquisitions typically extends beyond the corporate development team and may incorporate a number of specialists and analysts. There are also different types of financial models that vary as the situation demands. Depending on what is needed, this collaborative effort may include investment bankers, equity research analysts, credit analysts, risk analysts, data analysts, portfolio managers, investors, and members of the management team. By sharing the responsibilities amongst professionals with separate (but complementary) areas of expertise, and M&A model can more accurately portray the financial forecasts of any given deal in a holistic manner.
When companies enter into exploring mergers and acquisitions it must make sense for both parties. This is especially true for the acquiring company which would be taking on much of the burden of risk during an M&A deal. Financial modeling is an indispensable resource for determining the viability of a deal as well as the purchase price. By constructing thorough and accurate estimates regarding the financial impact of the deal, company executives will be better equipped to make an informed decision that will impact their long-term vision and success of the business.