# Merger Model - Basic

Walk me through a basic merger model.
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A merger model is used to analyze the financial profiles of 2 companies, the purchase price and how the purchase is made, and determines whether the buyer's EPS increases or decreases.

Step 1 is making assumptions about the acquisition - the price and whether is was cash, stock, debt, or some other combination of those. Next, you determine the valuations and shares outstanding of the buyer and seller and project out an Income Statement for each one.

Finally, you combine the Income Statements, adding up line items such as Revenue and OpEx, and adjusting for Foregone Interest on Cash and Interest Paid on Debt in the Combined Pre-Tax Income line; you apply the buyer's Tax Rate to get the Combined Net Income, and then divide by the new share count to determine the combined EPS.
There are many reasons:

- The buyer wants to gain market share by buying a competitor.
- The buyer needs to grow more quickly and sees an acquisition as a way to do that.
- The buyer believes the seller is undervalued.
- The buyer wants to acquire the seller's customers so it can up-sell and cross-sell to them.
- The buyer thinks the seller has a critical technology, intellectual property, or some other "secret sauce" it can use to significantly enhance its business.
- The buyer believes it can achieve significant synergies and therefore make the deal accretive for its shareholders.
An acquisition is dilutive if the additional amount of Net Income the seller contributes is not enough to offset the buyer's foregone interest on cash, additional interest paid on debt, and the effects of issuing additional shares.

Acquisition effects - such as amortization of intangibles - can also make an acquisition dilutive.
If the deal involves just cash and debt, you can sum up the interest expense for debt and the foregone interest on cash, then compare it against the seller's Pre-Tax Income.

And if it's an all-stock deal you can use a shortcut to assess whether it is accretive (see question #7).

But if the deal involves cash, stock, and debt, there's no quick rule-of-thumb you can use unless you're lightning fast with mental math.
Trick question. You can't tell unless you also know that it's an all-stock deal. If it's an all-cash or all-debt deal, the P/E multiples of the buyer and seller don't matter because no stock is being issued.

Sure, generally getting more earnings for less is good and is more likely to be accretive but there's no hard-and-fast rule unless it's an all-stock deal.
In an all-stock deal, if the buyer has a higher P/E than the seller, it will be accretive; if the buyer has a lower P/E, it will be dilutive.

On an intuitive level, if you're paying more for earnings than what the market values your own earnings at, you can guess that it will be dilutive; and likewise, if you're paying less for earnings than what the market values your own earnings at, you can guess that it would be accretive.
1. Foregone Interest on Cash - The buyer loses the Interest it would have otherwise earned if it uses cash for the acquisition.
4. Combined Financial Statements - After the acquisition, the seller's financials are added to the buyer's.
5. Creation of Goodwill & Other Intangibles - These Balance Sheet items that represent a "premium" paid to company's "fair value" also get created.

Note: There's actually more than this (see the advanced questions), but this is usually sufficient to mention in interviews.