Today I’m going to go into more detail about how P&Ls are combined in mergers — and how it’s analyzed in “real world” corporate M&A.  As I’ve already mentioned, how the P&Ls come together, and what the resulting accretion or dilution will be, drives strategic M&A more than any other factor.  It’s appropriate to drill down now and get more specific about what the combined income statement will look like.

Recall from last time that I addressed synergies and their relative importance. Considering synergies between buyer and seller led to the creation of several new line items on the newly combined P&L: Revenue Synergies (for revenues), COGS Synergies (for direct expenses), and OPEX Synergies (for fixed expenses).

But several other new line items are also needed. Changes to the mix of deal consideration must also flow through the combined P&L. Projected P&Ls include interest income and interest expense figures that assume a certain cash balance. When cash is used as part of the transaction consideration, however, interest income will be lower, so foregone interest on cash is a real cash deal expense that must be considered in accretion/dilution analyses. The potential for cash consideration in the deal means a line item called Foregone Interest is required. Also, a line item called New Debt Interest is necessary, of course, to cover situations where the buyer finances some of the purchase price with debt. Lastly, depending upon the P&L presentation, a line item called New Shares may be needed at the bottom of the combined P&L to show the effect of stock consideration in the deal when calculating accretion/dilution.

Balance sheet write-ups related to the transaction will also affect the combined P&L.  In M&A transactions, the seller’s fixed assets (PPE) is revalued and is almost always worth more than the carried book value.  The incremental increase in value means more depreciation will flow through the combined P&L, so a line item called Depreciation from PP&E Write-Up is necessary.

The other important balance sheet write-up of note concerns intangibles. The amount of the purchase price paid in excess of the target company’s book value is allocated and will usually be at least partially recorded as an Intangible Asset on the purchaser’s balance sheet. The purchaser must first allocate identifiable items (including trademarks, patents, and intellectual property), and then any amount that cannot be allocated to identifiable assets will be recognized as Goodwill. Amortization related to the newly created Intangible Assets will flow through the combined P&L, necessitating a line item called Amortization of New Intangibles. [When there is a relatively large amount of intangibles amortization, it is not unusual to show the accretion/dilution calculation two ways – one including the new intangibles amortization and a pro-forma without it. This is due in some part to the relative subjectivity in purchase price allocation when it comes to intangibles…]

That covers combining buyer and seller P&Ls.  The statements can be literally added together once synergies, changes related to mix of consideration, and balance sheet write-ups are accounted for.

Next time I’ll begin to discuss combining buyer and seller balance sheets in M&A transactions.

Posted by: Mory Watkins