Interview Questions: M&A

If you are preparing for an I-banking interview, this is a must prepare question. Read the papers and have at least one transaction thoroughly prepared. You should be able to cover various aspects of the transactions. You should know what the structure of the transaction was. Who was buying whom, or was it a merger of equals? Was it an all-stock transaction or was there cash involved?

For example, you could talk about America Online's acquisition of Netscape. In that transaction, a stock swap valued at $4.2 billion, AOL acquired Netscape. You should talk about how the acquisition was structured from a financial point of view, and the effect the acquisition is likely to have on AOL's earnings (both short-term and long-term).

2. What were the reasons behind that transaction? Does that transaction make sense?

Perhaps more important than understanding the nuts and bolts mechanics of transactions is understanding the factors that drive M&A activity. The America Online/Netscape deal is especially interesting in this regard because it involves heavy strategic planning in a fast-moving industry (as opposed to, say, the merger between Mobil and Exxon, through which the two giants simply hope to consolidate, save, and boost profits).

America Online is a content-driven company with more than 16 million subscribers. Netscape has popular software, in the form of a popular browser and tools for businesses to pursue e-commerce. However, Netscape has seen its browser market share fall as Microsoft, with its immense distribution strength (and questionable pairing of browser with operating system) has elbowed its way into the category. And despite America Online's undisputed lead in market share as an Internet service provider, it had not moved aggressively into what many consider to be the golden road of the Internet e-commerce.

This deal partners AOL and Netscape with Sun Microsystems, which is a hardware company that boasts strong hardware products and sales and support staff. The partners envision a world in which companies use the e-commerce tools developed by Netscape, hawk their wares on America Online (lured by the audience AOL can deliver), and are supported in their hardware and service needs by Sun. Synergy for the 21st century.

Again, your interviewer will expect you to discuss both the financial structure of a deal, its impact on earnings, as well as its strategic drivers.

~3. Do you know whether most mergers are stock swaps or cash transactions and why?

These days, most mergers are stock swaps, largely because the stock prices of companies are so high. In addition, stock swaps generally permit the acquirer to use pooling accounting to account for the merger.

4. When can you use pooling accounting?

Most generally, when a transaction is legally a merger, or a stock swap.

5. What is a dilutive merger?

A merger in which the acquiring company's earnings per share decreases as a result of the merger. Also remember the P/E rule: A dilutive merger happens when a company with a lower P/E ratio acquires a company with a higher P/E ratio.

6. What is an accretive merger?

The type of merger in which the acquiring company's earnings per share increase. With regard to P/E ratio, this happens when a company with a higher P/E ratio acquires a company with a lower P/E ratio. The acquiring company's earnings per share should rise following the merger.

7. Company A is considering acquiring Company B. Company A's P/E ratio is 55 times earnings, whereas Company B's P/E ratio is 30 times earnings. After Company A acquires Company B, will Company A's earnings per share rise, fall, or stay the same?

Company A's earnings per share will rise, because of the following rule: When a higher P/E company buys a lower P/E company, the acquirer's earnings-per-share will rise. The deal is said to be "accretive," as opposed to "dilutive," to the acquirer's earnings.

~8. Can you name two companies that you think should merge?

Identifying "synergies" between two companies is only part of correctly answering this question. You also need to ensure that the merger will not raise antitrust issues with FTC. For example, you could say that Apple and Microsoft should merge, but the combined company will have an unfair monopoly on the operating system market and the FTC will not approve the merger. Moreover, the top people running the two companies don't like each other and would not want to merge!

9. What is a hostile tender offer?

If company A wants to acquire company B, but company B refuses, company A can "issue a tender offering." In this offer, company A will take advertisements in major newspapers like The Wall Street Journal to buy stock in company B at a price much above the market price. If company A is able to get more than 50% of the stock that way, it can officially run and make all major decisions for company B ? including firing the top management. This is something of a simplistic view; there are scores of rules and regulations from the SEC governing such activity.

10. What is a leveraged buyout? How is it different than a merger?

A leveraged buyout occurs when a group, by refinancing a company with debt, is able to increase the valuation of the company. LBOs are typically accomplished by either financial groups such as KKR or company management, whereas M&A deals are led by companies in the industry.

11. If Company A buys Company B, what will the Balance Sheet of the combined company look like?

In this accounting, simply add each line item on the Balance Sheet.