Welcome back to the last in our series on breaking down case interview frameworks. You’ve almost made it to the end of our series! By the end of this article, you’ll be well on your way to applying the mergers & acquisitions framework and becoming an M&A case framework master.
Missed out on Parts 1-3? Have no fear! Check out our breakdowns on Market Sizing, Profitability, and Market Study to become a complete expert on each core framework you’ll need in your case interview.
Without further ado, here we go!
Mergers and Acquisitions
These cases can be some of the scariest because you feel tested on various finance principles and market intricacies, but on the other hand, they’re really easy to recognize. The most important part of an M&A question is knowing what type of acquirer you are dealing with. All acquirers will want to increase cash flow, but the length of their investment in the company will differ, depending on the type of investment they’re looking to make.
– Financial Acquirer, like a PE firm
They will seek to own 100%, usually in the hopes of selling the company for a significant return. To do so, they will often want to rapidly decrease costs and increase top-line revenues and profits through cash injections and quickly-implemented operational changes.
– Financial Investor, like a hedge fund
They will seek to own a non-majority share (<50% ownership of the entity) in the hopes of positively affecting the value of the shares before selling them on at a higher price than they originally purchased them for. The deal likely includes seats on the Board where they aim to influence corporate decisions that lead to greater profitability.
– Corporate Acquirer, like a multinational firm
They will seek to own 100% of the entity, adding it to their portfolio of companies/offerings. Many choose to integrate the target with their current operations, and the company may have no current intentions of the future sale of the company or its assets.
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How to use the Mergers and Acquisitions Framework
There are many important questions you should ask while utilizing the M&A framework. As with any framework, you need to customize these basic questions below to the exact case prompt scenario you are given in your case interview.
While most M&A cases are going to be focused on due diligence strategy (the yes/no question of whether one company should buy another), this framework is also helpful for any other large scale financial transaction (e.g., an investment resulting in a minority or majority stake, a departmental merger). In any of these cases, you should develop a robust line of questioning in 4 key areas:
– The (target) Market
- What is the size and composition of the target market? Is it growing?
- What’s the competitive landscape in this space? Is the market flooded with competitors?
- What are the barriers to entry in this market?
Note: Most investors do not want to buy a company that is in an unattractive market. The question you want to ask yourself is whether or not the market is big enough for your client’s ultimate goals.
– The (target) Company
- Does the company have strong profits?
- What is the company’s business model and offerings? Are they well positioned against competitors?
- Is it a top performer with revenue growth, or does it have room for improvement with potential for a greater market share in its field?
- What are the company’s projections regarding revenue growth?
Note: The client wants to make sure they’re picking the right company (within the right market). Once again, it all comes down to finances.
– (The Client’s) Post-acquisition strategy
Does the client have an expected timeframe to sell or specific revenue/growth targets in mind?
- Is the client positioned to grow revenues or decrease costs?
- (If your client wants to integrate the target:) Is there potential for synergy, either by piggybacking one company’s strong areas onto the other’s to increase sales or by reducing operating costs?
Note: This category ties the first two together, while also sending the message that once the company is bought, things are going to change. A market and the company valuation can help you figure out how much you should pay, while the post-acquisition strategy helps you figure out how much you can make over time (and whether it will meet the client’s targets).
– Risks and benefits
- How much of a risk is it to integrate two different sales departments, each of which with its own bonus structure?
- What do we know of the compatibility of organizational cultures and leadership styles?
- Are there any IP concerns in the purchase?
- Will governmental regulations hinder the buying process?
Note: One thing that is always difficult to determine is how to assess and value intangible assets, such as Intellectual Property (IP) or the strength of the management team. And if there are risks, what would the worst scenario be? What would the medium scenario be? What would the best-case scenario be? Having a category to explore various risks and benefits is the way to quantify some of the intangible issues that go into assessing an M&A opportunity.
Advanced Technique: How to Calculate Acquisition Value
The last thing to cover is a brief example of how to value an acquisition. Most candidates are rarely asked about how to value a target company, but some practices, like Bain PEG or McKinsey Private Equity & Principal Investors, will include this as part of the case interview.
The best thing to remember for this discussion is that there are three main ways to calculate the value of an acquisition.
- Revenue Comparative Multiples
- EBITDA Comparative Multiples (Earnings Before Interest, Taxes, Depreciation, and Amortization)
- NPV Calculation (where the acquisition is just a long “project”)
The first two examples follow the same logic. The difference is that Revenue Multiples are commonly used for early-stage companies, which might have negative EBITDA and/or profit, and EBITDA multiples are generally used for mature companies with positive EBITDA and profit.
These methods can get very complicated, but for a case interview, all you need to remember is that you can estimate the expected value of an acquisition by taking the Revenue or EBITDA and multiplying it by the industry average. You can usually ask for these values from your interviewer, or they will give you the data points to calculate them.
If you are forced to use the NPV method, then you are likely interviewing for a finance-specific consulting role. Check out our NPV guide for a refresher on how to calculate NPV and remember to think of the annual profits of the new company as the “project revenue”, and use the length of the acquisition investment as the project timeline.
M&A Framework Summary and Conclusion
Recommendations for M&A are some of the easiest to construct because you’re either for the investment or against it. If you are for it, make sure you utilize quantitative data from the case to build your rationale. If you aren’t, make sure you lay out your reasons clearly, concisely and confidently. In any M&A recommendation, you should be direct with your yes/no answer, evidence-based as you lay out your rationale why, and finally lay out 3 next steps (or risks) to further explore the investment opportunity.