Consolidation of M&A targets and Purchase Price Allocation (PPA)

My new blog on: Consolidation of M&A targets and Purchase Price Allocation (PPA), is just published.

In these confusing times it is important to take care of each other!

But it is also important to take care of yourself! You do this by doing what you love and what you are passionate about.

In my case: Consulting, training and writing on M&A and Business Valuation.

And just see this abnormal time as a fantastic opportunity to increase your skill set!

Now is the time to prepare yourself for the “rock concert” that will take place again in the future!

Think, reflect AND ACT!

Don’t wish it was easier, wish you were better! ?? (Jim Rohn)

Consolidation of M&A targets and Purchase Price Allocation (PPA)

Joris Kersten, Place: Uden/ Netherlands, March 18th 2020

www.joriskersten.nl

Consultant & Trainer Joris Kersten

I am an independent M&A consultant and Valuator from The Netherlands.

In addition, I provide training in “Financial Modelling”, “Business Valuation” and “Mergers & Acquisitions” all over the world (New York, London, Asia, Middle East).

This at leading (“bulge bracket”) investment banks, corporates and universities.

My training in “Business Valuation & Deal Structuring” this March 2020 in The Netherlands is rescheduled due to the corona virus.

But my NEW training calendar in The Netherlands is as follows:

1.     17, 18, 19, 20 and 22, 23 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;

2.     24, 25, 26, 27 and 29, 30 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;

3.     28, 29, 30, 31 October 2020 + 2, 3 November 2020: 6 days - Business Valuation & Deal Structuring. Location: Amsterdam Zuidas/ The Netherlands;

4.     16, 17, 18, 19 November 2020: 4 days - Financial Modelling in Excel. Location: Amsterdam Zuidas/ The Netherlands.

All info on these open training sessions can be found on: www.joriskersten.nl 

And 130 references on my training sessions can be found on: www.joriskersten.nl 

Introduction of this article on M&A consolidation

In this article I will talk about M&A target consolidation, purchase price allocation (PPA) and asset write ups.

I am NOT an accountant or lawyer, I am a corporate finance consultant involved in M&As, business valuation and financial modelling.

In order to be able to build financial models for valuation, or M&A, you need to have a basic understanding of for example PPA.

Think of for example “Leveraged Buyout (LBO) Analysis”, here you need to estimate the asset write ups and deferred tax liabilities (DTL’s) after the deal.

Also when you build a M&A model to calculate whether the deal is “accretive” or “dilutive”, you need to make these assumptions.

The assumptions you make in a M&A model; this is a model in which you assess the target + buyer in combination), concerning PPA influence the “accretion” or “dilution” in a deal.

In case you want to refresh you knowledge on the M&A model first, please read my previous blog on the link below:

Article: M&A Analysis – Accretion/ Dilution:

https://www.dhirubhai.net/pulse/ma-model-accretion-dilution-joris-kersten-msc-bsc-rab/

I only have a basic understanding of PPA, so I am a valuator/ financial modeller, and I work here with input that I get from accountants, lawyers and PPA specialists. I obviously advise you to do the same, this article can help you a little do to understand the basics.

I am not informed with all up to date info since “M&A consolidation” is NOT part of the job of a valuation/ corporate finance consultant. A CPA (certified public accountant) can inform you about all the very latest insights. You probably know one! ??

M&A consolidation: An introduction

How to consolidate a target company when you have bought it is very complex from a bookkeeping/ accounting perspective.

An important question is at what moment in time you can consolidate a target company. The rules are here that it should be done like with “normal” consolidation, so when you have “control” in the target.

But with M&A there in general is a large gap between the closing date of the deal an the first agreement on the acquisition.

And even when you own the company already from an “economic perspective”, this is not a criteria for consolidation.

The criterium here is still “control”, so the earnings that are for the buyer (before you have legal control) need to be deducted from the purchase price of the acquisition.

Read more on “economic” and “legal” ownership in my previous blog on “closing mechanisms” in M&A (locked box vs. completion accounts), the link can be found here:

M&A closing mechanisms: Locked Box & Completion Accounts

https://www.dhirubhai.net/pulse/ma-closing-mechanisms-locked-box-completion-accounts-joris/

(Loek Radix, 2016)

The opening balance sheet

Back in the old days you could just take the book values of the acquisition target in your own balance sheet.

And then deduct the goodwill (difference acquisition price and book values) from your equity.

Later on goodwill was put on the balance sheet and amortized. But still goodwill was the difference between the purchase price and the book value of the assets.

Nowadays (with IFRS) you need to look at the purchase price, and you need to allocate this price to the bought assets first. What is then left in the end in called “goodwill”.  

But here fore you need to re-value all the assets of the bought company to the actual value.

This including “assets” that are NOT on the balance sheet YET (pre deal), so intangible assets.

Let’s now take a look at the most important assets that we come across.

(Loek Radix, 2016)

Inventories

The inventory of finished products need to be valued on market value minus the costs that still need to be made to sell those inventories.

The idea is that for the profit inside the inventory of finished products is paid already in the acquisition price.

And with a FIFO system (“first in first out” administrated in the “costs of goods sold”) these inventories are sold first post-acquisition. Which means no profits in the first period after the acquisition.

(Loek Radix, 2016)

Fixed assets

All fixed assets need to be re-valued to real value. Often for this external (asset) valuators need to be consulted.

A higher value of the assets basically means more depreciation and a lower profit.

So for an inhouse controller it is very important to check, and understand, the asset valuation reports carefully since it will impact the P&L.

(Loek Radix, 2016)

Intangible assets

Basically here one (IFRS law makers) believes that the profit earning capacity of a company is the result of two factors.

One, there are “hard” variables like the fixed assets, but also intangible assets like:

·       technological knowhow, software, patents, brand-names, licenses, recipes, customer lists etc.

On the other side there are variables that are really immaterial like:

·       the quality of people, accumulated knowledge and experience, business culture etc.

After an acquisition there are many categories of intangible assets that need to be identified:

1.     Marketing related (e.g. brand names, logos);

2.     Customer related (e.g. customer lists, customer contracts);

3.     Contract related (e.g. licences);

4.     Technology related (e.g. patents, recipes).

The valuation of these intangible assets after an acquisition is work of specialists. And this is often done by external specialists.

We as M&A consultants, valuators and financial modellers make assumptions here.

But be careful, because as mentioned, your assumptions have an effect on for example the “accretion/ dilution” in a M&A model.

So get advise from accountants, lawyers and PPA specialists here when you are building you financial valuation model!

Although, for the specific valuation of the bought assets, future cash flows are isolated and allocated to these specific assets (so called “asset write ups”).

After that you get intangible assets of a certain amount, and amortization takes place on this amount.

(Loek Radix, 2016)

Goodwill

When after the re-valuation of the assets is something left (real value of the assets minus purchase price), then we can speak of “goodwill” on your balance sheet post deal.

Goodwill does not have to be amortized. But yearly a company needs to conduct an impairment test on this goodwill.

This is a sort of yearly valuation of the company/ business unit (think of a DCF valuation). And this in order to check whether the goodwill is still appropriate and legitimate.

(Loek Radix, 2016)

Deferred tax liabilities (DTL’s)

Post-acquisition new assets (or asset write ups) are realized, like intangible assets (or write ups) and fixed assets (or write ups).

And over the new assets or “write ups” a DTL is formed on the balance sheet.

From a bookkeeping perspective the asset write ups are depreciated and amortised. And the tax effect of this is yearly subtracted from the DTL until it’s gone from the balance sheet.

I have described this in detail in my earlier article on the M&A model, the link can be found below:

Article: M&A Analysis – Accretion/ Dilution:

https://www.dhirubhai.net/pulse/ma-model-accretion-dilution-joris-kersten-msc-bsc-rab/

(Loek Radix, 2016)

Source used for this blog

Book: Winstbegoocheling – Handboek voor de kritische controller (2016). Loek Radix. Publisher: Eburon.

Earlier blogs on “net debt” (cash & debt free)

Article 1: Valuation: Introduction to "net debt" (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-introduction-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 2: Valuation: Net debt (cash & debt free)

https://www.dhirubhai.net/pulse/valuation-net-debt-cash-free-joris-kersten-msc-bsc-rab/

Article 3: Valuation: Adjusted net debt – Cash like items

https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-cash-like-items-kersten-msc-bsc-rab/

Article 4: Valuation: Adjusted net debt – Debt like items

https://www.dhirubhai.net/pulse/valuation-adjusted-net-debt-like-items-joris-kersten-msc-bsc-rab/

Earlier blogs on Financial Modelling

Article 1: Financial Modelling in Excel: Circular references, interest calculations and iterations

https://www.dhirubhai.net/pulse/financial-modelling-excel-circular-references-kersten-msc-bsc-rab/?trackingId=T3qYTlCmRsKUBYmgv%2FHgyg%3D%3D

Earlier blogs on “various topics”

Financing a M&A transaction: An introduction

https://www.dhirubhai.net/pulse/financing-ma-transaction-introduction-joris-kersten-msc-bsc-rab/

Valuation: How to adjust for “Operating Lease” (under Dutch GAAP)

https://www.dhirubhai.net/pulse/valuation-how-adjust-operating-lease-under-dutch-gaap-joris/

M&A closing mechanisms: Locked Box & Completion Accounts

https://www.dhirubhai.net/pulse/ma-closing-mechanisms-locked-box-completion-accounts-joris/

Scoping a financial model built primarily for business valuation:

https://www.dhirubhai.net/pulse/scoping-financial-model-built-primarily-business-joris/

Earlier blogs on “bonds”

Article 1: Bonds - An introduction

https://www.dhirubhai.net/pulse/corporate-finance-bonds-introduction-joris-kersten-msc-bsc-rab/

Earlier blogs on “Valuation & funding of start-ups”

Article 1: Valuation & funding of start-ups - Funding rounds

https://www.dhirubhai.net/pulse/valuation-funding-startups-rounds-joris-kersten-msc-bsc-rab/

Earlier blogs on the “cost of capital”

Article 1: Valuation & Betas (CAPM)

https://www.dhirubhai.net/pulse/valuation-betas-capm-joris-kersten-msc-bsc-rab/

Article 2: Valuation & Equity Market Risk Premium (CAPM)

https://www.dhirubhai.net/pulse/valuation-equity-market-risk-premium-capm-joris-kersten-msc-bsc-rab/

Article 3: Is the Capital Asset Pricing Model dead ? (CAPM)

https://www.dhirubhai.net/pulse/capital-asset-pricing-model-dead-capm-joris-kersten-msc-bsc-rab/

Article 4: Valuation & the cost of debt (WACC)

https://www.dhirubhai.net/pulse/valuation-cost-debt-wacc-joris-kersten-msc-bsc-rab/

Article 5: Valuation & Capital Structure (WACC)

https://www.dhirubhai.net/pulse/valuation-capital-structure-wacc-joris-kersten-msc-bsc-rab/

Article 6: International WACC & Country Risk – Part 1

https://www.dhirubhai.net/pulse/valuation-international-wacc-country-risk-part-1-joris/

Article 7: International WACC – Part 2

https://www.dhirubhai.net/pulse/valuation-international-wacc-part-2-joris-kersten-msc-bsc-rab/

Article 8: Present Values, Real Options, the Dot.com Bubble

https://www.dhirubhai.net/pulse/valuation-present-values-real-options-dotcom-bubble-joris/

Article 9: Valuation: Different DCF & WACC techniques

https://www.dhirubhai.net/pulse/valuation-different-dcf-wacc-techniques-joris-kersten-msc-bsc-rab/

Article 10: Valuation of a company abroad

https://www.dhirubhai.net/pulse/valuation-company-abroad-joris-kersten-msc-bsc-rab/

Article 11: Valuation: Illiquidity discounts, control premiums and minority discounts

https://www.dhirubhai.net/pulse/valuation-illiquidity-discounts-control-premiums-joris/

Article 12: Valuation: Small firm premiums

https://www.dhirubhai.net/pulse/valuation-small-firm-premiums-joris-kersten-msc-bsc-rab/

Earlier blogs on “Business valuation to Enterprise Value”

From June until August I have written the following blogs on valuation:

1)    Leveraged Buyout (LBO) Analysis:

https://www.dhirubhai.net/pulse/leveraged-buyouts-lbos-joris-kersten-msc-bsc-rab/

2)    M&A Analysis – Accretion/ Dilution:

https://www.dhirubhai.net/pulse/ma-model-accretion-dilution-joris-kersten-msc-bsc-rab/

3)    Discounted Cash Flow Valuation:

https://www.dhirubhai.net/pulse/discounted-cash-flow-valuation-dcf-joris-kersten-msc-bsc-rab/

4)    Valuation Multiples 1 – Comparable Companies Analysis:

https://www.dhirubhai.net/pulse/valuation-multiples-1-comparable-companies-analysis-joris

5)    Excel Shortcuts & Business Valuation:

https://www.dhirubhai.net/pulse/excel-shortcuts-business-valuation-joris-kersten-msc-bsc-rab

6)    Valuation Multiples 2 – Precedent Transaction Analysis:

https://www.dhirubhai.net/pulse/valuation-multiples-2-precedent-transaction-kersten-msc-bsc-rab

Earlier blogs on Wall Street

Article 1: Wall Street – A general introduction

https://www.dhirubhai.net/pulse/wall-street-general-introduction-joris-kersten-msc-bsc-rab/

Article 2: Wall Street – The Federal Reserve banking system

https://www.dhirubhai.net/pulse/wall-street-federal-reserve-banking-system-kersten-msc-bsc-rab/

Training calendar

My training in “Business Valuation & Deal Structuring” this March 2020 in The Netherlands is rescheduled due to the corona virus.

But my NEW training calendar in The Netherlands is as follows:

1.     17, 18, 19, 20 and 22, 23 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;

2.     24, 25, 26, 27 and 29, 30 June 2020: 6 days - Business Valuation & Deal Structuring. Location: Uden/ The Netherlands;

3.     28, 29, 30, 31 October 2020 + 2, 3 November 2020: 6 days - Business Valuation & Deal Structuring. Location: Amsterdam Zuidas/ The Netherlands;

4.     16, 17, 18, 19 November 2020: 4 days - Financial Modelling in Excel. Location: Amsterdam Zuidas/ The Netherlands.

All info on these open training sessions can be found on: www.joriskersten.nl 

And 130 references on my training sessions can be found on: www.joriskersten.nl