They say one of the motivations behind M&A deals is Boostrapping EPS. And then, on the next LOS, Schweser gives an example. My question is, why does it need to be a stock transaction for the “Bootstrapping EPS” to occur?
In my view, when there is a common cash (and not stock as they point out) acquisition, when a high P/E company buys a low P/E company, the statistical effect would lead the resulting company being traded at a lower P/E than initially (or higher EPS). Isn’t that right?
So, think about the math. The basic EPS formula is Net Income/ # of shares.
If the acquirer borrows cash to make the acquistion, Net Income will decrease by the new additional interest payments, net of the tax benefit of debt. And it will incease by the target’s net income. But # of shares remain the same.
So, the math tells us that if interest payments (net of taxes) are less than the Net Income you are buying, you will see an increase in EPS.
In other words, borrowing may or may not increase EPS. Go to your example on p. 342. Run the numbers with a 7% borrow rate and EPS decreases. But increases with a 4% rate.
I think I got confused with the term “stock transaction”. By reading the next pages, I can see they call a stock transaction when the acquired is buying the target’s shares, instead of its assets. I’d think a stock transaction is when the acquirer gives out its own shares as payment. Its just a matter of different naming.
Anyway, your example makes sense. And thanks for that!