ProForma Earnings vs GAAP in Merger Models

>> YOUR LINK HERE: ___ http://youtube.com/watch?v=utYBy3eB8lk

In this lesson, you’ll learn about pro-forma vs. GAAP earnings in merger models, what the difference between both types of EPS is, and the arguments in favor of and against these “pro-forma” metrics. • http://breakingintowallstreet.com/ • Financial Modeling Training And Career Resources For Aspiring Investment Bankers • Table of Contents: • 3:48 When Pro-Forma Figures Make a Difference, and How Bankers Use Them • 7:01 Arguments For and Against Pro-Forma Metrics • QUESTION: • “What is the significance of the ‘Pro-Forma Earnings’ and ‘Pro-Forma EPS’ and ‘Pro-Forma Accretion/Dilution’ you calculate in merger models?” • “What do they mean, and how do bankers use these metrics to advise clients?” • SHORT ANSWER: • Pro-Forma Earnings always make a company’s results look better by removing certain expenses, and they let bankers argue in favor of marginal-to-poor deals. • Typically, to calculate Pro-Forma Earnings, you remove restructuring costs, amortization of intangibles, legal settlement costs, asset impairments, gains/losses, and sometimes even stock-based compensation! • In an M A scenario, you usually remove new depreciation amortization on asset-writeups and sometimes also restructuring / integration costs (if they appear on the Income Statement) and deferred revenue write-downs. • These changes can make a massive difference for some companies (Merck, Alcoa, etc.), but tend not to make a huge difference in most “normal” M A deals for companies with clean financial statements (e.g., Starbucks / Krispy Kreme). • When Does It Matter? • “Pro-Forma” or “Non-GAAP” or “Adjusted” or “Operating” earnings in M A deals make the biggest difference when: • Condition #1: The deal is “borderline” accretive/dilutive, and removing a few expenses could flip it. • Condition #2: The normal acquisition-related expenses, such as amortization of intangibles, are significant portions of pre-tax income (e.g., more than a few percentage points). • Condition #3: OR there are other significant expenses, such as restructuring or integration costs on the Income Statement, that you’re also removing. • As an example, if amortization of intangibles were much bigger in a deal – let’s say that 30% of the purchase premium, rather than 5%, were allocated to Definite-Lived Intangibles, then Pro-Forma figures might “flip” the deal to accretive. • A banker could then approach the company and argue in favor of the deal on the basis of those Pro-Forma numbers. • Arguments FOR Pro-Forma Numbers • Argument #1: Pro-Forma metrics give a clearer picture of ongoing business performance since they remove one-time expenses. • Argument #2: Pro-Forma metrics better represent a company’s future earnings potential, which investors use to evaluate it • Argument #3: Items like the Amortization of Intangibles in M A deals are not “real” expenses because they’re non-cash and shouldn’t reduce a company’s earnings like Interest Expense does. • Arguments AGAINST Pro-Forma Numbers • Argument #1: Companies abuse these metrics and label many recurring items, like Restructuring, “non-recurring” (See: Alcoa). • Argument #2: There’s little-to-no consistency in the calculations; companies remove wildly different items, so you can’t even use Pro-Forma metrics to compare firms. • Argument #3: Some M A-related items may be non-cash, but they still reflect the cost of doing a deal – and that acquired company will become a part of the core business in the future! • Our Opinion(s) • We are skeptical of these “Pro-Forma” metrics. If you use them, keep in mind the following: • Point #1: Always include the GAAP or IFRS-compliant metrics as well. • Point #2: You shouldn’t base a deal or investment recommendation entirely on these metrics, but they can be part of your argument. • Point #3: Always explain or footnote what you’re doing so that other people understand which expenses have been removed. • RESOURCES: • https://youtube-breakingintowallstree...

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