The Daily Technical #01

Good morning. Welcome to the first edition of The Daily Technical. You’re here for one reason so let’s dive in.

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OVERVIEW OF YESTERDAY’S QUESTION

Since this is the first edition, we don’t have a question to review. Instead, we’re going to walk you through a commonly asked question:

Is it better to finance a deal via debt or stock?

Let's break this down from both the buyer's and seller's perspectives:

Buyer’s Perspective: The decision between financing with debt or stock largely depends on the buyer's financial position and the nature of the target company. When the buyer’s price-to-earnings (P/E) ratio is significantly higher than the target’s, using stock for the transaction is often accretive, meaning it can immediately increase the buyer’s earnings per share (EPS). This makes stock a more attractive option in such situations, as it can enhance the buyer’s financial metrics without the immediate cash outlay.

On the other hand, debt financing could be preferable if the buyer has favorable access to low-cost debt and wants to preserve ownership equity. The buyer must weigh the potential impacts on its capital structure, such as the debt-to-equity ratio, and consider the implications for its credit rating. An increase in debt may affect the buyer’s creditworthiness, which could increase the cost of future borrowing.

Seller’s Perspective: From the seller’s side, the preference often leans toward cash (which typically comes from debt financing) because it provides immediate liquidity and certainty of value. Sellers are usually hesitant to accept stock unless tax deferment is a priority or if they believe the buyer’s stock will appreciate in value. A stock sale is more appealing to the seller when the deal resembles a merger of equals, or if the buyer is a public company with stable stock, providing the seller with some assurance of value over time.

Common Mistakes Interviewees Make:

• Focusing only on the buyer’s financial benefit without considering the seller’s perspective. A deal has to make sense for both sides.

• Overlooking the impact of credit ratings and capital structure when choosing debt financing.

• Assuming stock is always a safer or cheaper option without evaluating market conditions and investor confidence.

Key Takeaways: The choice between debt and stock financing depends on several factors, including the buyer’s financial position, the comparative P/E ratios, and the seller’s liquidity needs. Buyers need to balance the immediate and long-term financial implications of both options, while sellers are often motivated by the certainty and liquidity that debt-financed deals provide.

TODAY’S QUESTION
If the share price of a company increases by 10%, what is the balance sheet impact?

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