Advanced Financial Reporting

Evaluate a merger (M&A) transaction closed between January 1, 2010 and December 31, 2017. I require students to analyze events during this period because it allows you to study relatively recent transactions while also providing an opportunity to evaluate the pre- and post-transaction performance of the significant parties in the transaction. You must complete this project as a member of a group.

What is an M&A Transaction?
In general, I take a very broad, deal-maker view of M&A transactions. Included in this set are traditional business combination transactions like stock and asset acquisitions of other business entities. In addition, you may also consider other transactions that result in substantial changes in corporate structure. For example, spin offs and equity carve-out transactions are also fair game. When in doubt about the acceptability of a transaction, simply ask me. Important tip: when selecting a transaction, research and confirm your ability to access robust public financial statement and other information about both entities involved. Ideally, both entities will be public companies so that you can access robust stock prices, financial performance data and accounting disclosure information about the entities and the specific transaction. Also confirm that the transaction is significant enough to the acquirer to warrant robust financial statement footnote disclosure about the deal.

Tip: When searching for your transaction, I suggest that you google “US mergers and acquisitions for XXXX”, with the X’s representing a particular year. You should be able to find an article published in the financial press that gives some information about the most significant transactions in that year. That way you will have a bit of summary information about the companies and the deals, to help you decide which ones most interest you.

Outline of the requirements of the Final Report

  1. Overview
    Briefly describe the firms involved in the M&A transaction, assuming that your audience is not familiar with either company. Summarize the stated motive(s) for the transaction (examples: diversification, synergy, reduced operating costs, industry consolidation trends, etc.). Articles in the financial press (The Wall Street Journal, Business Week, Forbes, etc.) concerning the transaction should reveal possible motives of the parent company’s management. In addition, Management’s Discussion and Analysis in the acquirer’s SEC filings (e.g., SEC Forms 10K & 10Q, or possibly an S-4) and the companies’ press releases could reveal (albeit potentially biased) motives. Investment banking analyst’s reports are a recommended source of relatively independent analysis. In laying out the motives for the transaction, you should be considering ways that you will test the assertions made by management (and the financial press).
  2. Stock market reaction
    Analyze the stock market reaction to the M&A transaction. You should conduct your analysis around the key “event dates” on which investors received new information regarding the likelihood (and/or the proposed structure) of the transaction. Describe the event dates you select and why you chose them. You should include relevant stock-market information for the publicly listed parties in the transaction. Did stockholders appear to endorse or disapprove of the transaction? Was the stock-market return typical for the parent and target compared to industry or overall market performance? Daily stock prices and stock returns of both the parent (bidder) and subsidiary (target) should be presented in an appendix. The number of days examined is your decision (but somewhere between 5 and 60 days is probably appropriate). And, don’t forget, a picture (i.e., graph) is worth a thousand words…
  3. Accounting Analysis
    Describe the accounting and financing used to consummate the M&A transaction. Describe the consideration and how the transaction was financed (i.e., cash, debt, stock, or some combination, contingent consideration, etc). Which company was the acquirer, and why? What was the approximate Acquisition Accounting Premium (AAP)? How was it allocated? Was the transaction taxable or not, and what were the consequences of that? Although journal entries are not required, you may wish to harness the power and parsimony of journal entry notation to summarize and convey the effect of the M&A transaction on the acquiring company’s financial statements. If you choose to include an acquisition journal entry in your report, present the entry in the appendix. Also, you might choose to include a table summarizing the changes in the major net asset and equity accounts to summarize the acquisition accounting journal entry and the deal financing. Note that such a table is not constructed by subtracting balance sheets; it is constructed by summarizing the specific transactions that effected the deal being studied. Provide enough detail so that the major affected consolidated operating and financial assets and liabilities (and changes therein) are described in the discussion.

Also, highlight the nature of the most significant fair value adjustments to the acquiree’s accounts that were recorded, explain why those occurred and how these adjustments will impact future financial statements (i.e., amortization periods and amounts). You must study the financial statement footnote disclosures about the transaction and compare the fair value allocation to the book values previously recorded by the acquired entity to accomplish this analysis.

(Another tip: when selecting a transaction, make sure the transaction was significant enough to the acquiring company to warrant robust footnote disclosure for the acquisition/divestiture. Also be sure to confirm that you can access financial statements for both entities involved in the transaction.)

  1. Deal Performance
    The text of the paper should summarize the extent to which the M&A transaction achieved its advertised objectives and support this conclusion with data. Did the post-transaction entity achieve the stated objectives of the M&A transaction? Did the transaction affect performance in the way management predicted? A successful transaction should improve the performance of the combined companies, over what presumably would have been achieved separately. This “alternate universe” comparison is often the most challenging part of the analysis.

Part of the analysis is to understand the previous performance trends of the acquirer and the standalone acquiree companies. For subsequent performance, consider analyzing relevant segment-level financial data (available in the segment footnote) for the consolidated group performance data, especially if the company you are analyzing is a diversified conglomerate. To properly use segment data for this purpose, you must analyze the company’s disclosures about how it allocated the acquisition to its segments.

Often, benchmark data is very useful when trying to draw a conclusion about the relative success of a deal’s subsequent performance. Benchmarks could include previous performance trends by the same company (or business segment), or comparison to industry data, for example.

Relevant non-financial operational measures and industry benchmarks should be considered in addition to standard financial analysis metrics. Benchmark data may also help you understand external factors that affected subsequent performance but were unrelated to the deal.

When analyzing subsequent financial performance data, keep in mind that an acquisition naturally increases the consolidated net assets and generally net income, because the consolidated group becomes bigger. A more relevant and interesting question, for example, is whether the net income increased sufficiently to justify the amount that was invested in the acquisition. So, for example, measures such as return on assets or return on equity are more relevant than simply measuring the increase in net assets or increased earnings.

The number (and types) of ratios examined and the number of years included in the analysis are your decision. I want you to think critically and creatively about how to measure and analyze the success of your transaction. You might need to restate some of the financial information if the firm adopted unusual accounting policies or had unusual one-time items. Also, you should check subsequent financial statements to check to see if there have been any goodwill or other impairment charges relevant to the acquisition.

If you present financial ratios, you are required to include definitions of the numerator and denominator in both words and numbers and present this detail in an appendix to your report, along with footnotes indicating the sources you used for your data. Provide enough detail so our TA can trace and verify all of your source data and understand and assess your calculations.

  1. Conclusion
    Based on your analysis, briefly summarize your conclusions. Some questions to consider include (but are not limited to) the following: Was this transaction “successful?” Did the controlling company meet their objectives? How were other stakeholders (e.g., labor, consumers, the environment) affected by the transaction? Are there limitations to your analysis? This is where you let it all hang out: it is your opportunity to tie up all the loose ends and to provide a compelling conclusion to your analysis.

Other Details

  1. Critical dates

September 18 Transaction Selection Due (2 points): Before 5:00pm on Friday, one member of each group must submit a document in Compass (located in the TAP folder) that describes the transaction it wishes to investigate, and a second choice in case your first choice is already taken. You must completely fill out the form that is provided on Compass to capture relevant information about your selections. (description, close date, etc.) Pay special attention to the deal finalization date; it must conform to the allowed range (2010- 2017). Your transaction can change after this submission, without penalty, but you must coordinate any change with our TA and me, to avoid a duplication. Our TA will review all submissions and notify groups if there is a duplication.
October 9 TAP – Phase 1 Report Due (20 points) Before 5:00 pm, maximum 4
pages, conforming to format instructions in Section 6. Submit this report in Compass. In addition, you must include a copy of the relevant financial statement footnote information that you plan to use to analyze the accounting for the transaction.

This report represents (1) a first draft of the “Overview” section and (2) an outline of the remaining analysis that you expect to be included in your final report. At a minimum, the Phase 1 Report should describe the transaction and fully discuss the transaction motives (i.e., Section 1 stuff), AND clearly outline the specific, detailed analyses that you plan to include in Sections 2, 3 & 4 of the final report, customized to your transaction. Do not simply reiterate the instructions for these parts.

December 3 Final Witten Report and Presentation printouts Due (65 points): For all groups, online submission of your report and presentation slides by 8 am.

December 3 & 8
Project Presentations (38 points)

  1. Teams
    The report will be prepared in teams which I will select. Teams will be comprised of 5 students.

I expect all team members to contribute to the project. Although you can contract with your teammates to allocate the workload in any way you choose, all team members should be exposed to planning and executing all aspects of the report (i.e., each team member should be able to knowledgeably answer any question during the presentation). To check whether all members within a team “fairly” contributed to the project, I will solicit peer evaluations at the end of the project. If there is evidence of “shirking” by an individual, this will be reflected in a lower grade for class participation (i.e., between one and 50 points will be deducted from the “Collegiality/Citizenship” category of points in the course).

  1. Research process
    One of the objectives of this project is to give students the opportunity to research a finance and accounting-related question. Your report must be based on your own original research. Note that using other individuals’ similar projects completed in other courses is “unauthorized aid.”

This project is a good opportunity to learn more about the information that is available in SEC filings such as the 10-K. I have posted a link to an SEC website that provides an overview of breadth of data that is available in the 10-K report, including but certainly not limited to the audited financial statements and footnotes.

  1. Choice of M&A transaction

Tip: When searching for your transaction, I suggest that you google “US mergers and acquisitions for XXXX”, with the X’s representing a particular year. You should be able to find an article published in the financial press that gives some information about the most significant transactions in that year. That way you will have a bit of summary information about the companies and the deals, to help you decide which ones most interest you.

In addition, two good sources for identifying M&A transactions are the quarterly periodical, Mergers and Acquisitions and The Wall Street Journal Index (you can search under the heading, “mergers and acquisitions”). I encourage you to choose firms/industries in which you are interested from a personal or professional viewpoint.

Important tips: Use caution in selecting the transaction! Before you finalize your selection, verify that both entities (parent and acquired company) have stock prices and financial statements available during the time period leading up to the announcement of the M&A transaction and the parent company has financial statement information available before and after the M&A transaction. Also, be sure that the transaction is significant enough to the acquiring entity so that it results in robust footnote disclosure about the transaction in the subject company’s annual financial statements. The number one reason that students have a less-than-great time on this project is because they select companies that are private or too small (not enough juicy data available…). Another pitfall occurs when students select big companies that have lots of data, but the analyzed transaction involves the exchange of a relatively small division or set of operating assets.

  1. Data
    General information about the M&A transaction and the firms: There are several sources you can use to identify and access firm-specific financial press articles. Both Factiva and Lexis/Nexis are convenient, online, full-text databases that cover news and other firm-specific information.

Stock price information: You can use the resources available in the Margolis Information Lab in the BIF atrium.

Financial statement information: There are several sources of firm-specific financial statement information including the SEC Edgar database , the “Annual Report Gallery” site , Lexis/Nexis and Thompson Research’s Compact D (the “SEC” tab under Compact D), Mergent Online , or Capital IQ (described in the syllabus), through the acquiring company’s web page, and, of course, through direct contact with the firm. The SEC filings that are most relevant to your project are the Forms 10-K, 10-Q (typically less detail than the 10-K), 8-K and various types of registration statements (i.e., a SEC Form S-4 registration if new securities were involved in the transaction).

Industry information: You have access to numerous online databases that provide industry-targeted information and within-industry financial comparisons, including Standard and Poor’s NetAdvantage, the Datamonitor Business Information Center, the Market Research Monitor, and others. (S&P NetAdvantage is a particularly good source of industry-specific reports. It includes sections on Current Environment, Industry Profile, Industry Trends, How the Industry Operates, Key Industry Ratios and Statistics [e.g., “How to Analyze an Airline”].) Please let me know when you find an online database that is particularly useful or interesting.

  1. Report Font/Margins/Spacing/Length
    You need to document the sources of the information in your report. Please prepare your paper’s in-text references and citations in conformity with the guidelines in the APA Style Guide No bottom of page footnotes for references – you must use parenthetical citations in the body of the paper. For financial statement references, you must refer to the footnote number and page number as well as the name and date of the report. Regardless of the Style Guide’s prescriptions, you must format the main body of your report in the following way:

• Arial font, 11 point (just like this line)
• One-inch margins on each side
• Double space
• Title page with student names, class section, team number, and company names
• No more than eight (8) pages of text

The eight-page length restriction applies only to the main body of the report. It does not apply to the cover page, appendices, figures, graphs and tables that you include with your report. The length restriction may seem difficult at first, but part of preparing a good report is learning to convincingly express the most important ideas in a concise manner.

  1. Presentation guidelines
    Prepare a 15-minute presentation of your project. All team members must participate in the presentation. Use PowerPoint (or a similar presentation software) and strive to capture the main points from your project on your slides in a concise manner. Your presentation should be engaging and presented in a professional style – imagine that you are presenting to the top executives or the board of directors of a major corporation. The information on your slides should be easy to read from the back of the classroom and keep the audience’s interest. Your verbal presentation should provide additional information, and NOT consist solely of reading the information from your slides. You will be required to submit your presentation slides in Compass. You will also record a video of your presentation and submit the video on Compass.

In your final report submission, you should include the following items in the appendix (not just the links!):

• Copies of the two (2) most relevant articles for your report.
• The primary financial statements (i.e., BS, IS and SCF) and the footnote describing the acquisition from the financial statements of the acquiring company for the period immediately after the M&A transaction.
• The primary financial statements (i.e., BS, IS and SCF) for the target company for the period immediately preceding the M&A transaction.

  1. Final notes
    The project (including the presentation) will be worth 125 points (out of 525 for the semester, or about 24% of your course grade). Rigor, originality, and creativity are encouraged.

Sample Solution