Question: Acquirer: Share price = $30.50 EPS = $1.6 Target: Share price = $20 EPS = $1.1 If the acquirer uses common stock to acquire the Target’s common stock at the current market price, the bootstrap earnings effect on post merger earnings would most likely occur if the Target’s acquisition price is: A) is $20 or lower B) is $20 or higher C) is $20 or lower and the acquirer’s post-merger PE remains at the current level The answer is C: the bootstrap earnings effect will occur if the acquisition price is less than $20 (yes I agree with this one, at levels above that the PE of the target firm is higher than the acquirer so no bootstrap effect); but it then goes on to say that the post-merger PE must remain at it’s current level! I reckon that’s wrong - it doesn’t matter what happens to the PE after the merger (assuming that EPS does not fall), the merger would have been EPS accretive surely?
It does matter what happens to P/E after the merger. P/E needs to stay up for the bootstrap to work properly (this is in CFAI). Theoretically P/E should be the weighted average of the contribution of each firm pre-merger but if investors don’t like merger, the P/E will go down post acquisition, ruining the effect of the bootstrap in the first place
hmm…I thought the bootstrap effect was an increase in EPS - nothing to do with PE except coincidentally.
I didn’t see anything about P/E except for what Aliman said about the P/E being the weighted average of the two firms revenues. If that is the case and assuming a high P/E firm is buying a low P/E firm (which Schweser says has to happen to make the bootstrapping work), wouldn’t this necessarily mean that the combined firm P/E will be lower than the acquirer’s P/E pre-merger? I do understand however, that from a shareholders standpoint that increased EPS has no benefit if it is coupled with a contracting multiple…
OK after thinking about it, it makes sense. EPS is only going up b/c of the bootstrapping effect. There is no economic value added. Therefore the the market should adjust the post-merger P/E down because the denominator is higher despite there being no economic value added. Therefore bootstrapping will only benefit shareholders if the market does not make this adjustment. That being said, I think this is another example of a poorly worded question because it doesn’t say anything about bootsrapping’s value to shareholders only the effect it has on EPS
yeah ok, I’ll just go with the PE must remain at least at the previous level if the bootstrap effect is to have occured