Structuring a Sound M&A Deal

Cash, stock or a combo? The choices sound simple, but making the right decision isn't always so easy.

Having successfully completed eight deals over the past four years, Jeff Ginsberg knows all the ins and outs of structuring merger-and-acquisition (M&A) transactions. The chairman of Eureka Networks, a New York City-based communication services provider, has steered his organization through some complex deals, the first four of which were acquisitions that the company snapped up in exchange for stock at a time when it needed to conserve its cash resources. Back in 2001, "all our capital was used to fund operations and keep the businesses going," recalls Ginsberg. In addition, the company's profit levels were below what potential lenders would have wanted to see before helping to finance the transactions.

Since then, Eureka Networks has consolidated its new businesses and eliminated many redundant operations. The success of those first deals freed up funds for more M&A projects. At press time, the company was finalizing its merger with Melville, N.Y.-based InfoHighway Communications Corp. in an all-cash transaction.

Ginsberg's company is not alone in aggressively seeking expansion opportunities. The M&A market is growing, and it will remain strong through 2005, according to a March survey by audit, tax and advisory firm KPMG LLP in New York City. Nearly 90 percent of the 110 finance executives who participated said their company expects to complete at least one merger or acquisition this year. That's up from the 70 percent who gave that response in a comparable KPMG survey in 2004.

A little more than half of the respondents in the 2005 study indicated that the improving economy was a key driver of this trend. "Many executives are finding that they must make acquisitions in order to grow," says Rick Dowd, managing director and head of the strategic advisory group with Wachovia Securities in Charlotte, N.C. "They've done all they can internally, and they have to acquire to grow, complement product opportunities and achieve more scale."

The increasing number of companies shopping for acquisitions has helped drive up valuations of target businesses, Dowd adds. In M&A deals worth more than $500 million in 2004, the average purchase price was 7.5 times the acquired company's EBITDA. That's the highest multiple in that category since 1999.

For any organization undertaking an M&A transaction, two questions are central. First, what type of currency -- cash, stock or some combination of these -- should it use to pay for the deal?

Second, what exactly does the company want to buy? Should it purchase the target company's assets? Or would it be better off buying its stock -- but thereby assuming any liabilities that may escape detection in the due diligence process?