Financing growth typically raises all of the same questions as when refinancing or contemplating optimal capital structure—debt versus equity or equity-linked, term structure, fixed versus floating, currency, seniority, optionality, and so forth. We see three common pitfalls that confound the deal financing decision and interfere with the investment decision:
1. To view the structure as a separate and distinct entity, apart from the context of the buyer’s existing capital structure
2. To assume new financings are the only method to affect change toward the optimal or most appropriate capital structure
3. To view the value of an acquisition as being dependent on how it is to be financed, with the benchmark for value being the WACC
Though incremental analysis is the foundation to any discounted cash flow (DCF) or NPV analysis, liability management and the entire field of risk management require us to look at any situation in its entire context. Ideal acquisition funding depends in part on the existing capital structure plus any debt being assumed as part of the deal.
For example, if credit rating targets are a concern, possibly a constraint, for deal financing, then pro forma ratios will be critical to the amount and sources of cash that can be used to minimize stock in the structure. Quantification of existing excess cash plus the cash available from operations 12 to 18 months postdeal will depend on the total company.
If coverage appears to be the ratings constraint, ...