The first step in our merger analysis is to model BuyerCo’s income statement to include historical results and projections. When sufficient data is available, we can calculate both “cash” and GAAP net income and EPS figures. Cash figures exclude the non-cash amortization and stock-based compensation (“SBC”) expenses and non-recurring charges that GAAP figures include.
It is important to calculate cash figures when BuyerCo trades on cash, rather than GAAP, multiples. For example, BuyerCo might trade at 18.4x 2008 cash EPS. You can tell if a company trades on cash figures by comparing GAAP EPS with the EPS figures that Wall Street research analysts compute. If these numbers are different, then analysts are using cash figures.
Companies often embed SBC expenses in SG&A (or COGS). We separate SBC from SG&A (or COGS) whenever possible to facilitate the calculation of cash figures and the reconciliation of cash to GAAP. You can usually determine how much of SG&A (or COGS) expense is attributable to SBC by examining the footnotes of a company’s public filings.
We also separate depreciation and amortization expenses because 1) doing so facilitates calculation of cash figures and the cash-to-GAAP reconciliation and 2) depreciation and amortization are projected differently into the future as we will soon see.
Note that some line items are computed as “% Margin” and others as “% of Sales”. The latter term generally applies to expenses and the former generally applies to income/earnings.
Most of the historical inputs to our historical income statement come from either a BuyerCo’s public filings or, if the historical figures require adjustment to account for acquisitions, divestitures, etc., from Wall Street research reports.