Contribution analysis says what each side brings to a stock merger. On EBITDA it only means something once each company's net debt has been taken out.
Divide the target's share of each metric by the combined total, then turn each share into the exchange ratio it implies. For EBITDA and revenue the share is unlevered, so it must first be converted into equity by deducting each company's own net debt. In the worked case below the target contributes 42.86 per cent of combined EBITDA but only 39.21 per cent of the equity on a levered basis, and the proposed exchange ratio gives its holders 36.95 per cent.
Worked in full in Mergers and Acquisitions by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
Two fictional listed companies agree an all-share merger. The acquirer offers a 25 per cent premium to the target's share price. Figures are in millions, except per share amounts, and all are illustrative.
| Item | Acquirer | Target |
|---|---|---|
| Revenue | 1,000.0 | 600.0 |
| EBITDA | 200.0 | 150.0 |
| Net income | 97.5 | 62.25 |
| Net debt | 400.0 | 450.0 |
| Shares outstanding | 80.0 | 50.0 |
| Share price | 20.00 | 15.00 |
| Equity value | 1,600.0 | 750.0 |
| Enterprise value | 2,000.0 | 1,200.0 |
| EV / EBITDA | 10.0x | 8.0x |
| Price / earnings | 16.4x | 12.0x |
Offer per target share = 15.00 × 1.25 = 18.75
Exchange ratio = 18.75 / 20.00 = 0.9375 acquirer shares per target share
New shares issued = 0.9375 × 50.0 = 46.875, for 126.875 in total
Target holders' ownership = 46.875 / 126.875 = 36.95%
The mechanics of the ratio itself are in how to calculate the exchange ratio in a stock merger. Contribution analysis asks a different question: is 36.95 per cent a fair split of what each side brings?
For each metric, the target's share is its figure over the combined figure. Each share then implies an exchange ratio, because ownership s requires the target's holders to receive s / (1 − s) times the acquirer's 80.0 shares.
Implied exchange ratio = s / (1 − s) × acquirer shares / target shares
Revenue: 600.0 / 1,600.0 = 37.50%, so 0.375 / 0.625 × 80.0 / 50.0 = 0.9600
Excel: =s/(1-s)*AcqShares/TgtShares, and the implied offer price =ratio*AcqPrice
Revenue and EBITDA belong to all capital providers. Shareholders own what is left after net debt, and the target carries 450.0 of it against 150.0 of EBITDA, three turns, where the acquirer carries two. Comparing 150.0 with 200.0 as if it were an equity split hands the target's holders value that belongs to its lenders. The fix is to capitalise each company's EBITDA at one common multiple, subtract its own net debt, and compare the equity that remains.
Common multiple = combined EV / combined EBITDA = 3,200.0 / 350.0 = 9.143x
Target: 150.0 × 9.143 = 1,371.4, less 450.0 of net debt = 921.4 of equity
Acquirer: 200.0 × 9.143 = 1,828.6, less 400.0 = 1,428.6
Levered EBITDA contribution = 921.4 / 2,350.0 = 39.21%
Excel: =(TgtEBITDA*CombEV/CombEBITDA-TgtNetDebt)/(CombEV-AcqNetDebt-TgtNetDebt)
Net income needs no adjustment: it is already after interest, so it is an equity metric as it stands. Market equity value is equity by construction.
| Metric | Target share | Implied ratio | Implied offer | Implied premium |
|---|---|---|---|---|
| Revenue (unlevered) | 37.50% | 0.9600 | 19.20 | 28.0% |
| EBITDA (unlevered) | 42.86% | 1.2000 | 24.00 | 60.0% |
| EBITDA (levered) | 39.21% | 1.0320 | 20.64 | 37.6% |
| Net income | 38.97% | 1.0215 | 20.43 | 36.2% |
| Market equity value | 31.91% | 0.7500 | 15.00 | 0.0% |
| Proposed deal | 36.95% | 0.9375 | 18.75 | 25% |
Two readings come out of the table. First, on every earnings metric the target contributes more than the 36.95 per cent it is offered: on levered EBITDA, 2.26 points more. The target's board will use that page. Second, the market values the target at 8.0 times EBITDA against the acquirer's 10.0, which is why its market share, 31.91 per cent, sits below everything it contributes. The acquirer's board will say the gap reflects growth, margin durability or risk the market has already priced, and contribution analysis cannot settle that argument: it measures what each side brings today, not what either is worth. That is its use and its limit. It frames the range a negotiation will run within, here a ratio of 0.75 to about 1.03, and it shows which side is asking the other to pay for its future.
| Target net debt | Implied target equity | Target share | Implied ratio | Implied premium |
|---|---|---|---|---|
| 300.0 | 1,071.4 | 42.86% | 1.2000 | 60.0% |
| 450.0 | 921.4 | 39.21% | 1.0320 | 37.6% |
| 600.0 | 771.4 | 35.06% | 0.8640 | 15.2% |
At 300.0 of net debt the target carries two turns of leverage, the same as the acquirer, and the levered and unlevered shares coincide at 42.86 per cent. That is the only case in which the raw EBITDA split is a valid ownership split. Every 150.0 of extra target debt moves the fair premium by more than 20 points.
Reading the unlevered EBITDA share as if it were the ownership the target deserves. Here it says 42.86 per cent and an exchange ratio of 1.2000, which would issue 60.0 new shares instead of the 51.600 the levered contribution supports: 8.40 million shares, transferred from the acquirer's holders to the target's, that pay for debt the combined company still has to service. The same error runs the other way when the acquirer is the more indebted party. A related trap is mixing bases on one slide, revenue and EBITDA unlevered beside net income and market value levered, and then averaging them. Average only metrics that sit on the same side of net debt.
The book takes one deal through seven ways of quoting its price, with the debt-like items qualified line by line, in the free workbooks for this case. For what the agreed ratio then does to earnings per share, see how to calculate EPS accretion or dilution.
Unlevered contribution compares metrics that belong to debt and equity together, such as revenue and EBITDA. Levered contribution converts them to equity by capitalising each company's EBITDA at a common multiple and deducting its own net debt. In the illustrative case the target's EBITDA share falls from 42.86 to 39.21 per cent once its 450.0 of net debt is deducted. Only levered figures can be compared with ownership.
Ownership s for the target means its holders receive s / (1 - s) times the acquirer's existing shares. Divide by the target's share count to get the ratio. A 39.21 per cent levered EBITDA contribution, with 80.0 acquirer shares and 50.0 target shares, implies 1.0320 acquirer shares per target share, an offer of 20.64 at a 20.00 acquirer price.
Because the market prices the target on a lower multiple. Here it trades at 8.0 times EBITDA against the acquirer's 10.0, so its 31.91 per cent share of market equity sits below its 38.97 per cent share of net income. Contribution analysis ignores growth and risk, so the gap is the subject of the negotiation, not proof of an unfair deal.
This article is one calculation from Mergers and Acquisitions. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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