Pro-Forma Earnings vs. GAAP in Merger Models

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Financial modeling to use GAAP or Pro-Forma Earnings

Published on Feb 2, 2017

In this lesson, you’ll learn about pro-forma vs. GAAP earnings in merger models, what the difference between both types of EPS is, and the arguments in favor of and against these “pro-forma” metrics.

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Table of Contents:

3:48 When Pro-Forma Figures Make a Difference, and How Bankers Use Them

7:01 Arguments For and Against Pro-Forma Metrics


“What is the significance of the ‘Pro-Forma Earnings’ and ‘Pro-Forma EPS’ and ‘Pro-Forma Accretion/Dilution’ you calculate in merger models?”

“What do they mean, and how do bankers use these metrics to advise clients?”


Pro-Forma Earnings always make a company’s results look better by removing certain expenses, and they let bankers argue in favor of marginal-to-poor deals.

Typically, to calculate Pro-Forma Earnings, you remove restructuring costs, amortization of intangibles, legal settlement costs, asset impairments, gains/losses, and sometimes even stock-based compensation!

In an M&A scenario, you usually remove new depreciation & amortization on asset-writeups and sometimes also restructuring / integration costs (if they appear on the Income Statement) and deferred revenue write-downs.

These changes can make a massive difference for some companies (Merck, Alcoa, etc.), but tend not to make a huge difference in most “normal” M&A deals for companies with clean financial statements (e.g., Starbucks / Krispy Kreme).

When Does It Matter?

“Pro-Forma” or “Non-GAAP” or “Adjusted” or “Operating” earnings in M&A deals make the biggest difference when:

Condition #1: The deal is “borderline” accretive/dilutive, and removing a few expenses could flip it.

Condition #2: The normal acquisition-related expenses, such as amortization of intangibles, are significant portions of pre-tax income (e.g., more than a few percentage points).

Condition #3: OR there are other significant expenses, such as restructuring or integration costs on the Income Statement, that you’re also removing.

As an example, if amortization of intangibles were much bigger in a deal – let’s say that 30% of the purchase premium, rather than 5%, were allocated to Definite-Lived Intangibles, then Pro-Forma figures might “flip” the deal to accretive.

A banker could then approach the company and argue in favor of the deal on the basis of those Pro-Forma numbers.

Arguments FOR Pro-Forma Numbers

Argument #1: Pro-Forma metrics give a clearer picture of ongoing business performance since they remove one-time expenses.

Argument #2: Pro-Forma metrics better represent a company’s future earnings potential, which investors use to evaluate it

Argument #3: Items like the Amortization of Intangibles in M&A deals are not “real” expenses because they’re non-cash and shouldn’t reduce a company’s earnings like Interest Expense does.

Arguments AGAINST Pro-Forma Numbers

Argument #1: Companies abuse these metrics and label many recurring items, like Restructuring, “non-recurring” (See: Alcoa).

Argument #2: There’s little-to-no consistency in the calculations; companies remove wildly different items, so you can’t even use Pro-Forma metrics to compare firms.

Argument #3: Some M&A-related items may be non-cash, but they still reflect the cost of doing a deal – and that acquired company will become a part of the core business in the future!

Our Opinion(s)

We are skeptical of these “Pro-Forma” metrics. If you use them, keep in mind the following:

Point #1: Always include the GAAP or IFRS-compliant metrics as well.

Point #2: You shouldn’t base a deal or investment recommendation entirely on these metrics, but they can be part of your argument.

Point #3: Always explain or footnote what you’re doing so that other people understand which expenses have been removed.

Pro-Forma Earnings – RESOURCES:


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