Question

ABC has 1.00 million shares outstanding, each of which has a price of $ 17. It has made a takeover offer of XYZ Corporation, which has 1.00 million shares outstanding, and a price per share of $ 2.27. Assume that the takeover will occur with certainty and all market participants know this. Furthermore, there are no synergies to merging the two firms.

A. Assume ABC made a cash offer to purchase XYZ for $ 3.67$3.67 million. What happens to the price of ABC and XYZ on the announcement? What premium over the current market price does this offer represent?

b. Assume ABC makes a stock offer with an exchange ratio of 0.14. What happens to the price of ABC and XYZ this time? What premium over the current market price does this offer represent?

c. At current market prices, both offers are offers to purchase XYZ for $3.67 million. Does that mean that your answers to parts (a ) and (b ) must be identical? Explain.

Answer 1

(a) As the acquisition creates no synergy gains for ABC, going through with the acquisition would make no difference to the firm's (acquirers) overall value. Hence, the announcement of an acquisition in which ABC pays a premium for XYZ in return for no synergy gains would depress the acquirer's stock price and elevate the target's stock price.

Offer Price per share = 3.67 / 1 = $ 3.67 per share and Market Price of XYZ = $ 2.27 per share

Therefore, Acquisition Premium = Offer Price - Market Price = 3.67 - 2.27 = $ 1.4 per share

(b) Exchange Ratio is the number of acquirer's share being offered for one share of the target firm.

Therefore, ABC is offering 0.14 of its own share for one share of XYZ. This implies that ABC is offering (0.14 x 17) = $ 2.38. As ABC is still offering a premium over XYZ's fair market value in return for zero synergy gains it would again depress ABC share price and elevate XYZ share price.

Acquisition Premium = 2.38 - 2.27 = $ 0.11 per share (lower premium as compared to the cash deal)

(c) A key difference between stock and cash acquisition is that cost of the merger is dependent on the merger gains as the same shows up in the post-merger share price, in case of a stock merger. In case of a cash deal, merger gains do not impact the cost in any way. Also, if in a stock deal the acquirer's share price is felt to be undervalued prior to the merger, it would surely go up post-merger, thereby accruing extra benefits to the target company shareholder's. This, in turn, would imply that the acquirer's cost of the merger would go up (as the target's gain is the acquirer's cost). Hence, an acquirer would strongly prefer cash deals in case they feel that the acquirer's share is undervalued and would do the opposite (prefer stock deal) if they feel that the acquirer's share is overvalued.

Hence, the answer to the two parts should not be the same as the piece of information mentioned above would also be available to the target company. If the target company feels that the acquirer is pushing too much for a stock deal, it would indicate a grossly overvalued acquirer share price and hence the target would drive a harder bargain and get acquired at a higher price.