Question

It is commonly argued that the NPV of a merger depends on the method of payment used. Cash offers seem to yield a higher NPV than stock offers. Thus, acquiring firms need to be very careful in setting the exchange ratio in a stock offer deal. Give a DETAILED EXPLANATION why?

Answer 1

Cash is king. As shareholder of the acquired company you can take your cash consideration and invest in whatever you want, if you're in the mood to remain in the market. If paid in stock, you're locked into holding a single company's shares for a long while unless the acquirer is a public company that is so large in comparison to yours that there is no lockup.

Asset sales, which are disadvantageous to the acquired company from a tax and liability standpoint, are more likely to be cash transactions. If that's what it is, it's not as good as an actual merger.

If you're a team member on a vesting schedule, you're less likely to get vesting acceleration in a stock deal, where the acquiring company can give you its own stock subject to vesting. In a cash deal there may be a holdback or earnout, but they are less likely to stage the pay-out over years to come.

If it's done as a tax-free merger, the tax on the gain is deferred until selling the acquiring company stock. Deferring taxes is a good thing because the money you would have otherwise paid the government is still in your hands appreciating, you get the time value of that money. Same reason an IRA works.

If the acquirer is a private company, the selling shareholders have access to stock that they would be unable to buy in the investment market. Because they're now helping the acquiring company to succeed, there may be some good upside. If you luck out you can get acquired by a mid to late stage company that still has a lot of upside before its own acquisition or IPO liquidation. I've seen shareholders realize 20X plus return in a matter of months, being acquired by a company on the eve of announcing its IPO, which zoomed on the first day of trading. Good times.