Question

In: Accounting

ABC has 1.00 million shares​ outstanding, each of which has a price of $15. It has...

ABC has 1.00 million shares​ outstanding, each of which has a price of $15. It has made a takeover offer of XYZ​ Corporation, which has 1 million shares​ outstanding, and a price per share of $2.54. 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 $ 3.58 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?

Solutions

Expert Solution

A) When a cash offer is made by ABC to purchase XYZ :

In an Acquistion, two companies are involved, the company that acquires another is called the "Acquisition company" and the company which is being acquired is called as the "Target company". The acquiring company usually pays a premium over and above the prevailing market price of the stock, to acquire the shares of the target company.

Effect on the stock price of ABC (acquiring company) :

In the given case, ABC pays $3.58 million to acquire the stock of XYZ. The market value of the stock is only $2.54 million. The excess of acquisition price over the market price is called "Control premium".

The stock price of ABC falls on the merger announcement. This is because, the company is making a cash offer which means the company has to incur a huge outflow of cash resources and finance the excess money required by raising it through borrowings. Therefore, the investors might feel the pressure to sell the shares of the company, which leads to fall in value of the stock price.

Howvever, there are other factors like productivity of the target company, merger expenses, legal factors that affect the stock price to fall. The investors might also feel the acquisition premium paid is too high for the value which leads to the fall in the value of the stock price.

Effect on the stock price of XYZ (target company) :

On the other hand, the stock price of the XYZ (target company) rises. This is because the target company is on the receiving end. It is receiving a premium over and above the market price, hence leading to rise in the price.

B) When stock offer is made by ABC to purchase XYZ :

In this case, instead of paying cash ABC offers its stock at a ratio of 0.14 to XYZ. Here, no cash outlfow is involved.

Effect on the stock price of ABC (acquiring company) :

The stock price of ABC falls. This is because of "dilution of control". The current shareholders lose their control over the stock because the number of shareholders increases and the number of shares outstanding increases.

Effect on the stock price of XYZ (target company) :

The stock price of XYZ rises. This is becasue the shareholders of XYZ gets 0.14 shares of ABC for every share held. Even though the number of shares is less than the shares held in the present company, the value of stock price increases since ABC company is in a better off position than XYZ and the impact of positive synergies is high.  

However, the price of XYZ might also fall as the exchange is low because for every 1 share held, the shareholder of XYZ gets only 0.14 shares in ABC.


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