Reading: Acquisition Price and Value

Let's look at a combination of the two deal forms, namely a deal structure where part of the acquisition price is paid in cash and the rest in stocks of the acquiring company.  

We keep assuming a total consideration of $900 million or $30 per share of the target company. With respect to the composition of the acquisition price, we assume that half of it is paid in cash and the other half with newly issued stocks of the acquiring company.

Therefore, the total consideration for the acquiring shareholders is:

• $450 million in cash ($15 per share)
• $450 million in stocks of the acquiring company ($15 per share)

Post-Merger Valuation (E_A*)

The cash outflow to the target shareholders of $450 million reduces the value of the merged firm accordingly. Therefore, after the transaction, the equity value of the acquiring firm will be 2'250 million (which is, not surprisingly, right in the middle of the post-merger valuation of the cash deal and the stock deal):

Equity Value Merged Firm = E_A* = Stand-Alone Value_A + Stand-Alone Value_T + Net Synergy – Cash Payment = 1'600 + 600 + 500 – 450 = 2'250.
  

Post-Merger Shares Outstanding (N_A*)

In addition to the cash payment of $450 million, the target shareholders also receive a stock consideration with a value of $450 million. Given a post-merger valuation of $2'250 million, the target shareholder's required ownership stake in the merged company (λ_T) is 20%:

Required Ownership in A for T Shareholders \( = \lambda_T = \frac{\text{Offer price}}{E^*_A} = \frac{450}{2'250} = 0.20 \)

Consequently, the 100 million shares that are currently owned by the Acquirer's shareholders will account for 80% of the merged company's ownership structure (= 1 - 0.20). If 100 million shares represent 80% of the post-merger ownership structure, the ownership stake of 20% that goes to the target shareholders represents 25 million newly issued shares:

Newly Issued Shares of A to T Shareholders \( = N_A \times \frac{\lambda_T}{1-\lambda_T} = 100 \times \frac{0.2}{1-0.2} = 25 \) 

Therefore, given that the target company currently has 30 million shares outstanding, the Share Exchange Ratio is 0.833:

Share Exchange Ratio \( = \frac{\text{Newly Issued Shares to T}}{N_T} \) = \( \frac{25}{30} = 0.833 \)

For each share of the target company, the acquiring firm therefore pays 0.833 newly issued shares. After the merger, the acquiring firm will have 125 million shares outstanding (N_A*):

Post-Merger Shares Outstanding \( = N_A^* = N_A + \text{Newly Issued Shares to T} = 100 + 25 = 125 \)

Post-Merger Stock Price

Given an equity valuation of $2'250 million and 125 million shares outstanding, the post-merger stock price therefore remains at 18:

Acquirer's Post-Merger Stock Price \( = P^*_A = \frac{E^*_A}{N^*_A} = \frac{2'250}{125} = 18 \)

The following graph summarizes the valuation that results from the cash only transaction:

And the following table summarizes the value allocation that results from this mixed cash and stock deal: 

The main takeaways of this deal form are:

• The mixed deal does not actually cost anything in terms of hard currency to the acquiring company, as it simply prints new shares of its own stock. 
   
• Because of the cash payment, the ownership dilution is less pronounced in the mixed deal (20%) than in the stock-only deal (33%). 
   
• Consequently, after the deal, the target shareholders have an even smaller stake in the merged company.
   
• Because the payment is in part in stocks of the acquiring firm, the target shareholders' return is not fully "safe." The target shareholders therefore partially share the risk of differing market expectations with the acquiring shareholders. 
   
• In terms of value allocation, the mixed deal is equivalent to the cash deal and the stock deal (as long as the market agrees with management's expectations).