Understand the intricacies of exchange ratios in mergers and acquisitions, including how they maintain the value for shareholders and the variations in methodologies used. Discover the difference between fixed and floating exchange ratios, and how they impact the control and value in a deal.
Key Insights
- The exchange ratio refers to the number of new shares given to existing shareholders of a company that has been acquired or merged with another, ensuring the preservation of relative value.
- This ratio determines how many shares an acquiring company must issue per share owned by an investor in a target company to maintain the same relative value.
- The purchase price of the target company often includes a premium paid by the acquiring company for gaining full control.
- When determining the exchange ratio, the intrinsic value of the shares and the underlying company value are taken into account.
- There are two types of exchange ratios: fixed and floating. The fixed exchange ratio keeps the number of issued shares constant, while the deal value fluctuates. This method is often preferred by the acquiring company.
- The floating exchange ratio keeps the deal value constant while the number of shares fluctuates. This method is generally preferred by the target company or seller, as they are assured of the exact value they will receive.
Exchange Ratio Concepts
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Definition
Ratio of acquirer shares issued per target share. 0.5 ratio = 1 target share gets 0.5 acquirer.
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Fixed Ratio
Set ratio regardless of stock price moves.
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Floating Ratio
Adjusts so target shareholders get fixed dollar value.
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Collar
Caps and floors limiting how far ratio can move.
The exchange ratio is the relative number of new shares that will be given to existing shareholder of a company that has been acquired or that has merged with another. After the old company shares have been delivered, the exchange ratio is used to give shareholders the same relative value in new shares of the merged entity.
- The exchange ratio calculates how many shares an acquiring company needs to issue for each share an investor owns in a target company to provide the same relative value to the investor.
- The target company purchase price often includes a price premium paid by the acquirer due to buying 100% control of the target company.
- The intrinsic value of the shares and the underlying value of the company are considered when coming up with an exchange ratio.
- There are two types of exchange ratios: a fixed exchange ratio and a floating exchange ratio.
A fixed exchange ratio is fixed until the deal closes. The number of issued shares is known but the value of the deal is unknown. The acquiring company prefers this method as the number of shares is known therefore the percentage of control is known.
A floating exchange ratio is where the ratio floats so that the target company receives a fixed value no matter the changes in price shares. In a floating exchange ratio, the shares are unknown but the value of the deal is known. The target company, or seller, prefers this method as they know the exact value they will be receiving.
Excel Example:
C11=C8*(1+C9)*C10
C12=C11/B8
C13=C12/C10
An exchange ratio is designed to give shareholders the amount of stock in an acquirer company that maintains the same relative value of the stock the shareholder held in the target, or acquired company.
Video Transcription:
Full Video Transcript
The exchange ratio is the relative number of new shares that will be given to existing shareholders of a company that has been acquired or that has merged with another after the old company shares have been delivered. The exchange ratio is used to give shareholders the same relative value in new shares of the merged entity. The exchange ratio calculates how many shares an acquiring company needs to issue for each share an investor owns in a target company to provide the same relative value to the investor.
The target company purchase price often includes a price premium paid by the acquirer due to buying 100% control of the target company. The intrinsic value of the shares and the underlying value of the company are considered when coming up with an exchange ratio.
Types of Exchange Ratios
There are two types of exchange ratios: a fixed exchange ratio and a floating exchange ratio. A fixed exchange ratio is fixed until the deal closes. The number of issued shares is known, but the value of the deal is unknown. The acquiring company prefers this method as the number of shares is known, therefore the percentage of control is known.
A floating exchange ratio is where the ratio floats so that the target company receives a fixed value no matter the changes in price shares. In a floating exchange ratio, the shares are unknown, but the value of the deal is known. The target company or seller prefers this method as they know the exact value they will be receiving.
Exchange Ratio Calculation Formula
Here's the exchange ratio calculation: you would take acquirer new shares issued and divide them by the target shares to come up with the exchange ratio. Then to calculate acquirer new shares issued, you would take equity issued to do the deal and divide it by acquirer share price.
Worked Example
Let's calculate an exchange ratio for the given example. We are given that acquisition price is $30,000, equity financing is basically 100%, and synergies is $2,000. We are given current share price for buyer and target, acquisition premium, and diluted shares outstanding for buyer and target.
So my equity purchase price will be my current share price multiplied by one plus my acquisition premium, and multiplied by diluted shares outstanding. Then new shares issued would be equity purchase price divided by my buyer's current share price. My exchange ratio would be my new shares issued divided by diluted shares outstanding, and the result is 1.1 for this example.
An exchange ratio is designed to give shareholders the amount of stock in an acquirer company that maintains the same relative value of the stock the shareholder held in the target or acquired company. Great job!
