SWAP RATIOMerger and AcquisitionsSWAP RATIOMerger and Acquisitions

SWAP/Exchange ratio

»The exchange ratio is the number of the acquirer’s shares that are offered for each share of the target.

»The number of shares offered depends on the valuation of the target by the acquirer.

»For example , in April 2006 . Alcatel and Lucent announced a stock for stock merger in which each Lucent shareholder would receive 0.1952 of an Alcatel share of Lucent they owned

Exchange ratio

»For example , in May 2010 . ICICI Bank and Rajasthan Bank announced a stock for stock merger.

»The boards of both banks approved the swap ratio at 1 : 4.72, meaning 25 new shares of ICICI to be issued for every 118 shares of BoR

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Exchange ratio

Steps for determining SWAP ratio

1. To arrive at exchange ratio both the acquirer and the target conduct a valuation of the target.

2. From the above process the acquirer determines the maximum price it is willing to pay while the target determines minimum it is willing to accept .

3. Within this range , the actual agreement

Exchange ratio

price will depend on each party’s other investment opportunities and relative bargaining abilities.

4 Based on the valuation of target , the acqurier determines the per share price it is offering to pay.

5 The exchange ratio is determined by dividing the per share offer price by the market price of the acquirer’s shares

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United Communications (Acquirer)

Dynamic Entertainment (Target)

Net Income (PAT) 5,00,00,000 1,00,00,000

Share outstanding

50,00,000 20,00,000

Earning per share 10 5

Stock price 150 50

P/E ratio 15 10

Example

»Let us assume that based on valuation of dynamic , United Communication has determined that it is willing to offer Rs 65 per share of Dynamic . This is 30% premium above the pre merger price of Dynamic.

»In terms of United’s shares the Rs 65 offer is equivalent to United’s Rs 65/150 share

»SWAP RATIO = .43 :1

Example

»Based on the preceding data , United can calculate the total number of shares that it is willing to offer to complete a bid for 100% of Dynamic

»The shares that United will issue :

»((Offer price)(total outstanding shares of target))/price of acquirer or

»(Swap ratio )(total outstanding shares of target)

»(Rs 65)(20,00,000)/Rs 150= 866666.67

Earning per share of surviving company

»Calculating the EPS of the surviving company reveals the impact of the merger on the acquirer’s EPS

»Combined earning = 6,00,00,000

»Total share outstanding = 50,00,000 +866666.67 = 58,66,666.67

»United communication ‘s impact on EPS

Premerger EPS = Rs 10, post merger Rs 600,00,000/58,66,667 =10.23 This is an example of accretion in EPS (EPS accretive)

»Incase Dynamic rejects the offer and offer is revised to Rs 90 per share

»Exchange ratio Rs 90/Rs 150= .60 shares

»Rs 90/150 * 20,00,000 = 12,00,000

»Premerger EPS Rs 10

»Post merger EPS= 600,00,000/62.00,000= Rs 9.68

»United communication ‘s EPS declined the following the higher offer of Rs 90 . This is an example of dilution in EPS

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Dilution in EPS

»Dilution of EPS will occur any time the P/E ratio paid for the target exceeds the the P/E ratio of the company doing the acquiring.

»The P/E ratio paid is calculated by dividing the offer price by EPS of the target company This is as follows :

» P/E ratio Paid = Rs 65/Rs5= 13< 15

Rs 90/5 = 18 > 15

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Practice questions

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Question -1

Particulars Mani Ltd (Acquirer)

Ratnam Ltd (Target)

Profit After Tax Rs 40,00,000 8,00,000

No. of Shares Rs 4,00,000 2,00,000

PE Ratio 10 5 

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1. What is the swap ratio based on current market prices? 2. What is the EPS of Mani Ltd after the acquisition? 3. What is the expected market price per share of Mani Ltd after the acquisition, assuming its PE Ratio is adversely affected by 10% ? 4. Determine the market value of the merged Company. 5. Calculate gain / loss for the shareholders of the two independent entities, due to the merger.

What is the swap ratio based on current market prices?

Particulars Mani Ltd (Acquirer)

Ratnam Ltd (Target)

1 Profit After Tax Rs 40,00,000 8,00,000

2 No. of Shares Rs 4,00,000 2,00,000

3 PE Ratio 10 5

4 EPS (1 / 2 ) 10 45 MPS ( 3 X 4) 100 206 SWAP RATIO 20/100= .2 :1

7The shares that Mani Ltd will issue 40,000( .2 X 2,00,000)= 40000

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What is the EPS of Mani Ltd after the acquisition?MANI LTD RATNAM

LTDCOMBINED

Profit after tax 40,00,000 8,00,000 48,00,000

No. of Shares (4,00,000+40000) 4,40,000

EPS post merger 10.91

Expected price of Mani Ltd post merger as same PE ratio

10X 10.91 109.10

Expected price of Mani Ltd post merger as 10% less PE ratio

9X 10.91 98.19

Market Value of New Company 109.1X 4,40,000 4,80,04,000

Market value of both the companies before merger

4,40,00,000

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Company A will acquire company B with shares of common stock

Company A Company B

Present earnings 2,00,00,000 50,00,000

Shares outstanding 50,00,000 20,00,000

Earning per share 4 2.5

Price per Share 64 30

PE Ratio 16 12

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Company B has agreed on an offer of Rs 35/- per share in common stock of company A1.. Compute Swap ratio2…number of shares to be issued to company B by company A3..Earning per share post merger of Company A4.. What will be the earning per share post merger if the company B renegotiated the offer to Rs 50 per share

(a) A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one share of T

Ltd.). Following information is provided: A Ltd T ltd

Present earnings 18,00,000 3,60,000

Shares outstanding 6,00,000 1,80,000

Earning per share 3 2

Price per Share 30 14

PE Ratio 10 7

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1…number of shares to be issued to T Ltd by A Ltd2..Earning per share post merger of A Ltd3. What I s the expected price per share of A ltd after the acquisition4.Determine the market value of the merged firm

What is the EPS of A ltd after the acquisition?A LTD B LTD COMBINED

The shares that A Ltd will issue .5 X 1,80,000=90 000

Profit after tax 18,00,000 3,60,000 21,60,000

No. of Shares (6,00,000+90000) 6,90,000

EPS post merger 3.13

Expected price of Mani Ltd post merger as same PE ratio

10X 3.13 31.30

Market Value of New Company 31.3X 6,90,000 2,15,97000

Market value of both the companies before merger

2,05,20000

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X Ltd wants to taker over Y Ltd and the financial details are as follows

X Ltd Y LtdEquity Share capital Of Rs 10 each 1,00,000 50,000

Preference Share capital 20000

Share Premium 2000

Profit and Loss A/c 38000 4000

Debentures 15000 5000

Total 173000 61000

Fixed Assets 122000 35000

Current Assets 51000 26000

Total 173000 61000

Profit After Tax and preference dividend 24000 15000

Market Price 24 27

What should be share exchange ratio to be offered to the shareholders of Yltd based on1 Net Asset value 2 EPS 3 Market price.. Which should be preferred by Xltd

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(1)  Share Exchange Ratio based on Net Asset Value :

X Ltd Y Ltd

Total Assets 173000 61000

Debentures 15000 5000

Preference Share Capital 20000 0

Total liabilities 35000 5000

Net Worth 138000 56000

No of Shares 10000 5000

Net Worth per share 13.8 11.2Share Exchange ratio

Worth per share of target firm / Worth per share of acquiring firm

Share Exchange ratio = 0.8116

No of shares to be issued 5000 0.812 5000*.812 4058

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(2) Share exchange ratio based on EPS

Earning 24000 15000

No of Shares 10000 5000

EPS 2.4 3

Share exchange ratio EPS of target firm/EPS of acquiring firm

Share Exchange ratio Rs3/Rs 2.4 1.25

No of shares 1.25 5000 6250

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(3) shares exchange ratio based on Market price

Market price of Y ltd 27

Market price of X ltd 24

SWAP RATIO and No of shares 1.125 5000 5625

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Shares issued on the basis ofNet worth 4058 preferred by X ltd ( Acquirer)EPS 6250MPS 5625

X Ltd wants to taker over Y Ltd and the financial details are as follows

X Ltd Y LtdEquity Share capital Of Rs 10 each 100000 50000

Preference Share capital 20000

Share Premium 2000

Profit and Loss A/c 38000 4000

Debentures 15000 5000

Total 173000 61000

Fixed Assets 122000 35000

Current Assets 51000 26000

Total 173000 61000

Profit After Tax and preference dividend 24000 15000

Market Price 24 27

What should be share exchange ratio to be offered to the shareholders of Yltd based on1 Net Asset value 2 EPS 3 Market price.. Which should be preferred by Xltd

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»Create a list of comparable companies, often industry peers, and obtain their market values.

»Convert these market values into comparable trading multiples, such as P/E, price-to-book, enterprise-value-to-sales and EV/EBITDA multiples.

»Compare the company's multiples with those of its peers to assess whether the firm is over or undervalued.

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