Finding the Win-Win Deal P.V. Viswanath Class Notes for FIN 648: Mergers and Acquisitions

P.V. Viswanath2 Framework  In a stock-for-stock deal, the exchange ratio is the number of buyer shares per target share.  In a cash deal, the cash exchange ratio is the number of dollars exchanged per target share.  To determine the “correct” ratio in a cash deal, compare the cash payment to the intrinsic value of the asset.  In principle, the rule is the same in the stock deal as well; however, in this case, both buyer and target shares have to be valued.  The greater the synergy, the greater the possibility for a win- win deal.  This analysis provides the data needed for negotation between buyer and target.

P.V. Viswanath3 Terms  ER= exchange ratio: buyer shares per target share.  ER 1 = max acceptable exchange ratio for buyer.  ER 2 = max acceptable exchange ratio for seller.  P 1 = buyer’s price before transaction  P 2 = target’s price before transaction  P 1 = buyer’s shares outstanding before transaction  P 2 = target’s shares outstanding before transaction  P 12 = price of combined company  DCF 12 = discounted cashflow value of combined company

P.V. Viswanath4  Share-for-Share Exchange  Buyers’ Maximum Acceptable Exch Ratio  P 12  P 1  Seller’s Min Acceptable Exch Ratio  P 12 ER 2  P 2 Max/Min Acceptable Exch Ratios - DCF

P.V. Viswanath5 Share-for-Share Exchange

P.V. Viswanath6 Max/Min Acceptable Exch Ratios (DCF)  Cash-for-Share Exchange  Buyers’ Maximum Acceptable Exch Ratio  P 12  P 1  For the seller, the minimum acceptable exch ratio is simply P 2, the price of the target prior to the acquisition.

P.V. Viswanath7 Cash-for-Share Exchange

P.V. Viswanath8 Max/Min Acceptable Exch Ratios (P/E)  Share-for-Share Exchange (P/E Model)  Need to estimate PE 12 (corresponds to DCF estimation in previous analysis).  Buyer’s Maximum Acceptable Exchange Ratio  P 12  P 1  P 12 = (PE 12 )(EPS 12 )  EPS 12 = (E 1 +E 2 +E synergies )/(S 1 +S 2 ER 1 )

P.V. Viswanath9 Max/Min Acceptable Exch Ratios (P/E)  Share-for-Share Exchange  Seller’s Maximum Acceptable Exchange Ratio  P 12 ER 2  P 2  P 12 = (PE 12 )(EPS 12 )  EPS 12 = (E 1 +E 2 +E synergies )/(S 1 +S 2 ER 1 )

P.V. Viswanath10 Choosing a ratio in the Win-Win Zone  Bargaining Power  Control Premium in comparable transactions  Focal points based on relative contribution of the two firms. Keep relative pre-merger share prices of target and buyer ER = P target /P buyer Some contribution indicators are: Operating profits, assets, unit sales, revenues, no. of employees If C = contribution % of buyer: