Stock or Cash? The Trade-Stock or Cash? The Trade-Offs for Buyer and Sellers in Offs for Buyer and Sellers in

Merger and Acquisitions.Merger and Acquisitions.

Kaushal Khatore

AcquisitionsAcquisitionsA corporate action in which a company buys

most, if not all, of the target company's ownership stakes in order to assume control of the target firm.

Acquisitions are often made as part of a company's growth strategy whereby it is more beneficial to take over an existing firm's operations and niche compared to expanding on its own.

Acquisitions are often paid in ◦ Cash, ◦ The Acquiring Company's Stock or ◦ A Combination of both.

Stock vs CashStock vs CashIn a cash deal, the roles of the two parties are

clear-cut, but in a stock deal, its less clear who is the buyer and who is the seller.

In cash deal, roles of the two parties are clear-cut, but in a stock deal, it's less clear who is the buyer and who is the seller.

A really confident acquirer would expect to pay for the acquisition with cash.

If the acquirer believes the market is undervaluing its shares, it should not issue new shares to finance an acquisition.

RiskRiskIn cash the risk stays with only the

acquirer.

In stock deal the risk in distributed between the buyer and the seller.

The companies should never be beguiled into thinking that issuing stock is risk-free.

Fixed Share or Fixed ValueFixed Share or Fixed ValueIf the acquirer believes the market is

undervaluing its shares, it should not issue new shares to finance an acquisition.

In fixed shares the number of shares are fixed but the value may fluctuate between the date of announcement and the closing date.

In fixed value, the value is fixed but the stock fluctuates.

Why is the Market Sceptical Why is the Market Sceptical about Acquisitionsabout Acquisitions

Many of the Acquisitions fail because they set a very high performance bar.

Many Acquisitions fail because the benefits which they bring can easily be replicated by the competitors.

Acquisitions require full payment upfront.

If a merger goes wrong it becomes extremely difficult and expensive to unwind the decisions.

The calculation of the purchase price is driven by the Comparable other acquisitions rather than the calculations.

Questions for the AcquirerQuestions for the Acquirer

Valuation of acquirer's shares◦Are the Acquiring Company’s shares

undervalued, fairly valued or over valued?Synergy Risks

◦What is the risk that the expected synergies needed to pay for the acquisition premium will not materialize?

Pre-closing Market Risk◦How likely is it that the value of the acquiring

company’s shares will drop before closing?

Questions for the SellerQuestions for the SellerThe task of the selling company is very simple.

They have to compare the value of the company as an independent versus the price offered.

The Questions are:

“How much is the acquirer worth?”

“How likely is it that the expected synergies will be realized?”

“How great is the pre-closing market risks?”

Tax Consequences of Tax Consequences of Acquisition Acquisition

Cash purchase of shares is the most tax-favorable way for acquirer as depreciation but in the shareholders of the selling company will face a tax bill for capital gains.

By Contrast, the stock-financed acquisition appear to favor selling shareholders as they are allowed to receive the acquirer’s stock tax-free.

Accounting Treatment of Accounting Treatment of Acquisition Acquisition

Cash deals must be accounted for through the purchase-accounting method.

In case of Cash Deals, the price paid between the acquisition price and the fair value of the company is Goodwill.

Acquisition that are at least 90% paid for in shares, and meet a number of other requirements as specified in AS-14 Amalgamations and Mergers, are treated as the pooling-of-interest method.

Shareholder Value At Risk Shareholder Value At Risk (SVAR)(SVAR)

It is the premium paid for the acquisition divided by the market value of the acquiring company before the announcement is made.

ORPremium Percentage x Relative Market Value

of Seller to the Buyer◦For Acquirer

The premium at risk calculation shows the attractiveness of a fixed value offer relative to fixed share offer.◦For Selling Company

Thank you…Thank you…

Kaushal Khatore