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SWAP RATIO Merger and Acquisitions

SWAP/Exchange ratio
The exchange ratio is the number of the acquirers 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 partys 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 acquirers shares

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United Dynamic Communications Entertainment (Acquirer) (Target)

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


Share outstanding 50,00,000

1,00,00,000
20,00,000 5 50

Earning per share 10 Stock price 150

P/E ratio

15

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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 Uniteds shares the Rs 65 offer is equivalent to Uniteds 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 acquirers 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)
8,00,000
2,00,000

Profit After Tax


No. of Shares

Rs
Rs

40,00,000
4,00,000

PE Ratio

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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.
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What is the swap ratio based on current market prices? Ratnam Mani Ltd Ltd Particulars (Acquirer) (Target) 1 2 Profit After Tax No. of Shares Rs Rs 40,00,000 8,00,000 4,00,000 2,00,000

3
4 5 6 7

PE Ratio
EPS (1 / 2 ) MPS ( 3 X 4) SWAP RATIO The shares that Mani Ltd will issue ( .2 X 2,00,000)= 40000

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10 4 100 20 20/100= .2 :1 40,000


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What is the EPS of Mani Ltd after the acquisition?


MANI LTD RATNAM LTD COMBINED 48,00,000 4,40,000

Profit after tax No. of Shares (4,00,000+40000) EPS post merger


Expected price of Mani Ltd post merger as same PE ratio Expected price of Mani Ltd post merger as 10% less PE ratio Market Value of New Company Market value of both the companies before merger

40,00,000

8,00,000

10.91 10X 10.91 9X 10.91 109.1X 4,40,000 109.10 98.19 4,80,04,000 4,40,00,000
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Company A will acquire company B with shares of common stock


Company A Company B 50,00,000 20,00,000 2.5 30

Present earnings Shares outstanding Earning per share

2,00,00,000 50,00,000 4 64

Price per Share


PE Ratio

16 12 Company B has agreed on an offer of Rs 35/- per share in common stock of company A 1.. Compute Swap ratio 2number of shares to be issued to company B by company A 3..Earning per share post merger of Company A 4.. What will be the earning per share post merger if the company B renegotiated the offer to Rs 50 per share

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(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:ltd A Ltd T Present earnings Shares outstanding Earning per share
18,00,000 6,00,000 3 30 10 3,60,000 1,80,000 2 14 7

Price per Share


PE Ratio

1number of shares to be issued to T Ltd by A Ltd 2..Earning per share post merger of A Ltd 3. What I s the expected price per share of A ltd after the acquisition 4.Determine the market value of the merged firm

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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


No. of Shares (6,00,000+90000) EPS post merger
Expected price of Mani Ltd post merger as same PE ratio Market Value of New Company Market value of both the companies before merger

18,00,000

3,60,000

21,60,000
6,90,000

3.13 10X 3.13 31.3X 6,90,000 31.30 2,15,97000 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 Ltd
1,00,000 20000 2000 38000 15000 173000 122000 51000 173000 24000 24 4000 5000 61000 35000 26000 61000 15000 27 50,000

Equity Share capital Of Rs 10 each Preference Share capital Share Premium Profit and Loss A/c Debentures Total Fixed Assets Current Assets Total Profit After Tax and preference dividend Market Price

What should be share exchange ratio to be offered to the shareholders of Yltd based on 1 Net Asset value 2 EPS 3 Market price.. Which should be preferred by Xltd
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Share Exchange Ratio based on Net Asset Value :


(1) X Ltd Total Assets 173000 Y Ltd 61000

Debentures Preference Share Capital Total liabilities Net Worth No of Shares

15000 20000 35000 138000 10000

5000 0 5000 56000 5000

Net Worth per share


Share Exchange ratio Share Exchange ratio = No of shares to be issued

13.8 11.2 Worth per share of target firm / Worth per share of acquiring firm
0.8116 5000 0.812 5000*.812

4058

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(2) Share exchange ratio based on EPS


Earning No of Shares EPS Share exchange ratio Share Exchange ratio No of shares 24000 10000 2.4 15000 5000 3

EPS of target firm/EPS of acquiring firm Rs3/Rs 2.4 1.25 5000 1.25 6250

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(3) shares exchange ratio based on Market price Market price of Y ltd Market price of X ltd SWAP RATIO and No of shares 27 24 1.125 5000 5625

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

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X Ltd wants to taker over Y Ltd and the financial details are as follows
X Ltd Y Ltd
100000 20000 50000

Equity Share capital Of Rs 10 each Preference Share capital Share Premium Profit and Loss A/c Debentures Total Fixed Assets Current Assets Total Profit After Tax and preference dividend Market Price

2000
38000 15000 173000 122000 51000 173000 24000 24 4000 5000 61000 35000 26000 61000 15000 27

What should be share exchange ratio to be offered to the shareholders of Yltd based on 1 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-tobook, 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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