Finding the Win-Win Deal

P.V. Viswanath

Class Notes for FIN 648: Mergers and Acquisitions

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. Viswanath

Terms
ER= exchange ratio: buyer shares per target share.
ER1= max acceptable exchange ratio for buyer.
ER2= max acceptable exchange ratio for seller.
P1= buyers price before transaction
P2= targets price before transaction
P1= buyers shares outstanding before transaction
P2= targets shares outstanding before transaction
P12= price of combined company
DCF12= discounted cashflow value of combined company

P.V. Viswanath

Max/Min Acceptable Exch Ratios - DCF

Share-for-Share Exchange
Buyers Maximum Acceptable Exch Ratio
P12 P1
DCF12
P12
P1
S1 S 2 ( ER1 )

DCF12 P1S1
ER1
P1S 2

P2 S1
Sellers Min Acceptable ER
Exch
Ratio
2
DCF12 P2 S 2
P12ER2 P2
P.V. Viswanath

Share-for-Share Exchange

P1
P2
S1
S2

60
40
100
100

Exchange Ratio

Win-Loss Boundaries: DCF Analysis

1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00

II. Target Wins,

Buyer Loses
III. Both
Lose

I. Both Win

IV. Buyer Wins

Target Loses

$7,000

$9,000

P.V. Viswanath

$11,000

$13,000

DCF Value of "New co"

Buyer's Maximum ER
Target's Minimum ER

Max/Min Acceptable Exch Ratios (DCF)

Cash-for-Share Exchange
Buyers Maximum Acceptable Exch Ratio
P12 P1
DCF12 Cash
P12
P1
S1

DCF12 P1S1
ER1
S2

For the seller, the minimum acceptable exch ratio is

simply P2, the price of the target prior to the acquisition.

P.V. Viswanath

Cash-for-Share Exchange
Win-Loss Boundaries: DCF Analysis
60
40
100
100

80.00

Exchange Ratio

P1
P2
S1
S2

70.00

II. Buyer Loses,

Target Wins

60.00

I. Both Win

50.00
40.00
30.00

IV. Buyer Wins

Target Loses

III. Both
Lose

20.00
$7,000

$9,000

$11,000

DCF Value of "New co"

$13,000

Buyer's Maximum ER
Target's Minimum ER

P.V. Viswanath

Max/Min Acceptable Exch Ratios (P/E)

Share-for-Share Exchange (P/E Model)
Need to estimate PE12 (corresponds to DCF
estimation in previous analysis).
Buyers Maximum Acceptable Exchange Ratio
P12 P1
P12 = (PE12)(EPS12)
EPS12 = (E1+E2+Esynergies)/(S1+S2ER1)
S1 E1 E 2 E synergies
ER1

.PE12
S2
P1 S 2
P.V. Viswanath

Max/Min Acceptable Exch Ratios (P/E)

Share-for-Share Exchange
Sellers Maximum Acceptable Exchange Ratio
P12ER2 P2
P12 = (PE12)(EPS12)
EPS12 = (E1+E2+Esynergies)/(S1+S2ER1)
P2 S1
ER2
( PE12 )( E1 E2 Esynergies ) P2 S 2

P.V. Viswanath

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 = Ptarget/Pbuyer

Some contribution indicators are:

Operating profits, assets, unit sales, revenues, no. of employees
If C = contribution % of buyer:
S Buyer

ER
P.V. Viswanath

S Buyer

S T arg et
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