6) FORM OF PAYMENT - PART 1 Flashcards
what are 3 things to consider when deciding the form of payment
a) dilution (in terms of control based on shareholders, wealth of shareholders and their relative control)
b) leverage positions (changing D and E on the balance sheet)
c) optimal financing (need to try and get the lowest WACC, must consider the balance sheet)
Always consider what the form of payment does to
the balance sheet of the acquirer
7 forms of payment
1) cash
2) Script (share exchange)
3) cash underwritten share offer
4) loan stock
5) preferred shares
6) deferred payment
7) conditional payment
1) cash
cash in exchange for shares
2) Script (share exchange)
specified number of bidder shares for each target share
3) cash underwritten share offer
Bidder’s shares that may be sold for cash to institution (vendor placing) or bidder’s shareholders (vendor rights)
4) loan stock
Loan stock (debenture) (issuing new debt) in exchange for their shares
5) preferred shares
Convertible to bidder’s shares at predetermined period and rate
6) deferred payment
Payment paid in instalments, may be subject to performance
7) conditional payment
Deferred payment made if pre-specified criteria met
Exchange ratio
no. shares of the buyer’s stock to be received for each share of the target firm’s stock
Need to choose a purchase price and ER in order to avoid
earnings dilution
Maximum ER depends on
expected post-acquisition earnings growth rates of bidder and target
low growth rates lead to
earnings dilution
4 advantages of being paid cash - TARGET’S perspective
- Avoid brokerage costs
- No value uncertainty
- Protected from downside moves in acquirer’s share price
- Avoid synergy valuation risk
3 advantages of being paid scrip - TARGET’S perspective
- Benefit from upside moves in acquirer’s share price
- Benefit from better than expected realised synergy value post-deal
- Avoid capital gains tax
disadvantage of being paid cash - TARGET’S perspective
Do not benefit from upside moves in acquirer’s share price
4 disadvantages of scrip payment - TARGET’S perspective
- Will have to pay brokerage if exiting position
- Offer value implied by value of acquirer (additional uncertainty)
- Exposed to downside moves in acquirer’s share price
- Exposed to worse than expected realised synergies post-deal
3 advantages of being paid cash - ACQUIRER’S perspective
• Lower issuance cost
• Maximise depreciation tax offset
• Deter interlopers (market signal)
A really confident acquirer would be expected to pay for the acquisition with cash so that its shareholders would not have to give any of the anticipated merger gains to the acquired company’s shareholders.
4 advantages of being paid scrip - ACQUIRER’S perspective
- Maintains financial flexibility
- Take advantage of buoyant stock price
- Require target’s shareholders to continue to have “skin in the game” through implementation
- Share synergy valuation risk
3 disadvantages of being paid cash - ACQUIRER’S perspective
- Restricts financial flexibility
- No risk-sharing
- May not be feasible given deal size
4 disadvantages of being paid scrip - ACQUIRER’S perspective
- Potentially dilutes EPS
- Potentially voting dilution
- Potential voting concentration in target’s shareholders
- Higher issuance cost
Implied deal value per share for 100% cash deal
just the value of amount offered by the bidder per share
Implied deal value per share for 100% scrip deal
(x amount of shares in bidders company per company B share) X Bidder’s current share price
choice of form of payment is linked to flexibility acquirer wishes to maintain in their capital financing. This is influenced by 7 things:
(Choice of payment currency for a cross border acquisition is based on trade-off of these conflicting criteria)
1) Acquirer’s existing cash levels
2) Maintaining a reasonable gearing ratio and the credit rating
3) Ensuring adequacy of lines of credit from banks is another
4) Taking advantage of any tax provisions to reduce the cost of capital is also relevant
5) Timing of security issues to exploit favourable market conditions
6) Capital structure of the target
Deal flexibility is advantageous becuase
enhances prob of deal being accepted (ie in both parties interests)
- Friendly mergers and more likely to be paid in cash.
FALSE
100% cash mergers result in, on average, a higher target abnormal return than 100% scrip deals.
TRUE
Bidders prefer to pay in cash because it is less risky than scrip.
FALSE
Targets prefer to receive cash because it is less risky than scrip.
TRUE
A bidder will optimally pay in scrip for a target with strategic human capital, all else equal.
TRUE
Target signing pre-bid exclusivity agreement =
A concession made by the target that benefits the acquirer, all else equal
Acquirer offering flexibility in form of payment =
concession made by the acquirer that benefits the target, all else equal
Target accepting earn-out payment
A concession made by the target that benefits the acquirer, all else equal
Acquirer offering additional consideration to significant target shareholders
A concession made by the acquirer that benefits the target, all else equal
Nil Premium Exchange Ratio =
Offer price (the current price of the target) / Current share price of the bidder)
A mutually beneficial deal occurs when
bidder’s max ER (ER≤ ERmax) is above the target’s min (ER≥ERmin)
===> zone of potential agreement
In terms of deals going through, synergies increase
increase the range of potential agreement ERs that merger parties would rationally accept, increasing in turn the likelihood of a proposal successfully closing
max and min ER of buyer and seller depend on the
estimated value of the merged entity
Because value of merged entity is UNCERTAIN, must assess min and max ER ratio across range of possible values for merged entity. How is this done?
1) Focus on the likely P/E ratio of the merged entity
2) Estimate the likely DCF value of the equity of the merged entity
Importance of having deal boundaries (ie, min and max ER)
1) Given an informed (rational) view ofDCF value or P/E of MergeCo can identify a negotiation range and some likelihood of agreement
2) Given a proposed ER, one can identify P/E or DCF break-even assumptions necessary to permit a mutually beneficial deal
3) Given both a proposed ER and view of DCF value or P/E of the merged entity, one can evaluate the adequacy of a proposal
Win win (for ER and merged entity P/E)
Bidder ER ≤ ER max
Target ER ≥ ER min
Bidder wins (target loses)
Bidder ER ≤ ER max
Target ER ≱ ER min
Target wins (bidder loses)
Bidder ER ≰ ER max
Target ER ≥ ER mi
Lose lose
Bidder ER ≰ ER max
Target ER ≱ ER min
what does the optimal ER depend on?
projected values of the merged co
Synergies create bargaining flexibility becuase
the greater the synergies, the greater the win-win zone –> wider ZOPA more likely to result in a successful deal
fixed ER
the deal moves with the ACQUIRER’s share price (target knows the no shares it’s getting)
floating ER
deal adjusts inversely to changes in the acquirer’s share price (ratio floats so that target gets a fixed deal no matter what)
