Topic 8 - M&A Flashcards
Problem 1 - Accretion / Dilution Analysis - Context
Company A, equity value of $100m, purchases Company B for $100m
All-stock transaction
Company A = price/earnings of 10 | Company B = price/earnings of 5
Company A has 1m shares
Problem 1 - Accretion / Dilution Analysis - Is the deal accretive or dilutive for Company A shareholders’ earnings? (Step 1 + 2)
Step 1) Calculate Company A’s share price
100m market cap/ 1m shares = 100$ per share.
Step 2) Realise that this is an all-stock transaction
Company A needs to issue another 1 mil shares to pay for the $100mil market value of Company B. As a result, A has 2 million shares outstanding post – deal
Problem 1 - Accretion / Dilution Analysis - Is the deal accretive or dilutive for Company A shareholders’ earnings? (Step 3 + 4)
Step 3) Get the combined firm’s earnings and EPS
Earnings for CompA = Market Cap * P/E ratio = 100m / 10 = $10m earnings
10m earnings / 1mil shares = 10$ EPS
Earnings for CompB = Market Cap * P/E ratio = 100m / 5 = $20m earnings
20m earnings / 1 mil shares = 20$ EPS
Earnings for CompCombined = $30m
$30m in earnings/ 2m outstanding shares = $15 NEW EPS
Step 4) Transaction is:
(New EPS / Acquirer EPS) – 1
15 / 10 = 1.5
1.5 – 1 = 0.5
50% increase from previous EPS, therefore 50% accretive to earnings
Problem 2 - Method of Payment - Context
Firm A is thinking of acquiring Firm B.
Firm A has 1,000 shares, 12£ per share
Firm B has 4,000 shares. 3£ per share
Synergies = £6,000
Which of the three offers maximises Firm A’s NPV of the transaction?
i) 4.5£ cash per Firm B stock
ii) 1.5£ cash per Firm B stock + 1 share of Firm A per 4 shares of Firm B
iii) 2/3rds of the stock of the combined firm.
Problem 2 - Method of Payment - Calculate all of them. Start with Offer i - 4.5£ cash per Firm B stock
Synergies = £6,000
Premium = (£4.54000)(£3*4000) = 18,000 – 12,000 = £6,000
NPV = 6,000 – 6,000 = 0
Bad choice.
Problem 2 - Method of Payment - Calculate all of them. Next is Offer ii - 1.5 cash and 4 shares of B for a share of A / 1 share of B for 0.25 shares of A
0.25 shares of A * B’s shares
0.25 * 4,000 = 1,000 new shares
A already has 1,000 old shares (keep in mind)
Share Price of the combined firm:
Share Value of Combined firms (value of A + value of B) + Synergies – Cash / (New shares + existing A shares)
(£121000 + £34000) + 6,000 – (4,000£1.5) / (1000 + 1000) = £12
Value paid for B by A = combined price * new shares + cash = £12 * 1000 + £1.54000 = £18,000 (same premium as before) So, seems fairly ok.
Problem 2 - Method of Payment - Calculate all of them. Last is Offer iii - 2rds of the Stock of the Combined Firm (Part 1)
M = 2/3 (N + M)
We know N = 1,000 (existing A stock)
M = 2/3 (1,000 + M)
M = 666.67 + 2/3M
3/2M = 1,000 + M
0.5M = 1,000
M = 2,000
Share Price of the combined firm:
Share Value of Combined firms (value of A + value of B) + Synergies – Cash / (New shares + existing A shares)
(121000 + 34000) + 6,000) / (1000 + 2000) = £10
Problem 2 - Method of Payment - Calculate all of them. Last is Offer iii - 2rds of the Stock of the Combined Firm (Part 2)
Value paid for B by A (Pt) = combined price * new shares + cash = £10 * 2000 + 0 = £20,000
Vt = £3 * 4000 = £12,000
Premium = Pt - Vt = 20,000 - 12,000 = £8,000
NPV = £6,000 (synergies) - £8,000 (this premium) = -£2,000 -> No Go!
None of these alternatives adds value for the bidder.
Problem 3 - Merger Arbitrage - Context
4th Jan 2018, ACQ makes acquisition bid of $115 per share for all TAR’s equity using all-stock payment method at exchange ratio of 1 share ACQ for 2 shares TAR.
TAR stock price, at a year earlier from this date, was $100, but increases to $113 on the announcement day.
ACQ’s share price is $230.
I am a risk arbitrageur who speculates on the successful completion of this.
Problem 3 - Merger Arbitrage - Question 1 - What’s my Strategy in initiating this position, setting a spread, and calculating the size of this spread ($ per TAR share)
Initiate the position by:
Buying the TAR stock (go long) and sell the acquirer’s stock (go short).
Size of spread is offer price – current price (115 – 113) = $2 per target’s share
Problem 3 - Merger Arbitrage - Question 2 - Explain how my position is protected under this strategy when: (and comment on these results)
1 – ACQshare-price up from $230 to $260 on deal completion (Part 1 - this part)
2 – ACQ share-price down from $230 to $200 on deal completion (Part 2 - next part)
To start, I buy TAR stock at 113$ per share. At completion, one TAR stock will be 0.5 ACQ stock. Value from conversion depends on ACQ’s stock price at deal completion AND EQUALS to 0.5 * ACQ’s stock price.
1 – Gain from long position: (260 * 0.5) – 113 = $17
Loss from short position: (230 – 260) * 0.5 = $15 (negative)
Net Gain = 17 – 15 = $2 profit per target share.
Problem 3 - Merger Arbitrage - Question 2 - Explain how my position is protected under this strategy when: (and comment on these results)
1 – ACQshare-price up from $230 to $260 on deal completion (Part 1 - last part)
2 – ACQ share-price down from $230 to $200 on deal completion (Part 2 - this part)
To start, I buy TAR stock at 113$ per share. At completion, one TAR stock will be 0.5 ACQ stock. Value from conversion depends on ACQ’s stock price at deal completion AND EQUALS to 0.5 * ACQ’s stock price.
2 – Loss from long position: 200*0.5 – 113 = $13 (negative)
Gain from short position: (230 – 200) * 0.5 = $15
Net Gain = 15 – 13 = $2 profit per target’s share
Problem 3 - Merger Arbitrage - Question 3 - Assume, in the deal failure, TAR’s stock price goes back to stand-alone price of $100, calculate the probability of deal success at announcement.
Normal formula =
Current Price = (prob success * offer price) + (prob failure * stand-alone price)
Adjusted formula =
Current Price = (prob success * offer price) + (1 – prob success * stand-alone price)
Final formula =
prob success = (current price – stand-alone price) / (offer price – stand-alone price)
= (113 – 100) / (115 – 100) = 0.87 or 87%
