what happens to your stock when a company is sold
The legendary merger mania of the 1980s pales abreast the M&A action of this decade. In 1998 alone, 12,356 deals involving U.S. targets were appear for a total value of $1.63 trillion. Compare that with the 4,066 deals worth $378.9 billion appear in 1988, at the height of the 1980s merger movement. But the numbers should be no surprise. Subsequently all, acquisitions remain the quickest route companies accept to new markets and to new capabilities. As markets globalize, and the pace at which technologies modify continues to accelerate, more and more companies are finding mergers and acquisitions to be a compelling strategy for growth.
What is hitting about acquisitions in the 1990s, nonetheless, is the way they're existence paid for. In 1988, virtually sixty% of the value of large deals—those over $100 million—was paid for entirely in cash. Less than 2% was paid for in stock. Only just ten years afterwards, the profile is nearly reversed: 50% of the value of all large deals in 1998 was paid for entirely in stock, and only 17% was paid for entirely in cash.
This shift has profound ramifications for the shareholders of both acquiring and acquired companies. In a cash deal, the roles of the ii parties are clear-cut, and the exchange of money for shares completes a simple transfer of buying. But in an exchange of shares, it becomes far less clear who is the buyer and who is the seller. In some cases, the shareholders of the acquired company can end upward owning about of the company that bought their shares. Companies that pay for their acquisitions with stock share both the value and the risks of the transaction with the shareholders of the visitor they acquire. The decision to utilize stock instead of cash can also affect shareholder returns. In studies covering more than 1,200 major deals, researchers have consistently found that, at the fourth dimension of announcement, shareholders of acquiring companies fare worse in stock transactions than they do in cash transactions. What'southward more, the findings show that early performance differences between cash and stock transactions get greater—much greater—over fourth dimension.
In a cash bargain, the roles of the ii parties are clear-cut, just in a stock deal, it's less articulate who is the buyer and who is the seller.
Despite their obvious importance, these issues are oft given curt shrift in corporate board-rooms and the pages of the financial press. Both managers and journalists tend to focus mostly on the prices paid for acquisitions. It's non that focusing on price is incorrect. Price is certainly an of import issue confronting both sets of shareholders. But when companies are considering making—or accepting—an offer for an exchange of shares, the valuation of the company in play becomes simply 1 of several factors that managers and investors need to consider. In this article, we provide a framework to guide the boards of both the acquiring and the selling companies through their decision-making process, and we offer two uncomplicated tools to help managers quantify the risks involved to their shareholders in offering or accepting stock. Only first let'southward look at the basic differences between stock deals and cash deals.
Greenbacks Versus Stock Trade-Offs
The main stardom betwixt cash and stock transactions is this: In greenbacks transactions, acquiring shareholders take on the entire run a risk that the expected synergy value embedded in the acquisition premium volition not materialize. In stock transactions, that risk is shared with selling shareholders. More precisely, in stock transactions, the synergy hazard is shared in proportion to the percent of the combined company the acquiring and selling shareholders each will own.
To see how that works, let's await at a hypothetical example. Suppose that Heir-apparent Inc. wants to learn its competitor, Seller Inc. The marketplace capitalization of Buyer Inc. is $5 billion, made up of fifty one thousand thousand shares priced at $100 per share. Seller Inc.'southward market place capitalization stands at $2.8 billion—xl one thousand thousand shares each worth $seventy. The managers of Buyer Inc. estimate that by merging the ii companies, they tin create an additional synergy value of $1.7 billion. They denote an offer to buy all the shares of Seller Inc. at $100 per share. The value placed on Seller Inc. is therefore $iv billion, representing a premium of $ane.2 billion over the company'due south preannouncement market value of $two.8 billion.
The expected internet gain to the acquirer from an conquering—we call it the shareholder value added (SVA)—is the deviation between the estimated value of the synergies obtained through the acquisition and the acquisition premium. And so if Buyer Inc. chooses to pay greenbacks for the deal, then the SVA for its shareholders is simply the expected synergy of $1.7 billion minus the $1.ii billion premium, or $500 one thousand thousand.
But if Buyer Inc. decides to finance the acquisition by issuing new shares, the SVA for its existing stockholders will drop. Let'southward suppose that Buyer Inc. offers one of its shares for each of Seller Inc.'due south shares. The new offer places the aforementioned value on Seller Inc. as did the greenbacks offer. Merely upon the deal's completion, the acquiring shareholders volition find that their ownership in Buyer Inc. has been reduced. They volition own only 55.5% of a new total of 90 one thousand thousand shares outstanding later on the conquering. So their share of the acquisition'south expected SVA is simply 55.5% of $500 1000000, or $277.5 million. The balance goes to Seller Inc.'s shareholders, who are now shareholders in an enlarged Buyer Inc.
The only way that Heir-apparent Inc.'s original shareholders can obtain the same SVA from a stock bargain as from a cash bargain would be by offering Seller Inc. fewer new shares, justifying this by pointing out that each share would be worth more if the expected synergies were included. In other words, the new shares would reflect the value that Heir-apparent Inc.'due south managers believe the combined company will be worth rather than the $100-per-share preannouncement market value. Simply while that kind of deal sounds fair in principle, in practice Seller Inc.'s stockholders would be unlikely to accept fewer shares unless they were convinced that the valuation of the merged company will plough out to exist even greater than Buyer Inc.'s managers estimate. In light of the disappointing track tape of acquirers, this is a hard sell at best.
On the face of it, then, stock deals offer the acquired company'southward shareholders the hazard to profit from the potential synergy gains that the acquiring shareholders look to brand in a higher place and beyond the premium. That's certainly what the acquirers will tell them. The problem, of class, is that the stockholders of the caused visitor besides accept to share the risks. Permit's suppose that Heir-apparent Inc. completes the buy of Seller Inc. with an exchange of shares and and then none of the expected synergies materialize. In an all-cash bargain, Buyer Inc.'s shareholders would shoulder the unabridged loss of the $1.ii billion premium paid for Seller Inc. But in a share deal, their loss is only 55.5% of the premium. The remaining 44.five% of the loss—$534 million—is borne past Seller Inc.'s shareholders.
In many takeover situations, of course, the acquirer will exist so much larger than the target that the selling shareholders volition end up owning only a negligible proportion of the combined visitor. Only every bit the evidence suggests, stock financing is proving peculiarly popular in large deals (see the exhibit "The Popularity of Paper"). In those cases, the potential risks for the acquired shareholders are large, as ITT'south stockholders constitute out afterwards their company was taken over past Starwood Lodging. It is ane of the highest contour takeover stories of the 1990s, and it vividly illustrates the perils of being paid in paper.
The Popularity of Paper Source: Securities Data Visitor
The story started in January 1997 with an offering by Hilton Hotels of $55 per share for ITT, a 28% premium over ITT's preoffer share toll. Under the terms of the offer, ITT's shareholders would receive $27.fifty in cash and the rest in Hilton stock. In the face of stiff resistance from ITT, Hilton raised its bid in August to $70 per share. At that betoken, a new bidder, Starwood Lodging, a real estate investment trust with extensive hotel holdings, entered the fray with a bid of $82 per share. Starwood proposed paying $15 in greenbacks and $67 in its own shares.
In response, Hilton announced a bid of $80 per share in this course—ITT shareholders would receive $80 per share in cash for 55% of their shares and ii shares of Hilton stock for each of the remaining 45% of their shares. If the stock did non reach at to the lowest degree $40 per share 1 year after the merger, Hilton would make up the shortfall to a maximum of $12 per share. In essence, then, Hilton was offering the equivalent of an all-cash bid that would be worth at to the lowest degree $80 per share if Hilton's shares traded at $28 or higher one year later on the merger. Hilton's management believed it would clinch the deal with this lower bid by offering more cash and protecting the future value of its shares.
Starwood countered by raising its offer to $85 per share. This time, it gave ITT's shareholders the pick to accept payment entirely in stock or entirely in cash. But in that location was a take hold of: if more than 60% of the stockholders chose the greenbacks option, and so the greenbacks payout to those shareholders would exist capped at just $25.fifty, and the remainder would be paid in Starwood stock. Despite this take hold of, ITT's board voted to recommend the Starwood offering over the less risky Hilton offering, and it was then approved by shareholders. Ironically, while ITT'southward board chose the offer with the larger stock component, the stockholders actually had a strong preference for cash. When the votes were counted, almost 75% of ITT's shareholders had selected Starwood'due south cash pick—a pct far greater than publicly predicted by Starwood's management and which, of class, triggered the $25.50 cap.
Equally a consequence of accepting Starwood's offer, ITT's shareholders ended upwards owning 67% of the combined company'due south shares. That was because even before the bid was announced (with its very substantial premium), ITT's market value was almost twice as large equally Starwood'southward. ITT'south shareholders were left very exposed, and they suffered for it. Although Starwood'south share price held steady at effectually $55 during the takeover, the price plunged after completion. A year later, it stood at $32 per share. At that toll, the value of Starwood's offer had shrunk from $85 to $64 for those ITT shareholders who had elected cash. Shareholders who had called to be paid entirely in stock fared even worse: their parcel of Starwood shares was worth only $49. ITT'south shareholders had paid a steep price for choosing the nominally higher but riskier Starwood offer.
Fixed Shares or Fixed Value?
Boards and shareholders must do more simply choose between cash and stock when making—or accepting—an offer. There are two ways to structure an offering for an exchange of shares, and the pick of one approach or the other has a significant touch on on the allocation of risk betwixt the two sets of shareholders. Companies tin either event a fixed number of shares or they can issue a fixed value of shares.
Fixed Shares.
In these offers, the number of shares to be issued is certain, but the value of the deal may fluctuate between the declaration of the offering and the closing engagement, depending on the acquirer'southward share price. Both acquiring and selling shareholders are affected past those changes, but changes in the acquirer's price will not impact the proportional ownership of the 2 sets of shareholders in the combined visitor. Therefore, the interests of the 2 sets of shareholders in the deal's shareholder value added exercise not change, even though the actual SVA may turn out to be different than expected.
In a fixed-share bargain, shareholders in the acquired company are especially vulnerable to a autumn in the price of the acquiring company's stock because they have to deport a portion of the toll risk from the time the deal is announced. That was precisely what happened to shareholders of Green Tree Financial when in 1998 it accustomed a $vii.ii billion offer past the insurance company Conseco. Under the terms of the deal, each of Green Tree'southward common shares was converted into 0.9165 of a share of Conseco common stock. On April 6, a solar day earlier the deal was announced, Conseco was trading at $57.75 per share. At that price, Greenish Tree'south shareholders would receive just under $53 worth of Conseco stock for each of their Green Tree shares. That represented a huge 83% premium over Green Tree's preannouncement share toll of $29.
Conseco'southward rationale for the bargain was that information technology needed to serve more than of the needs of center-income consumers. The vision articulated when the deal was announced was that Conseco would sell its insurance and annuity products along with Green Tree's consumer loans, thereby strengthening both businesses. But the acquisition was not without its risks. First, the Green Tree deal was more than than eight times larger than the largest deal Conseco had ever completed and almost twenty times the average size of its by 20 deals. Second, Dark-green Tree was in the business of lending money to buyers of mobile homes, a business very different from Conseco's, and the deal would require a costly postmerger integration endeavor.
The marketplace was skeptical of the cantankerous-selling synergies and of Conseco's power to compete in a new business concern. Conseco'south growth had been congenital on a series of highly successful acquisitions in its core businesses of life and health insurance, and the marketplace took Conseco's diversification as a signal that acquisition opportunities in those businesses were getting deficient. So investors started to sell Conseco shares. Past the time the deal airtight at the end of June 1998, Conseco's share price had fallen from $57.75 to $48. That fall immediately striking Greenish Tree's shareholders likewise as Conseco'southward. Instead of the expected $53, Green Tree'due south shareholders received $44 for each of their shares—the premium had fallen from 83% to 52%.
Dark-green Tree'south shareholders who held on to their Conseco stock after closing lost fifty-fifty more. By Apr 1999, one year after announcement, Conseco's share price had fallen to $thirty. At that toll, Green Tree's shareholders lost not simply the unabridged premium but also an additional $1.fifty per share from the preannouncement value.
Stock-still Value.
The other way to structure a stock deal is for the acquirer to outcome a stock-still value of shares. In these deals, the number of shares issued is not stock-still until the closing date and depends on the prevailing cost. As a result, the proportional ownership of the ongoing visitor is left in doubt until closing. To see how fixed-value deals work, let's get back to Heir-apparent Inc. and Seller Inc. Suppose that Heir-apparent Inc.'s offer is to be paid in stock but that at the closing appointment its share price has fallen past exactly the premium it is paying for Seller Inc.—from $100 per share to $76 per share. At that share cost, in a fixed-value deal, Heir-apparent Inc. has to issue 52.6 million shares to requite Seller Inc.'due south shareholders their promised $4 billion worth. But that leaves Buyer Inc.'s original shareholders with but 48.seven% of the combined company instead of the 55.five% they would take had in a fixed-share deal.
Equally the analogy suggests, in a fixed-value bargain, the acquiring company bears all the cost take a chance on its shares betwixt announcement and closing. If the stock toll falls, the acquirer must issue boosted shares to pay sellers their contracted fixed-dollar value. So the acquiring company's shareholders have to accept a lower stake in the combined visitor, and their share of the expected SVA falls correspondingly. Yet in our feel, companies rarely contain this potentially significant take chances into their SVA calculations despite the fact that the acquirer's stock toll decreases in a substantial majority of cases. (Encounter the table "How Risk Is Distributed Between Acquirer and Seller.")
The way an acquisition is paid for determines how the hazard is distributed between the heir-apparent and the seller. An acquirer that pays entirely in cash, for example, assumes all the run a risk that the cost of its shares will driblet between the announcement of the deal and its closing. The acquirer as well assumes all the operating chance later the bargain closes. By contrast, an acquirer that pays the seller a fixed number of its own shares limits its hazard from a drop in share cost to the percentage it will own of the new, merged company. The acquirer that pays a fixed value of shares assumes the entire preclosing market chance but limits its operating risk to the percentage of its postclosing buying in the new company.
By the same token, the owners of the caused company are better protected in a fixed-value deal. They are not exposed to any loss in value until after the deal has closed. In our example, Seller Inc.'s shareholders volition not have to bear whatever synergy risk at all because the shares they receive at present comprise no synergy expectations in their price. The loss in the share price is made upward by granting the selling shareholders actress shares. And if, after closing, the market reassesses the acquisition and Buyer Inc.'due south stock cost does rise, Seller Inc.'southward shareholders will bask higher returns because of the increased percentage they ain in the combined visitor. However, if Buyer Inc.'southward stock price continues to deteriorate after the closing date, Seller Inc.'s shareholders will bear a greater percentage of those losses.
How Tin can Companies Choose?
Given the dramatic effects on value that the method of payment tin can take, boards of both acquiring and selling companies have a fiduciary responsibility to incorporate those furnishings into their controlling processes. Acquiring companies must be able to explain to their stockholders why they take to share the synergy gains of the transaction with the stockholders of the acquired visitor. For their part, the caused company's shareholders, who are being offered stock in the combined company, must be fabricated to empathise the risks of what is, in reality, a new investment. All this makes the job of the board members more complex. We'll look kickoff at the issues faced by the lath of an acquiring company.
Questions for the Acquirer.
The management and the board of an acquiring company should accost 3 economic questions before deciding on a method of payment. Get-go, are the acquiring company'southward shares undervalued, fairly valued, or over-valued? 2d, what is the risk that the expected synergies needed to pay for the acquisition premium will not materialize? The answers to these questions volition help guide companies in making the decision between a greenbacks and a stock offer. Finally, how likely is it that the value of the acquiring company's shares will drop earlier closing? The answer to that question should guide the decision between a fixed-value and a fixed-share offering. Let'southward await at each question in plough:
Valuation of Acquirer'southward Shares
If the acquirer believes that the market place is undervaluing its shares, and then information technology should non issue new shares to finance a transaction considering to do so would penalize current shareholders. Research consistently shows that the marketplace takes the issuance of stock by a company as a sign that the company's managers—who are in a better position to know about its long-term prospects—believe the stock to be overvalued. Thus, when management chooses to use stock to finance an conquering, there's plenty of reason to expect that company'due south stock to autumn.
If the acquirer believes the market is undervaluing its shares, it should non issue new shares to finance an acquisition.
What's more, companies that use stock to pay for an acquisition ofttimes base the price of the new shares on the electric current, undervalued market toll rather than on the higher value they believe their shares to be worth. That tin crusade a visitor to pay more than it intends and in some cases to pay more than than the conquering is worth. Suppose that our hypothetical acquirer, Buyer Inc., believed that its shares are worth $125 rather than $100. Its managers should value the twoscore meg shares information technology plans to issue to Seller Inc.'s shareholders at $5 billion, not $iv billion. So if Buyer Inc. thinks Seller Inc. is worth just $4 billion, information technology ought to offer the shareholders no more than 32 1000000 shares.
Of grade, in the real world, it's not piece of cake to convince a disbelieving seller to have fewer but "more than valuable" shares—as we have already pointed out. So if an acquiring company's managers believe that the market significantly undervalues their shares, their logical class is to proceed with a cash offering. Even so nosotros consistently find that the aforementioned CEOs who publicly declare their company's share cost to be as well depression will cheerfully event large amounts of stock at that "too depression" price to pay for their acquisitions. Which point is the market more likely to follow?
Synergy Risks
The decision to employ stock or cash likewise sends signals about the acquirer'southward estimation of the risks of failing to achieve the expected synergies from the deal. A really confident acquirer would exist 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. But if managers believe the risk of not achieving the required level of synergy is substantial, they can be expected to try to hedge their bets by offering stock. Past diluting their company'south ownership interest, they will too limit participation in whatever losses incurred either before or after the deal goes through. One time again, though, the market is well able to draw its own conclusions. Indeed, empirical research consistently finds that the market reacts significantly more favorably to announcements of cash deals than to announcements of stock deals.
A really confident acquirer would be expected to pay for the conquering with greenbacks.
Stock offers, then, send two powerful signals to the market: that the acquirer's shares are overvalued and that its management lacks confidence in the acquisition. In principle, therefore, a visitor that is confident near integrating an acquisition successfully, and that believes its own shares to be undervalued, should ever go along with a cash offer. A greenbacks offer neatly resolves the valuation problem for acquirers that believe they are undervalued as well as for sellers uncertain of the acquiring company's true value. Merely it's not e'er so straightforward. Quite often, for example, a company does non have sufficient cash resources—or debt capacity—to make a cash offer. In that case, the determination is much less articulate-cutting, and the board must approximate whether the boosted costs associated with issuing undervalued shares notwithstanding justify the conquering.
Preclosing Market Take chances
A board that has determined to proceed with a share offer nonetheless has to decide how to structure it. That conclusion depends on an assessment of the risk that the price of the acquiring company'due south shares will drop between the proclamation of the bargain and its closing.
Inquiry has shown that the market responds more than favorably when acquirers demonstrate their conviction in the value of their own shares through their willingness to behave more preclosing market risk. In a 1997 article in the Journal of Finance, for example, Joel Houston and Michael Ryngaert found in a large sample of banking mergers that the more than sensitive the seller'southward compensation is to changes in the acquirer's stock price, the less favorable is the market's response to the acquisition declaration. That leads to the logical guideline that the greater the potential impact of preclosing market risk, the more important information technology is for the acquirer to signal its confidence by assuming some of that risk.
A stock-still-share offer is not a confident signal since the seller's compensation drops if the value of the acquirer's shares falls. Therefore, the fixed-share approach should be adopted merely if the preclosing marketplace risk is relatively depression. That'south more probable (although not necessarily) the case when the acquiring and selling companies are in the same or closely related industries. Common economic forces govern the share prices of both companies, and thus the negotiated exchange ratio is more likely to remain equitable to acquirers and sellers at closing.
Merely there are means for an acquiring company to structure a fixed-share offer without sending signals to the market place that its stock is overvalued. The acquirer, for case, can protect the seller against a autumn in the acquirer'due south share price below a specified flooring level by guaranteeing a minimum price. (Acquirers that offering such a floor typically also insist on a ceiling on the total value of shares distributed to sellers.) Establishing a flooring not but reduces preclosing market take a chance for sellers but also diminishes the probability that the seller's board will back out of the bargain or that its shareholders will non approve the transaction. That might have helped Bell Atlantic in its bid for TCI in 1994—which would have been the largest deal in history at the time. Bell Atlantic's stock fell sharply in the weeks following the announcement, and the bargain—which included no marketplace-risk protection—unraveled as a issue.
An fifty-fifty more confident signal is given past a fixed-value offer in which sellers are assured of a stipulated market value while acquirers bear the entire cost of any decline in their share cost earlier closing. If the market believes in the merits of the offer, so the acquirer'due south cost may even rise, enabling information technology to event fewer shares to the seller's stockholders. The acquirer's shareholders, in that effect, would retain a greater proportion of the deal'southward SVA. Every bit with fixed-share offers, floors and ceilings can be attached to fixed-value offers—in the form of the number of shares to exist issued. A ceiling ensures that the interests of the acquirer's shareholders are not severely diluted if the share price falls earlier the deal closes. A flooring guarantees the selling shareholders a minimum number of shares and a minimum level of participation in the expected SVA should the acquirer's stock price rise appreciably.
Questions for the Seller.
In the case of a greenbacks offer, the selling visitor'south board faces a fairly straightforward task. It simply has to compare the value of the company as an contained concern against the toll offered. The just risks are that it could concur out for a higher price or that management could create improve value if the visitor remained contained. The latter example certainly can be hard to justify. Let'south suppose that the shareholders of our hypothetical acquisition, Seller Inc., are offered $100 per share, representing a 43% premium over the current $70 price. Permit's also suppose that they tin get a x% render by putting that cash in investments with a similar level of risk. After 5 years, the $100 would compound to $161. If the bid were rejected, Seller Inc. would take to earn an almanac return of 18% on its currently valued $70 shares to do also. So uncertain a return must compete against a bird in the hand.
More than likely, though, the selling visitor's board will be offered stock or some combination of cash and stock and then will also accept to value the shares of the combined company existence offered to its shareholders. In essence, shareholders of the caused company volition be partners in the postmerger enterprise and will therefore have every bit much interest in realizing the synergies as the shareholders of the acquiring company. If the expected synergies do not materialize or if other disappointing information develops after endmost, selling shareholders may well lose a meaning portion of the premium received on their shares. So if a selling company's board accepts an exchange-of-shares offer, information technology is not only endorsing the offer as a fair price for its ain shares, it is also endorsing the thought that the combined company is an attractive investment. Essentially, and then, the lath must act in the role of a heir-apparent every bit well as a seller and must go through the same determination process that the acquiring visitor follows.
At the stop of the day, however, no matter how a stock offer is fabricated, selling shareholders should never assume that the announced value is the value they volition realize before or after closing. Selling early may limit exposure, simply that strategy carries costs considering the shares of target companies almost invariably trade below the offering price during the preclosing period. Of course, shareholders who wait until afterwards the closing date to sell their shares of the merged visitor take no manner of knowing what those shares will be worth at that time.
The questions nosotros have discussed here—How much is the acquirer worth? How likely is it that the expected synergies will be realized?, and How cracking is the preclosing market place risk?—accost the economic issues associated with the decisions to offer or accept a particular method of paying for a merger or acquisition. There are other, less important, issues of tax treatment and accounting that the directorate of both boards will seek to bring to their attending (see the sidebars "Tax Consequences of Acquisitions" and "Accounting: Seeing Through the Smoke Screen"). But those concerns should not play a key function in the acquisition determination. The actual impact of revenue enhancement and bookkeeping treatments on value and its distribution is non equally great as it may seem.
Shareholder Value at Take chances (SVAR)
Before committing themselves to a major deal, both parties will, of course, need to assess the issue on each company's shareholder value should the synergy expectations embedded in the premium fail to materialize. In other words, what percentage of the company's market value are you betting on the success or failure of the conquering? We nowadays two unproblematic tools for measuring synergy take chances, 1 for the acquirer and the other for the seller.
A useful tool for assessing the relative magnitude of synergy gamble for the acquirer is a straightforward adding we phone call shareholder value at risk. SVAR is only the premium paid for the conquering divided past the market value of the acquiring visitor before the announcement is made. The index can also exist calculated as the premium percentage multiplied by the market place value of the seller relative to the market value of the buyer. (See the table "What Is an Acquirer's Hazard in an All-Greenbacks Deal?") We retrieve of it equally a "bet your company" index, which shows how much of your company's value is at risk if no postacquisition synergies are realized. The greater the premium pct paid to sellers and the greater their marketplace value relative to the acquiring company, the higher the SVAR. Of course, as we've seen, it's possible for acquirers to lose even more than than their premium. In those cases, SVAR underestimates risk.
What Is an Acquirer'southward Chance in an All-Cash Deal? An acquirer'due south shareholder value at risk (SVAR) varies both with the relative size of the conquering and the premium paid.
Let'south meet what the SVAR numbers are for our hypothetical deal. Buyer Inc. was proposing to pay a premium of $ane.two billion, and its ain market value was $5 billion. In a cash deal, its SVAR would therefore be one.2 divided by v, or 24%. But if Seller Inc.'s shareholders are offered stock, Buyer Inc.'south SVAR decreases because some of the risk is transferred to the selling shareholders. To calculate Heir-apparent Inc.'s SVAR for a stock deal, you lot must multiply the all-greenbacks SVAR of 24% by the percentage that Buyer Inc. will ain in the combined company, or 55.v%. Buyer Inc.'south SVAR for a stock deal is therefore just 13.three%.
A variation of SVAR—premium at risk—tin assistance shareholders of a selling company assess their risks if the synergies don't materialize. The question for sellers is, What percentage of the premium is at chance in a stock offer? The answer is the percentage of buying the seller will have in the combined visitor. In our hypothetical deal, therefore, the premium at take a chance for Seller Inc.'s shareholders is 44.5%. Once once again, the premium-at-take a chance adding is actually a rather conservative measure of risk, as it assumes that the value of the independent businesses is rubber and only the premium is at risk. Merely every bit Conseco's acquisition of Green Tree Fiscal demonstrates, unsuccessful deals can toll both parties more than than just the premium. (See the table "SVAR and Premium at Risk for Major Stock Deals Announced in 1998.")
SVAR and Premium at Risk for Major Stock Deals Announced in 1998 Data for calculations courtesy of Securities Data Company. The cash SVAR percentage is calculated equally the premium percentage multiplied by the relative size of the seller to the acquirer. The stock SVAR percentage is calculated every bit the greenbacks SVAR percentage multiplied past the acquirer's proportional buying.
From the perspective of the selling company'south shareholders, the premium-at-risk calculation highlights the attractiveness of a stock-still-value offer relative to a stock-still-share offering. Let'due south go back to our two companies. If Buyer Inc.'s stock price falls during the preclosing period by the entire premium paid, then Seller Inc.'south shareholders receive boosted shares. Since no synergy expectations are built into the price of those shares now, Seller Inc.'s premium at chance has been completely absorbed by Buyer Inc. In other words, Seller Inc.'s shareholders receive non only more shares but too less risky shares. But in a fixed-share transaction, Seller Inc.'s stockholders accept to bear their full share of the value lost through the autumn in Buyer Inc.'south price correct from the declaration date.
Although nosotros have taken a cautionary tone in this article, we are not advocating that companies should always avoid using stock to pay for acquisitions. Nosotros have largely focused on deals that have taken place in established industries such equally hotels and insurance. Stock issues are a natural manner for young companies with limited access to other forms of financing, specially in new industries, to pay for acquisitions. In those cases, a high stock valuation tin exist a major advantage.
Fifty-fifty managers of Internet companies like Amazon or Yahoo! should not exist beguiled into thinking that issuing stock is risk-free.
But it is a vulnerable one, and even the managers of Cyberspace companies such as America Online, Amazon.com, and Yahoo! should not be beguiled into thinking that issuing stock is risk-free. Once the market has given a thumbs-downward to 1 deal past mark downwards the acquirer'southward share cost, information technology is likely to exist more guarded nearly hereafter deals. A poor stock-price performance can also undermine the motivation of employees and slow a visitor'southward momentum, making the difficult task of integrating acquisitions even harder. Worse, it can trigger a spiral of reject because companies whose share prices perform desperately find it hard to concenter and retain skilful people. Internet and other loftier-applied science companies are especially vulnerable to this situation because they need to be able to offering expectations of large stock-option gains to recruit the best from a deficient puddle of talent. The choice between cash and stock should never exist fabricated without total and careful consideration of the potential consequences. The all-too-frequent disappointing returns from stock transactions underscore how important it is for the boards of both parties to understand the ramifications and be vigilant on behalf of their shareholders' interests.
A version of this article appeared in the Nov–December 1999 consequence of Harvard Business Review.
Source: https://hbr.org/1999/11/stock-or-cash-the-trade-offs-for-buyers-and-sellers-in-mergers-and-acquisitions
0 Response to "what happens to your stock when a company is sold"
Publicar un comentario