Estimated Post-Acquisition Value

In a merger and acquisition transaction, the acquirer will always want to get the best possible price for the target, while the target will always want to sell at a higher price. As such, the acquirer usually pays a premium to convince shareholders to give up control over the company.

$$\text{Target shareholder’s gain}=\text{Premium}=\text{P}_{\text{T}}-\text{V}_{\text{T}}$$

Where:

\(\text{P}_{\text{T}}=\) Price paid for the target company.

\(\text{V}_{\text{T}}=\) Pre-merger value of the target company.

The acquirer anticipates that the premium paid for the target will translate to gains derived from synergies increasing the value of the acquiring company.

$$\text{Acquirer’s gain}=\text{Synergies}-\text{Premium}=\text{S}-(\text{P}_{\text{T}}-\text{V}_{\text{T}})$$

Where:

\(S\) = Synergies created by the business combination

The post-merger value of the company is:

$$V_A∗=V_{A}+V_{T}+S-C$$

Where:

\(V_A∗=\) Post-merger value of the combined companies

\(V_A=\) Pre-merger value of the acquirer

\(\text{C}=\) Cash paid to target shareholders

The least bid that the target company’s shareholders should accept is the pre-merger value of the target company since in the open market, shareholders can sell their shares for a higher price than they would obtain by accepting a low bid. On the other hand, an acquirer’s shareholders are unwilling to pay a high number for an overvalued target as this will lower the overall value of the acquirer.

Thus, the merger analysis depends on assessing the target company’s value and the estimates of any synergies attained when the companies merge. The payment method—cash or stock—and the bid price reflect the confidence level of management in synergy estimates.

Example: Stock Offer and Cash Offer

Marcus Engineering Ltd. is considering a friendly acquisition of Salt Bay Ltd. The management teams have agreed on a transaction value of $13.00 per share of Salt Bay Ltd. stock. Consider the following information.

$$\small{\begin{array}{l|c|c} {}& \text{Marcus} & \text{Salt Bay}\\ \hline\text{Pre-merger stock price (\$)} & \$ 17 & \$11 \\ \hline\text{Number of shares outstanding (millions)} & 80 & 36\\ \hline\text{Pre-merger market value (\$ millions)} & \$1,360 & \$396\\  \end{array}}$$

Salt Bay Ltd. is considering the following offers from Marcus.

1. Stock offer of 0.65 shares of Marcus per share of Salt Bay.
2. Cash offer of $13 per share.

Estimate the combined company’s post-merger value and stock price based on each form of payment and evaluate which offer Salt Bay should accept.

Solution

Stock Offer

Stock offer of 0.65 shares of Marcus stock per share of Salt Bay stock implies that:

Marcus must issue \(\text{36 million} × 0.65= \text{23.4 million shares}\) to Salt Bay shareholders.

The post-merger value of the company is:

$$V_A∗=V_{A}+V_{T}+S-C$$

$$V_{A∗}=\$1,360+\$396+\$100 – 0 = \text{\$1,856 million}$$

\(C=0\) as no cash is paid to target (Salt Bay) shareholders.

$$\text{Post-merger stock price}=\frac{\text{\$1,856m}}{(\text{80m}+\text{23.4m})}=\$17.95\ \text{per share}$$

$$\text{Total value paid to Salt Bay}=$17.95\times23.4\ \text{million}=$420.03\ \text{million}$$

$$\text{Salt Bay’s gain}=\text{Takeover premium}=\text{P}_{T}-\text{V}_{T}$$

$$\text{Takeover premium}= \text{\$420.03 million} – \text{\$396 million}= \text{\$24.03 million}$$

$$ \text{Acquirer’s gain} =\text{Synergies}-\text{Premium}=\text{S}-(\text{P}_{\text{T}}-\text{V}_{\text{T}}) $$

$$\text{Marcus’ gain (acquirer’s gain)} = \text{\$100 million} – \text{\$24.03 million} = \text{\$75.97 million}$$

Cash Offer

The cash offer of $13 per share means that Marcus will pay $468 million to acquire Salt Bay Ltd.

The price paid to Salt Bay is:

$$ \text{P}_{\text{T}}=\$13\times\text{36 million}=\$468\ \text{million} $$

$$\text{Salt Bay shareholders’ gain} = \text{Takeover premium}=\text{P}_{\text{T}}-\text{V}_{\text{T}}$$

$$\text{Takeover premium}=$468\ \text{million}-$396\ \text{million}=$72\ \text{million}$$

$$\text{Acquirer’s gain}=\text{Synergies}-\text{Premium}=\text{S}-(\text{P}_{\text{T}}-\text{V}_{T})$$

$$\text{Marcus’ gain (acquirer’s gain)} =$100\ \text{million}-$72\ \text{million}=$28\ \text{million}$$

The post-merger value of the company is:

$$V_A∗=V_{A}+V_{T}+S-C$$

$$\text{V}_A∗=\$1,360+\$396+\$100-\$468=\$1,388\ \text{million}$$

The stock price of Marcus will rise to \(\bigg(\frac{$1,388}{\text{80}}\bigg) = $17.35\)

Conclusion: The cash offer results in the highest value (takeover premium) to Salt Bay’s shareholders.

Question

Joe Blake, an investment banker, is part of a team tasked with estimating cash offers presented to their client, McDowell Software Inc., in an ongoing acquisition deal between McClurkin Ltd. Both companies agreed on a transaction value of about $13 per share of McDowell’s stock. Blake estimates that the combined company will result in economies of scale worth $70 million. Blake compiled the following data.

$$\small{\begin{array}{l|c|c} & \textbf{McClurkin} & \textbf{McDowell} \\ \hline\text{Pre-merger stock price} & \$16 & \$11 \\ \hline\text{Number of shares outstanding (millions)} & 70 & 28 \\ \hline\text{Pre-merger market value (millions)} & \$1,120 & \$308\\  \end{array}}$$

The premium gain the target will get because of the merger is closest to:

1. $56 million.
2. $364 million.
3. $14 million.

Solution

Correct answer is A.

First, we will calculate the price paid for the target.

$$\text{P}_{\text{T}}=28\ \text{million}\times\$13=\$364\ \text{million}$$

$$\text{McDowell’s gain}=\text{Takeover premium}=\text{P}_{\text{T}}-\text{V}_{\text{T}}$$

$$\text{Takeover Premium} = \$364\ \text{million}-\$308\ \text{million} =\$56\ \text{million}$$

B is incorrect. This is the price paid for McDowell.

C is incorrect. This is the acquirer’s gain \(=\$70\ \text{million}-\$56\ \text{million}=\$14\ \text{million}\)

Reading 18: Merger and Acquisition

LOS 18 (h) Evaluate a takeover bid and its effects on the target shareholders versus the
acquirer shareholders.