All stock buyout

CFA Level I Equities
#1

Hi guys - I need help understanding the mechanics of an all stock buyout. Suppose CoA is trading at $50 with 100 shares o/s and CoB is trading at $25 with 100 shares o/s. CoA announces a buyout of CoB by issuing .7 shares of A for each share of B ($35 equivalent). What should the price of CoA be (ignore synergies and ignore EPS method of valuing the new A). Suppose both are all-equity firms (no debt). I know the new share count will be 170 since A will issue 70 shares but what will the equity value of A be? 1. (100x$50+100x$25)/170 = $44.11 2. (100x$50+100x$35)/170 = $50 or something else I know this isn’t on the CFA but I’m having a hard time understanding this. Appreciate any help. Thank you.

#2

According to the market, A was worth $5,000 before the deal and B was worth $2,500 before the deal. Ignoring synergies, the combined entity should be worth $7,500. So, $7,500/170 = $44.11. Of course that’s before all the shareholder lawsuits claiming that A overpaid.

#3

But now, B shareholders have a stock worth $44.11 as opposed to the $35 offer price. How did this happen? Did I not correctly calculate the consideration?

#4

The offer was $35/share for 100 shares, or $3,500. They actually ended up with $3,088 because, ignoring the possibility of synergies, the offer was too high and therefore dilutive. They still make out alright though, as they should have only received $2,500 based on the market’s valuation of them.

#5

p.s. I think this is on the CFA in L2.

#6

Okay, let me organize this a bit.

  1. The deal gets announced before the market opens and right after the open, A’s stock trades at $44.11 because of the dilution.

  2. Since the consideration was not in cash but in stock, B’s shareholders now have “new” A stock worth $3,088 or $44.11 for each of the 70 shares they received in exchange for the 100 of B they had previously.

Thank you!

I need to open my L2 books!

#7

Glad I could help. BTW, it’s crap like this that makes me hate working on stock deals. Give me an all cash transaction any day. Heck, even throw in a bunch of contingent consideration if you want, just make it cash.