The exchange ratio in a merger is the proportion at which shares of the acquiring company are exchanged for shares of the target company. It determines how many shares the acquiring company must issue for each share owned by the target company’s shareholders to maintain equivalent value.
Definition
• The exchange ratio represents the number of new shares that will be given to the target company’s shareholders per share they hold in the target company.
• It ensures that shareholders receive fair value based on the relative market prices or intrinsic values of the two companies involved in the merger.
Calculation
The basic formula for the exchange ratio is:
Exchange Ratio = Offer Price per Target Share / Acquirer’s Share Price
• Offer Price per Target Share: The price the acquiring company offers for each share of the target company, often including a takeover premium.
• Acquirer’s Share Price: The current price of the acquiring company’s shares.
For example, if the acquiring company’s share price is ₹ 11.75, and the offer price for the target company’s shares (including premium) is ₹21.63, the exchange ratio would be:
21.63 / 11.75 ≈ 1.84
This means the acquirer will issue 1.84 of its shares for each share held by the target company shareholders.
Types of Exchange Ratios
• Fixed Exchange Ratio: The ratio is fixed at the time of agreement and does not change until the deal closes. The number of shares issued is known upfront, but the final deal value can fluctuate depending on the acquirer’s share price movements. This method is preferred by the acquiring company.
• Floating Exchange Ratio: The ratio adjusts according to changes in the acquiring company’s share price so that the target company receives a fixed deal value regardless of stock price fluctuations. The number of shares issued can vary. This method is preferred by the target company.
• Collar Exchange Ratio: Combines features of fixed and floating ratios where the exchange rate remains fixed within certain share price ranges (collars) and adjusts if the share price moves outside that range, providing protection against volatility for both parties.
Purpose
The exchange ratio is a crucial term in a stock-based merger or acquisition as it directly affects shareholder ownership in the combined entity and the overall valuation perceived by both parties.
In summary, the exchange ratio ensures equitable treatment of target shareholders by balancing the share values and premiums in the merger transaction.
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