Module 4 Share Exchange ratio

SWAP RATIO/Share exchange ratio

 The ratio in which an acquiring company will offer

its own shares in exchange for the target company's
shares during a merger or acquisition. To calculate the
swap ratio, companies analyze financial ratios such as
book value, earnings per share, profits after tax and
dividends paid, as well as other factors, such as the
reasons for the merger or acquisition.
 The swap ratio determines the control that each group
of shareholders of the companies shall have over the
combined firm. It is an indicator of relative values of
financial and strategic results of the company.
 Cont.
 In finance, a swap ratio is an exchange rate of
the shares of the companies that would undergo
a merger.
For Example
 If a company offers a swap ratio of 1:1.5, it will
provide one share of its own company for every 1.5
shares of the company being acquired.
Exchange ratio
 For example , in May 2010 . ICICI
Bank and Rajasthan Bank
announced a stock for stock merger.
 The boards of both banks
approved the swap ratio at 1 :
4.72, meaning 25 new shares of
ICICI to be issued for every 118
shares of BoR

6-4
 United Dynamic
Communications Entertainment
(Acquirer) (Target)

Net Income 5,00,00,000 1,00,00,000

(PAT)

Share 50,00,000 20,00,000

outstanding

Earning per 10 5
share

Stock price 150 50

P/E ratio 15 10
Example
 Let us assume that based on valuation of
dynamic , United Communication has
determined that it is willing to offer Rs
65 per share of Dynamic . This is 30%
premium above the pre merger price of
Dynamic.
 In terms of United’s shares the Rs 65
offer is equivalent to United’s Rs 65/150
share
 SWAP RATIO = .43 :1
Example
 Based on the preceding data , United
can calculate the total number of shares
that it is willing to offer to complete a bid
for 100% of Dynamic
 The shares that United will issue :
 ((Offer price)(total outstanding shares of
target))/price of acquirer or
 (Swap ratio )(total outstanding shares of
target)
 (Rs 65)(20,00,000)/Rs 150= 866666.67
 Earning per share of surviving company

 Calculating the EPS of the surviving

company reveals the impact of the merger
on the acquirer’s EPS
 Combined earning = 6,00,00,000
 Total share outstanding = 50,00,000
+866666.67 = 58,66,666.67
 United communication ‘s impact on EPS
Premerger EPS = Rs 10, post merger Rs
600,00,000/58,66,667 =10.23 This is an
example of accretion in EPS (EPS
accretive)
 Incase Dynamic rejects the offer and offer is
revised to Rs 90 per share
 Exchange ratio Rs 90/Rs 150= .60 shares
 Rs 90/150 * 20,00,000 = 12,00,000
 Premerger EPS Rs 10
 Post merger EPS= 600,00,000/62.00,000=
Rs 9.68
 United communication ‘s EPS declined the
following the higher offer of Rs 90 . This is an
example of dilution in EPS
6-9
Dilution in EPS
 Dilution of EPS will occur any time the
P/E ratio paid for the target exceeds the
the P/E ratio of the company doing the
acquiring.
 The P/E ratio paid is calculated by
dividing the offer price by EPS of the
target company This is as follows :
 P/E ratio Paid = Rs 65/Rs5= 13< 15
Rs 90/5 = 18 > 15

6-10
 DETERMINATION OF SWAP RATIO
 The commonly used bases for establishing the
exchange ratio are:
1. Earnings Per Share
2. Market Price Per Share
3. Book Value Per Share
 1. EARNING PER SHARE
 Earning per share is one of the important factor to
determine the exchange ratio.
 Suppose the earnings per share of the acquiring
firm are Rs 5.00 and the earnings per share of the
target firm Rs 2.00. An exchange ratio based on
earnings per share will be 0.4 that is (2/5).
 This means 2 shares of the acquiring firms will be
exchanged for 5 shares of the target firm.
 While earnings per share reflect prime facie the
earnings power, there are some problems in an
exchange ratio based solely on current earnings per
share of the merging companies because it fails to
take into account the following:
* The difference in the growth rates of earnings of the
two companies
* The gains in earnings arising out of merger
* The differential risks associated with the earnings of
the two companies
2. MARKET PRICE PER SHARE
 The exchange ratio may be based on the relative
market prices of the shares of the acquiring firm
and the target firm.
 For example, if the acquiring firm’s equity share
sells for Rs 50 and the target firm’s equity share
sells for Rs 10 the exchange ratio based on the
market price is 0.2 that is (10/50).
 This means that 1 share of the acquiring firm will
be exchanged for 5 shares of the target firm.
3. BOOK VALUE PER SHARE
 The relative book values of the two firms may be
used to determine the exchange rate.
 For example, if the book value per share of the
acquiring company is Rs 25 and the book value per
share of the target company is Rs 15, the book
value based exchange ratio is 0.6 =(15/25).
 This means that 3 share of the acquiring firm will
be exchanged for 5 shares of the target firm.
 The proponents of book value contend that it provides a
very objectives basis. This however is not convincing
argument because book values are influenced by
accounting policies which reflect subjective judgments.
There are still serious objections against the use of the
book value.
1. Book values do not reflect changes in purchasing
power of money.
2. Book values often are highly different from true
economic values.
VALUATION OF MERGER
PROPOSAL
 INTRODUCTION
 An acquiring firm should pursue a merger only if it
creates some real economic values which may arise
from any source such as better and ensured supply of
raw materials, better access to capital market, better and
intensive distribution network, greater market share, tax
benefits etc.
 The financial evaluation of a target candidate,
therefore, includes the determination of the total
consideration as well as the form of payment, i.e., in
cash or securities of the acquiring firm.
METHODS OF VALUATION
 Valuation based on assets.
 Valuation based on earnings.
 Market value approach.
 Earnings per share.
 Share exchange ratio.
 Other methods of valuation.
 1. VALUATION BASED ON ASSETS

The worth of the target firm, no doubt, depends upon

the tangible and intangible assets of the firm.
The value of a firm may be defined as:-
Value of all assets – External Liabilities = Net Assets
The assets of firm may be valued on the basis of the
book values or realizable values
 BOOK VALUE OF THE ASSETS

In this case, the values of various assets given in the

latest balance sheet of the firm are taken as worth of
the assets.
From the total of the book values of all the assets,
the amount of external liabilities is deducted to find
out the net worth of the firm.
The net worth may be divided by the number of
equity shares to find out the value per share of the
target firm.
 REALISABLE VALUE OF THE ASSETS

 In this case, the current market prices or the realizable

values of all the tangible and intangible assets of the
target firm are estimated and from this the expected
external liabilities are deducted to find out the net
worth of the target firm.
2. VALUATION BASED ON EARNING

 In the earnings based valuation, the PAT (Profit after taxes) is

multiplied by the Price – Earnings ratio to find out the value.
MARKET PRICE PER SHARE = EPS * PE RATIO
 The earnings based valuation can also be made in terms of
earnings yield as follows:-
EARNINGS YIELD = EPS/MPS *100
 Earnings valuation may also be found by capitalizing the total
earnings of the firm as follows:-
VALUE = EARNINGS/ CAPITALIZATION RATE * 100
 3. MARKET VALUE APPROACH
 This approach is based on the actual market price of
securities settled between the buyer and seller.
 The price of a security in the free market will be its
most appropriate value.
 Market price is affected by the factors like demand
and supply and position of money market.
 Market value is a device which can be readily applied
at any time.
4. EARNINGS PER SHARE
According to this approach, the value of a
prospective merger or acquisition is a function of
the impact of merger/acquisition on the earnings
per share.
As the market price per share is a function
(product) of EPS and Price- Earnings Ratio, the
future EPS will have an impact on the market value
of the firm.
5. SHARE EXCHANGE RATIO
The share exchange ratio is the number of shares that
the acquiring firm is willing to issue for each share of
the target firm.
The exchange ratio determines the way the synergy is
distributed between the shareholders of the merged
and the merging company.
The swap ratio also determines the control that each
group of shareholders will have over the combined
firm.
 METHODS OF CALCULATION

 BASED ON EARNINGS PER SHARE (EPS)

Share Exchange Ratio = EPS of the target firm /
EPS of the Acquiring firm
 BASED ON MARKET PRICE (MP)
Share Exchange Ratio = MP of the target firm’s share /

MP of the Acquiring firm’s share

 BASED ON BOOK VALUE (BV)
Share Exchange Ratio = BV of share of the target firm /
BV of share of the Acquiring firm
6. OTHER METHODS OF VALUATION
 ECONOMIC VALUE ADDED
EVA is based upon the concept of economic return which refers to
excess of after tax return on capital employed over the cost of
capital employed.

 MARKET VALUE ADDED

MVA is another concept used to measure the performance and as a
measure of value of a firm. MVA is determined by measuring the
total amount of funds that have been invested in the company
(based on cash flows) and comparing with the current market
value of the securities of the company.
 Question -1
30

Mani Ltd Ratnam Ltd

Particulars (Acquirer) (Target)

Profit After Tax Rs 40,00,000 8,00,000

No. of Shares Rs 4,00,000 2,00,000

PE Ratio 10 5
1. What is the swap ratio based on current market prices?
2. What is the EPS of Mani Ltd after the acquisition?
3. Determine the market value of the merged Company.
5. Calculate gain / loss for the shareholders of the two
independent entities, due to the merger.
 What is the swap ratio based on current
market prices? Mani Ltd Ratnam
31
(Acquire Ltd
Particulars r) (Target)
1 Profit After Tax Rs 40,00,000 8,00,000
2 No. of Shares Rs 4,00,000 2,00,000

3 PE Ratio 10 5

4 EPS (1 / 2 ) 10 4
5 MPS ( 3 X 4) 100 20
6 SWAP RATIO 20/100= .2 :1
The shares that Mani Ltd will
7 issue 40,000
( .2 X 2,00,000)= 40000
 What is the EPS of Mani Ltd after the
MANI LTD RATNAM COMBINED
acquisition? LTD
32
Profit after tax 40,00,000 8,00,000 48,00,000

No. of Shares (4,00,000+40000) 4,40,000

EPS post merger 10.91

Expected price of Mani Ltd post 10X 10.91 109.10

merger as same PE ratio

Expected price of Mani Ltd post 9X 10.91 98.19

merger as 10% less PE ratio
Market Value of New Company 109.1X 4,40,000 4,80,04,000

Market value of both the 4,40,00,000

companies before merger
 Company A will acquire company B with shares of common stock

33 Company A Company B
Present earnings 2,00,00,000 50,00,000
Shares outstanding 50,00,000 20,00,000
Earning per share 4 2.5
Price per Share 64 30
PE Ratio 16 12
Company B has agreed on an offer of Rs 35/- per share in
common stock of company A
1.. Compute Swap ratio
2…number of shares to be issued to company B by company A
3..Earning per share post merger of Company A
4.. What will be the earning per share post merger if the company
B renegotiated the offer to Rs 50 per share
 (a) A Ltd. wants to acquire T Ltd. and has offered a swap ratio of 1:2 (0.5 shares for every one share of T Ltd.). Following information is

provided:

34

A Ltd T ltd
Present earnings 18,00,000 3,60,000
Shares outstanding 6,00,000 1,80,000
Earning per share 3 2
Price per Share 30 15
PE Ratio 10 7

1…number of shares to be issued to T Ltd by A Ltd

2..Earning per share post merger of A Ltd
3. What I s the expected price per share of A ltd after the
acquisition
4.Determine the market value of the merged firm
 What is the EPS of A ltd after B LTD
A LTD the acquisition?
COMBINED

35
The shares that A Ltd will .5 X 1,80,000=90 000
issue

Profit after tax 18,00,000 3,60,000 21,60,000

No. of Shares (6,00,000+90000) 6,90,000

EPS post merger 3.13

Expected price of Mani Ltd post 10X 3.13 31.30

merger as same PE ratio
Market Value of New Company 31.3X 6,90,000 2,15,97000

Market value of both the 2,05,20000

 X Ltd wants to taker over Y Ltd and the
financial details are as follows
36
X Ltd Y Ltd
Equity Share capital Of Rs 10 each 1,00,000 50,000
Preference Share capital 20000
Share Premium 2000
Profit and Loss A/c 38000 4000
Debentures 15000 5000
Total 173000 61000
Fixed Assets 122000 35000
Current Assets 51000 26000
Total 173000 61000
Profit After Tax and preference dividend 24000 15000
Market Price 24 27

What should be share exchange ratio to be offered to the shareholders of Yltd

based on
1 Net Asset value 2 EPS 3 Market price.. Which should be preferred by Xltd
(1)Share Exchange Ratio based on Net Asset
Value :
X Ltd Y Ltd

Total
37 Assets 173000 61000

Debentures 15000 5000

Preference Share Capital 20000 0

Total liabilities 35000 5000

Net Worth 138000 56000

No of Shares 10000 5000

Net Worth per share 13.8 11.2

Share Exchange ratio Worth per share of target firm / Worth per share of acquiring
firm

Share Exchange ratio = 0.8116

No of shares to be issued 5000 0.812 5000*.812 4058

38
(2) Share exchange ratio based on EPS

Earning 24000 15000

No of Shares 10000 5000

EPS 2.4 3

Share exchange ratio EPS of target firm/EPS of acquiring firm

Share Exchange ratio Rs3/Rs 2.4 1.25

No of shares 1.25 5000 6250

39

(3) shares exchange ratio based on Market

price

Market price of Y ltd 27

Market price of X ltd 24

SWAP RATIO and No of shares 1.125 5000 5625

Shares issued on the basis of

Net worth 4058 preferred by X ltd ( Acquirer)
EPS 6250
MPS 5625
 X Ltd wants to taker over Y Ltd and the
financial details are as follows
X Ltd Y Ltd
40
Equity Share capital Of Rs 10 each 100000 50000
Preference Share capital 20000
Share Premium 2000
Profit and Loss A/c 38000 4000
Debentures 15000 5000
Total 173000 61000
Fixed Assets 122000 35000
Current Assets 51000 26000
Total 173000 61000
Profit After Tax and preference dividend 24000 15000
Market Price 24 27

What should be share exchange ratio to be offered to the shareholders of Yltd based
on
1 Net Asset value 2 EPS 3 Market price.. Which should be preferred by Xltd
 Legal Aspects of Mergers/
Amalgamation and Acquisition

Mergers and Acquisition are very complicated and lengthy

affairs. The merging entities are required to adhere to a number
of provisions to ensure that the interest of all the stakeholders is
protected.
Following legal provisions that are prevalent in the country are as;
 Companies Act, 1956/2013

 SEBI (Buyback of Securities) Regulations, 1998

 SEBI (Substantial Acquisition of Shares and Takeovers)

Regulations,2011
Legal Aspects of Mergers/
Amalgamation and Acquisition

 Listing Agreement norms

 SEBI delisting of shares norms
 Corporate governance issues
 Provision of Income Tax, 1961
 Foreign Exchange Management Act
(FEMA),1999
 Competition Act, 2002
Legal Aspects of Mergers/
Amalgamation and Acquisition

 Companies Act 1956/2013: The Companies Act

is the primary legislation governing all
companies in India. All corporate transactions,
be it mergers, primary/ secondary acquisitions
or private equity funding, have to be
implemented in accordance with the provisions
of the companies act 1956/2013.
 Foreign Exchange Management Act, 1999:
FEMA and the various rules and regulations
issued under FEMA by the reserve bank of India
regulate foreign exchange transactions in India.
Legal Aspects of Mergers/
Amalgamation and Acquisition

 Competition Act, 2002: The competition Act 2002

read with competition commission of India (Procedure
in regard to transaction of business relating to
combinations) regulations, 2011 regulates
‘combinations’ and govern the M&A transactions likely
to cause an appreciable adverse effect on competition
in India.
 Income Tax Act 1961: The tax treatment of M&A
transaction in India is governed by the Income Tax act
1961 read with double taxation avoidance treaties
signed between India and the jurisdictional country of
non-resident person, if any, who is party to the
transaction.
 The Provisions of Company’s Act
1956/2013

Sec. 376: condition prohibiting reconstruction or

amalgamation of company
Sec. 391:Power to compromise or make arrangements
with creditors and members
Sec. 392: Power of NCLT (National Company Law
Tribunal) to enforce compromises and arrangements.
Sec.393: deals with the information as to compromise or
arrangement with creditors and members.
Sec.394: deals with the provisions for facilitating
reconstruction and amalgamation of companies.
 The Provisions of Company’s Act
1956/2013

Sec.394A: relates to notice to be given to central

government for application under sec. 391 and sec.
394.
Sec.395: deals with the powers and duties to acquire
shares of share holders dissenting from scheme or
contract approved by majority.
Sec.396: deals with the power of central govt. to
provide for amalgamation of companies in national
interest.
Sec. 396A: relates to preservation of books and papers
of amalgamated company.
 SEBI Takeover Code
As per recommendations of Justice P N Bhagwati
committee and was incorporated in the SEBI
Regulation Act, 1977.
It is a set of guidelines given by SEBI relating to
regulations of mergers and takeovers.
The Salient features of the takeover code are as
explained as under:
 Disclosure of holdings.

 Public announcement and open offer.

 Offer price.

 Disclosure.

 Content of the offer document.

1. SEBI Takeover Code – Disclosure of
holdings
• If an acquirer holding 5%-14% wants to
acquire share in a target company, he is bound
to disclose such holding to target company or
stock exchange within 2 days of acquisition.
 If he is holding 15%-75% wants to purchase/sell

share aggregating to 2% or more, he is bound

to disclose such holdings to target company
within 2 days of such acquisition.
 If he is holding more than 15% shares and a

promoter and person having control shall

disclose his aggregate shareholding within 21
days before, 31st March to the target company.
 2. Public announcement and open offer:

 Any acquirer intending to hold shares (other than

promoters holding) which entitle 15% voting power can
acquire such shares only after making public
announcement to acquire at least 20% voting power
from shareholders through an open offer.
 Acquirer holding more than 15% (other than promoters
holding) but less than 75% of voting rights which entitles
5% voting rights in any financial year can do so only
after making public announcement to acquire at least
20% shares of target company from shareholders
through an open offer.
 Any acquirer holding more than 75% shares (other than
promoters holding) can acquire further share only after
public announcement to acquire at least 20% shares
from shareholders through an open offer.
3. SEBI Takeover Code – Offer
Price
In determining the offer price it has to
be ensured that all relevant
parameters as listed below are taken
into account:
 Negotiated price under the

agreement.
 Price paid for acquisition

 Average high and low prices of

scripts of the acquiring company

during the period needs to be
4. SEBI Takeover Code – Disclosure

The offer document for such takeover

has to disclose the following details
in a clear manner
 Detailed terms of the offer.

 Identity of the offer.

 Details of offerors existing holdings

in Target Company.
5. SEBI Takeover Code – Contents of
the offer document

As per the law the offer document has

to contain the following:

 Offer’s financial info.

 Intention to continue offeree’s
business and to make major long
term change and long term
commercial justification of the offer.
Scheme of Merger /
Amalgamation

Wherever two/ more companies agree to merge with each other, they have to
prepare a scheme
of amalgamation. The acquiring company should prepare the scheme in
consultation with its
merchant banker(s) / financial consultants. The main contents of a model
scheme, inter-alia, are
as listed below.
 Description of the transfer and the transferee company and the business of the
transferor.
 Their authorized, issued and subscribed / paid –up capital.
 Basis of scheme : Main terms of the scheme in self-contained paragraphs on
the recommendation of valuation report, covering transfer of assets /
liabilities, transfer date, reduction or consolidation of capital, application to
financial institutions as lead institution for permission and so on.
 Change of name, object clause and accounting year.
 Protection of employment.
 Dividend position and prospects.
 Management : Board of directors, their number and
participation of transferee company’s directors on
the board.
 Application under section 291 and 394 of the
Companies Act, 1956, to obtain Higher Court’s
approval.
 Expenses of amalgamation.
 Conditions of the scheme to become effective and
operative, effective date of amalgamation.
Regulation by SEBI
 Securities and Exchange Board of
India (SEBI): The securities market in
India is governed by the regulations
and directions issued by SEBI, the
market regulator for publicly listed
companies. The SEBI (substantial
acquisition of shares and takeovers)
regulations, 2011 govern M&A
transaction which involve the
acquisition of a substantial stake in a
publicly listed company.