Case II Stock Acquisition

Things are somewhat more complicated when stock is the means of payment. In a cash merger, the shareholders in B receive cash for their stock, and, as in the U.S. Steel-Marathon Oil example, they no longer participate in the company. Thus, as we have seen, the cost of the acquisition in this case is the amount of cash needed to pay off B's stockholders.

In a stock merger, no cash actually changes hands. Instead, the shareholders of Firm B come in as new shareholders in the merged firm. The value of the merged firm in this case will be equal to the premerger values of Firms A and B plus the incremental gain from the merger, AV:

Ross et al.: Fundamentals VIII. Topics in Corporate 25. Mergers and © The McGraw-Hill of Corporate Finance, Sixth Finance Acquisitions Companies, 2002

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858 PART EIGHT Topics in Corporate Finance

To give $150 worth of stock for Firm B, Firm A will have to give up $150/20 = 7.5 shares. After the merger, there will be 25 + 7.5 = 32.5 shares outstanding, and the per-share value will be $700/32.5 = $21.54.

Notice that the per-share price after the merger is lower under the stock purchase option. The reason has to do with the fact that B's shareholders own stock in the new firm.

It appears that Firm A paid $150 for Firm B. However, it actually paid more than that. When all is said and done, B's stockholders own 7.5 shares of stock in the merged firm. After the merger, each of these shares is worth $21.54. The total value of the consideration received by B's stockholders is thus 7.5 X $21.54 = $161.55.

This $161.55 is the true cost of the acquisition because it is what the sellers actually end up receiving. The NPV of the merger to Firm A is:

We can check this by noting that A started with 25 shares worth $20 each. The gain to A of $38.45 works out to be $38.45/25 = $1.54 per share. The value of the stock has increased to $21.54, as we calculated.

When we compare the cash acquisition to the stock acquisition, we see that the cash acquisition is better in this case, because Firm A gets to keep all of the NPV if it pays in cash. If it pays in stock, Firm B's stockholders share in the NPV by becoming new stockholders in A.

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