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Determination of Exchange Ratio

In mergers and acquisitions (M&A), the share exchange ratio measures the number of shares the acquiring company has to issue for each individual share of the target firm. For M&A deals that include shares as part of the consideration (compensation) for the deal, the share exchange ratio is an important metric. Deals can be all cash, all shares, or a mix of the two.

Formula

Exchange Ratio = Offer Price for the Target’s Shares / Acquirer’s Share Price

Exchange Ratio example

Assume Firm A is the acquirer and Firm B is the target firm. Firm B has 10,000 outstanding shares and is trading at a current price of $17.30 and Firm A is willing to pay a 25% takeover premium. This means the Offer Price for Firm B is $21.63. Firm A is currently trading at $11.75 per share.

To calculate the exchange ratio we take the offer price of $21.63 and divide it by Firm A’s share price of $11.75.

The result is 1.84x. This means Firm A has to issue 1.84 of its own shares for every 1 share of the Target it plans to acquire.

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Importance of the Exchange Ratio

In the event of an all-cash merger transaction, the exchange ratio is not a useful metric. In fact, in this situation, it would be fine to exclude the ratio from the analysis. Often times, M&A valuation models will note the ratio as “0.000” or blank, when it comes to a full cash transaction. Alternatively, the model may display a theoretical exchange ratio, if the same value of the cash transaction were instead to be carried out by a stock transaction.

However, in the event of a 100% stock deal, the exchange ratio becomes a powerful metric. It becomes virtually essential and allows the analyst to view the relative value of the offer between the two firms.

In the event of a split deal, where a portion of the transaction involves cash and a portion involves a stock deal, the percentage of stock involved in the transaction must be considered. Excluding any cash effects, what is the actual exchange ratio based on the stock. Additionally, M&A models may want to also show what this transaction would look like if there was a 100% stock deal.

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