What is Acquisition or Takeover of a Company ?

In an acquisition the acquiring company buys controlling stake in the acquired company. The acquired company is also referred to as ‘Target Company’. There are two types of acquisitions; Friendly acquisitions and Hostile acquisitions. 

In a friendly acquisition the target company is formally informed about the acquisition and there is an agreement on corporate management and finance control. In a hostile take over the target company does not find it favorable that a majority of its shares are bought by the acquiring entity. In a hostile take over the acquiring company keeps on increasing its stake in the target company by buying the shares from institutional investors or through normal stock exchange transactions.

There are two ways in which the acquiring company can deal with the shares of the acquired company (In friendly takeover). Investment banks play a major role in ‘Mergers and Acquisitions’. Goldman Sachs is a specialist banker in this segment of banking. First method is Cash for stock: In this method the acquiring company pays all the shared holders at an agreed price and on a predetermined date.

Second method is Stock for Stock: In this the target company shared holders get shares of acquiring company in proportion to the predetermined exchange ratio.

Let’s take an example.

 

Company A

Company B

Share price

400

15

Total Number of Shares

100M

60M

Market Capitalization

40000M

900M

In the above example Company A is the acquiring Company and Company B is the acquired Company or Target Company. Consider A is buying all the shares of B and the offer price is Rs20 (greater than Rs15). In most of the cases offer price is greater than the target company’s market price so that the target company agrees to sell it.

Exchange Ratio = Offer price / market value of acquiring company

                          = 20/400
                          = 1:20

So the company A has to issue an additional shares of  3 Million shares (60/20) to share holders of B. An investor who holds 100 shares of company B will get 5 shares of A.

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January 24, 2009 | Filed Under Stock market Terminology 

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