What is merger and How merger of companies happen in stock market ?

Mergers and Acquisitions (M&As) is a phrase commonly used to represent either merger or acquisition or both. A merger usually takes place between two or more companies of same size. The main purpose of a merger is to create a new firm with combined shareholder value exceeding the sum of the values of the two companies through synergy. That is possible because the newly formed entity uses the expertise in different areas from both the companies involved in the merger. A merger reduces employees cost, improves market reach and expertise levels.

During merger the stocks of both the companies are surrendered and new shares are issued in place of them. Merger swap ratio decides the number of stocks to be issued to the existing stock holders of both the companies.

Let’s take an example to have the clear understanding on what happens to the stocks of the two companies in question.

 

Company A

Company B

Share price

400

150

Total Number of Shares

52M

76M

Market Capitalization

20800M

11400M

 
The two individual companies A and B get merged into a single entity AB. The new company decides to issue 60 Million shares of the new entity to the existing share holders.

Total market capitalization of both the companies is 20800 + 11400 = Rs 32200 Million.

Both the companies’ percentage of holdings value should be  same before and after the merger.

Company A should have 20800/(20800 + 11400) = 65% ownership (or market cap) after the merger.

Company B should have 11400 /(20800 + 11400) = 35% ownership (or market cap) after the merger.

Number of shares Company A after merger = 60 * 65 /100 = 39 Million shares.

Number of shares Company B after merger = 60 * 35 /100 = 21 Million shares.

Merger swap ratio of Company A = Old shares held by A / Shares of Company A after merger = 52/39 = 4:3

That is for every 4 shares of company A there will be 3 shares of new entity, meaning a share holder who holds 1200 shares of company A before the merger will get 900 (1200 *  3/4) shares after the merger.

Merger swap ratio of Company B = Old shares held by B / Shares of Company B after merger = 76/21 = 3.62:1

A share holder of Company B who holds 362 shares before the merger will get 100 shares after the merger. We will discuss about acquisitions in upcoming post.

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January 24, 2009 | Filed Under Fundamental Analysis 

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