Finding the Win-Win Deal
P.V. Viswanath
Class Notes for FIN 648: Mergers and Acquisitions
Framework
 In a stock-for-stock deal, the exchange ratio is the number of
buyer shares per target share.
 In a cash deal, the cash exchange ratio is the number of
dollars exchanged per target share.
 To determine the “correct” ratio in a cash deal, compare the
cash payment to the intrinsic value of the asset.
 In principle, the rule is the same in the stock deal as well;
however, in this case, both buyer and target shares have to
be valued.
 The greater the synergy, the greater the possibility for a winwin deal.
 This analysis provides the data needed for negotation
between buyer and target.
P.V. Viswanath
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Terms
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ER= exchange ratio: buyer shares per target share.
ER1= max acceptable exchange ratio for buyer.
ER2= max acceptable exchange ratio for seller.
P1= buyer’s price before transaction
P2= target’s price before transaction
P1= buyer’s shares outstanding before transaction
P2= target’s shares outstanding before transaction
P12= price of combined company
DCF12= discounted cashflow value of combined company
P.V. Viswanath
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Max/Min Acceptable Exch Ratios - DCF
 Share-for-Share Exchange
 Buyers’ Maximum Acceptable Exch Ratio
 P12  P1
DCF12
P12 
 P1
S1  S 2 ( ER1 )
DCF12  P1S1
ER1 
P1S 2
 Seller’s Min Acceptable Exch Ratio
P2 S1
 P12ER2  P2
ER 
2
P.V. Viswanath
DCF12  P2 S 2
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Share-for-Share Exchange
P1
P2
S1
S2
60
40
100
100
Exchange Ratio
Win-Loss Boundaries: DCF Analysis
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
II. Target Wins,
Buyer Loses
III. Both
Lose
I. Both Win
IV. Buyer Wins
Target Loses
$7,000
$9,000
P.V. Viswanath
$11,000
$13,000
DCF Value of "New co"
Buyer's Maximum ER
Target's Minimum ER
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Max/Min Acceptable Exch Ratios (DCF)
 Cash-for-Share Exchange
 Buyers’ Maximum Acceptable Exch Ratio
 P12  P1
DCF12  Cash
P12 
 P1
S1
DCF12  P1S1
ER1 
S2
 For the seller, the minimum acceptable exch ratio is
simply P2, the price of the target prior to the
acquisition.
P.V. Viswanath
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Cash-for-Share Exchange
Win-Loss Boundaries: DCF Analysis
60
40
100
100
80.00
Exchange Ratio
P1
P2
S1
S2
70.00
II. Buyer Loses,
Target Wins
60.00
I. Both Win
50.00
40.00
30.00
IV. Buyer Wins
Target Loses
III. Both
Lose
20.00
$7,000
$9,000
$11,000
DCF Value of "New co"
$13,000
Buyer's Maximum ER
Target's Minimum ER
P.V. Viswanath
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Max/Min Acceptable Exch Ratios (P/E)
 Share-for-Share Exchange (P/E Model)
 Need to estimate PE12 (corresponds to DCF
estimation in previous analysis).
 Buyer’s Maximum Acceptable Exchange Ratio
 P12  P1
 P12 = (PE12)(EPS12)
 EPS12 = (E1+E2+Esynergies)/(S1+S2ER1)
S1 E1  E 2  E synergies
ER1  

.PE12
S2
P1 S 2
P.V. Viswanath
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Max/Min Acceptable Exch Ratios (P/E)
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Share-for-Share Exchange
Seller’s Maximum Acceptable Exchange Ratio
P12ER2  P2
P12 = (PE12)(EPS12)
EPS12 = (E1+E2+Esynergies)/(S1+S2ER1)
P2 S1
ER2 
( PE12 )( E1  E2  Esynergies )  P2 S2
P.V. Viswanath
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Choosing a ratio in the Win-Win Zone
 Bargaining Power
 Control Premium in comparable transactions
 Focal points based on relative contribution of the
two firms.
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Keep relative pre-merger share prices of target and buyer
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ER = Ptarget/Pbuyer
Some contribution indicators are:
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Operating profits, assets, unit sales, revenues, no. of employees
If C = contribution % of buyer:
S
Buyer
ER 
P.V. Viswanath
C
 S Buyer
S T arg et
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