Share Swap

Share Swap Meaning

Share Swap is that it is a mechanism by which one equity-based asset is exchanged with another equity-based asset based on an exchange ratio under the circumstances of mergers, acquisitions, or takeovers.

How does Share Swap work?

During mergers and acquisitions, a firm pays for the acquisition of the target firm in the open market by issuing its shares to the shareholders of the target firm.

The new shares are issued based on a conversion mechanism based on the following vital parameters.

  1. The current market value of the target firm
  2. The current market value of the issuing firm
  3. The premium that the issuing firm wants to give to the target firm’s shares based on the growth prospects
  4. A predefined cut off date as the share price is a dynamic price that changes every moment in the market based on buyers’ and seller’s perception of the prevailing market price.

Share Swap Deal Example

Let’s consider the acquisitionAcquisitionAn acquisition is defined as the act of taking over or gaining control of all or most of another entity's stocks by purchasing at least fifty percent of the target company's stock and other corporate assets. read more of a major IT firm ABC. It has a significant market share in the US but a negligible presence in the European markets. The firm looks for inorganic growth and considers acquiring the firm XYZ, which has a good market presence in European markets. ABC can use its vast cash reserves to acquire XYZ or can get into a share swap deal by offering a deal to its shareholders in the open market.

Share Swap

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But before finalizing the deal, the firm has to take care of specific parameters like current market value, current share price, and the cut-off date. Consider the following data. All prices are in pounds.

  • Cut Off Date: 1-Aug-2019
  • Current Share Price (XYZ): 100
  • Current Share Price (ABC): 1,000
  • Total Market Value (XYZ) : 1,000,000
  • Total Outstanding Shares: 10,000
  • Share Value Offered: 125
  • Total Value of the Deal: 1,250,000
  • Premium Charged: 250,000
  • Premium Calculated per Share: 25
  • Share Swap: 8

As mentioned earlier, the firm has two options for the shareholders of the target firm. They can either shed their shares in the open market for $125 at a premium of $25. The second option is that the shareholders can swap their shares in the ratio of 1:8.

Advantages

Disadvantages

  • There is an exchange of equity in share swap – aka cashless transactions. When equity exchange hands, promotors, owners, or large shareholders might have to dilute their holding, leading to dilution of power in the newly formed entity structure.
  • Due to the exchange of equity, the stakeholders have less hold on the company. It could lead to fewer profits for the shareholders. For management, it can lead to more delays in executing decisions as there are new parties whose consent has become all the more important now. In fact, in specific scenarios, the newly formed firm structure can itself become prone to hostile takeovers and acquisitions.

Limitations

  • By helping in hostile takeovers, a share swap can be a nightmare for the management of the target firm. They can be acquired anytime if they hold on to the firm’s management. Thus, economists often criticize share swap for being capitalist friendly and favoring the rich.
  • Share swap has an inherent synergy risk. What if the newly created entity is too big to sustain or eating into each other’s market share or leading to discontent among the workforce due to contrasting work cultures. Such a scenario can lead to disastrous results.

Important points to note

Conclusion

For cash-rich companies, share swap can be a mechanism for hostile takeovers for the target firms, which are attractive because of their profit-making ability and forecasted growth opportunities, but their management is not keen on expanding the business. Shareholders of such firms will be more than interested in selling their shares to the buyer firm in the open market. Thus, share swap provides a farfetched mechanism to change the risk-averse management with growth-oriented, aggressive, and market-friendly management.

This article has been a guide to what is share swap and its meaning. Here we discuss how does a share swap deal works along with examples, advantages, and limitations. You can learn more about M&A from the following articles –

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