Mergers are a way for companies to access markets, business lines or customers that may be difficult or time-consuming for them to pursue organically. There are two primary ways to finance a merger – through the sale of stock or with cash. When the stock market is stable or rising, public companies often leverage their increased stock value by using their stock to pay for the merger.
A merger is the legal, operational and structural combination of two separate companies. Two companies come together to create one entity, sometimes under a combined name, sometimes under a new name. Mergers are typically strategic and meant to benefit both companies via market expansion or greater purchasing power. Companies usually merge because they believe that the combined entity has more value than the simple addition of one to the other.
Financing a Merger
When one or both companies are publicly-traded, the acquiring company often sells stock to finance the merger. However, instead of finding new buyers for the new stock issuance, the acquiring company uses the stock to compensate the target’s existing shareholders. Using the target company’s valuation as a basis, the acquiring firm issues sufficient stock to the target’s shareholders in exchange for those shareholders surrendering the target’s stock. This action may also be referred to as a stock swap.
Acquiror, Inc. is valued at $500 million and has 10 million shares outstanding, for a share price of $50 each. Target, Inc. agrees to merge with it. After accounting for synergies and cost savings resulting from strategic alignment of the two firms, Acquiror, Inc. agrees to pay $500 million for Target, Inc. This is a 15 percent increase over the market closing price before the deal was announced. Target has 20 million shares outstanding for a per share price of $25. To pay for the transaction, Acquiror, Inc. announces a stock swap and its intent to swap, or replace, two shares in Target, Inc. with one share in Acquiror, Inc.
Acquiror and Target notify all investors of record – owners of the combined 30 million shares outstanding – as of the date the merger is officially sanctioned and approved. The firms send surrender notifications directly to all the institutional investors and indirectly to individual investors through their brokerage firms. Acquiror, Inc. and Target, Inc. also place ads in the Wall Street Journal to induce those who may hold actual certificates in Target, Inc. to mail or turn them in to receive certificates in Acquiror, Inc. The value of the combined entity is now $1 billion, with 20 million shares of Acquiror stock outstanding. All of the Target stock has been retired.