I've two simple, little questions that I hope people here could help me a little with. Its all very theoretical and I'm simply trying to reason it in my head.
Company A and Company B are listed with market cap of US$10m each.
Assume Company A acquires 100% of Company B (consideration being anything, could be cash, debt, stock etc.)
Simplistically, would the market cap of the combined entity be approx. US$20m? I know that of course there are synergies and all sorts of other factors / uncertainties involved, but I would like to know if the combined market cap would be close to US$20m (would that be a relatively reasonable reference point?).
Also assuming you have access to all financials of the 2 stated companies, what is the quickest way for you to come up with a rough estimate of its share price? (Again i know this is dependent on the consideration but would be happy to see responses). I know maybe one way would be that you do a merger model, and carry out a DCF on the merged entity to come up with a valuation but I would like to find out if there are ways to come up with a quick estimation off the top of one's head, and along with it, the reasoning behind some an estimation.
Thank you!
I'll try to address all of your questions, roughly in order.
If Buyer of $10mm market cap and a share price of $10.00 buys Target of $10mm market cap and a share price of $10.00 with cash (either by taking on debt or using cash on hand), market cap on the other side will be $10mm. There is no dilution from shares that are now illiquid. In other words, you don't add Target's share count to the total and we are assuming no share price impact. If stock is issued to buy Target, it is a bit of a wash. In the situation above you are issuing 1 million shares at $10.00, which means you now have 2 million shares at $10.00 - in theory. In practice there is a severe dilution in share price that would result from this many shares being issued and so it's unlikely that share price would stay so high. $20mm is a poor reference point based on the above.
Easiest way to derive share price quickly would be to look at comparable P / E, EV / revenue, EV / EBITDA ratios and back calculate accordingly. This implied share price is what your comps are suggesting as reasonable for your company given the market it plays in
Hi Kaz, thanks for your reply.
In the first instance, you mentioned that market cap of the combined entity will not change, meaning to say, it stays at US$10m? I understand your point on lack of dilution and you appear to be discussing from a purely mathematical point of view.
What I am asking is this - how is it possible that the market cap of a combined entity of 2 companies previously with a market cap of US$10m be still at US$10m? Wouldn't investors recognise that the combined entity is double and subsequently price it such that the combined entity has a market cap of somewhere near US$20m? Let's disregard synergies, accretion/dilution of EPS affecting share price etc. for this discussion.
Thank you and I do appreciate your help!
Market capitalization is usually way above book capitalization and reflects a lot of things other than just a merger. You could say that rather than making an immediate change in market cap there will be a longer term change. A good example of this in practice is Live Nation (LYV), who bought Ticketmaster in February 2009. Pre-announcement, they traded at $5.29 a share with about 78mm shares, and it was an 1.3 to 1 all-stock purchase. Their share price halved to $2.67 after the announcement but the dilution had not yet taken place - in other words, market cap actually decreased substantially.
When the deal closed, in January 2010, LYV had roughly 172mm shares but price was now $11.47 a share - obviously this is a real world situation so there are other factors but market cap went from:
$5.29 * 78 = $410mm (roughly) $2.67 * 78 = $210mm (roughly) $11.47 * 172 = $1970mm (roughly)
In our theoretical example above we are basically assuming that the deal is announced and closes on the same day. In this case, we can usually say that market cap remains largely unchanged, and is dependent on the severity of the directional changes (how much lower does share price go for Buyer / how many shares are issued).
Thank you for your contribution, I sincerely appreciate it.
Could you clarify on the market cap of each entity you used in the example before the merger?
Also, I understand where you are coming from. Its just that perhaps my question was not clear enough. Let me try again - would the theoretical market cap of a combined entity be U$20m if it is a merger between two companies which has a market cap of US$10m each?
$410mm was LYV's market cap pre-merger $425mm was TKTM's market cap pre-merger
Post-merger, the market factored in share price dilution before share count had increased, so LYV's market cap dropped to about $210mm. The merger closed about a year later and market cap of this "combined company" was well above the $835 sum, meaning other factors were in play.
To answer your above question: $10mm market cap Buyer purchases $10mm market cap Target and Day 1 should have a market cap of $10mm. The equity of the target has no bearing on the immediate change in market cap. Over time you would expect that the market would price in this $10mm increase in market cap.
Thanks for this, I do not understand the monkey shits you are getting at all lol.
On your last statement, are you implying that yes perhaps the market could price in this increase such that the total market cap of the combined entity could converge to US$20m? Of course assuming no other influences in place.
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