Two companies merge, what is the resulting market cap?
I got the following question in my interview and I'm stumped trying to think of the correct answer.
If two companies A and B with market cap 1bn merge, what is the resulting market cap if company B's shares are valued at a 50% premium?
I was thinking along the lines of, if it's an all cash/debt, shares outstanding would be the same x share price so market cap wouldn't change (depending on market reaction). If it's a stock deal then it would be (acquirer's shares outstanding plus + (offer price/acquirer share price)*1.5bn) x acquirer's share price.
However that seems quite vague and it seemed the interviewer was looking for a concrete answer so I think I may be completely wrong.
Your logic seems right to me, in the stock deal it should simply be number of new shares issued (target+acq.)*acq. share price = market cap. The premium will only be useful in calculating the new shares issued (again assuming if it is a stock deal).
Don't over think it, interview is over now. I hope you hear good news!
If that's all the info you were given it's a pretty open-ended question but simple as long as you make the right assumptions.
I think the best way to look at it is to start with the change in Company A's Enterprise Value. TEV should increase by the standalone value of Company B plus the value of synergies between A&B. Let's say it is reasonable to assume that the 50% premium paid by Company A in the transaction correctly values the synergies, and thus TEV increases by $1B * (100% + 50%) = $1.5 billion
The change in equity value (market cap) is then determined by how the deal was financed. Given that this is a merger of roughly equals, it seems likely that it was equity financed or via a combination of debt and equity. Assume for simplicity it is all equity financed. Since there is no change in debt, and we'll assume for simplicity excess cash/assets aren't a factor in the above TEV, the change in equity market cap must be +$1.5 billion. Thus the resulting market cap is $2.5 billion.
So it's actually pretty simple if you make that set of assumptions. The key assumption is whether the value of the synergies is correctly and exactly forecasted by the premium paid for Company B's shares. Let's say there are in reality no synergies. If it's an all equity transaction, market cap is $2 billion, but Company A's shareholders only hold 1/2.5 = 40%*** of the company [$800M], given that they overpaid Company B's shareholders [who now have shares worth $1.2B]. Despite the overpayment, total value remains the same as pre-transaction, it is only redistributed between the parties. If the transaction were partly financed by cash, however, then value actually leaves the system and equity value would actually be $2 billion, less than the initial combined market cap.
**This assumes Company B accepts the offer assuming the shares are worth the pre-transaction price. Let's say Company A has 100M shares at $10 each. They offer Company B 150M shares, valued at $1.5B pre-transaction and $2.5B(1.5/2.5) = $1.5B post-transaction if the market values synergies at $500M. But in effect Company B's shareholders only receive the $1.2 billion if the synergies don't materialize. Thus if they know the deal overvalues the company, they'd rather receive some or all cash payment.
You don't pay a premium because of synergies. The premium is for control / private benefits. Public share price represents value of non controlling stake (ie less pv of private benefits)
You could be willing to pay a premium to the public market cap for a variety of reasons, and synergies are certainly one of them. Value of control is another reason.
1+1=2 billion. B=1B and trades at a 50% premium afterwards. 1+1.5= 2.5
@"Extelleron"
From your answer above, what you are saying is that if more cash is used the equity value of the combined company will decrease? I ran through a sample cash and equity transaction and in both the equity value remains the same. how does using a combination decrease it?
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