Share Swap 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. For cash-rich companies, share swaps can be a mechanism for hostile takeovers for the target firms, which are attractive because of their profit-making ability and forecasted growth opportunities.
Still, 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, a share swap agreement provides a farfetched mechanism to change risk-averse management with growth-oriented, aggressive, and market-friendly management.
A share swap is a financial transaction where shareholders exchange their existing shares in one company for shares in another entity. This process typically occurs during mergers, acquisitions, or corporate restructurings. Shareholders relinquish ownership in the original company in favor of becoming stakeholders in the acquiring or newly formed entity. The terms of the share swap, including the exchange ratio, are crucial in determining the fair distribution of ownership among the involved parties. The share swap deal has the biggest application in the mergers and acquisitions framework. It helps your assets (equity) buy the target firm using equity as a currency, eliminating any cost of carrying or risk of cash-based transactions.
During mergers and acquisitions, a firm pays for the acquisition of the target firm in the open market by issuing its shares to the target firm's shareholders.
The new shares are issued based on the following vital parameters: a conversion mechanism.
The current market value of the target firm
The current market value of the issuing firm
The premium that the issuing firm wants to give to the target firm's shares based on the growth prospects
A predefined cut-off date as the share price is a dynamic price that changes every moment in the market based on buyers' and sellers' perceptions of the prevailing market price.
Procedure
A share swap agreement can be well-executed through agreement from both parties or even during a hostile takeover. Either way, the points mentioned below are integral parts of the procedure.
Negotiation: Companies involved negotiate the terms of the share swap, including the exchange ratio, which determines how many shares of the acquiring company will be received for each share in the target company.
Due Diligence: Both parties conduct thorough due diligence to assess the financial health, assets, and liabilities of each other.
Announcement: After finalizing the terms, a public announcement is made, disclosing the intention to proceed with a share swap.
Shareholder Approval: Shareholders of both companies must approve the proposed share swap through voting.
Execution: Once approved, the share swap is executed, and shareholders of the target company exchange their shares for shares in the acquiring company.
Listing Changes: If applicable, changes to stock exchange listings and symbols are implemented to reflect the new ownership structure.
Post-Swap Integration: The companies integrate operations, management, and other aspects to realize synergies and enhance overall efficiency.
Examples
Let us understand the practicality of the share swap ratio through the examples below.
Example #1
Let's consider the acquisition of a major IT firm ABC. It has a significant market share in the US but a negligible presence in the European markets. So, the firm is looking for inorganic growth and is considering acquiring XYZ, which has a good market presence in European markets. ABC can use its vast cash reserves to acquire XYZ or get into a share swap deal by offering a deal to its shareholders in the open market.
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 target firm's shareholders. First, they can 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 a ratio of 1:8.
Example #2
UltraTech Cement, India's largest cement manufacturer under the leadership of Kumar Mangalam Birla, has announced its interest in engaging in a share swap deal with Kesoram Industries, the flagship company of the B K Birla group.
The proposed deal involves Kesoram's shareholders receiving shares of UltraTech Cement, a transaction that could result in Kesoram becoming an associate or subsidiary of UltraTech Cement. Following this announcement, UltraTech's stock closed at Rs 8,728 on the BSE, registering a 2.1% increase, while Kesoram experienced a 4.9% uptick in its closing stock value on the same exchange. This strategic share swap is indicative of potential synergies and could lead to a reshaping of the ownership landscape within the cement industry in India.
Advantages
Let us understand the advantages of share swap agreements through the points below.
The Biggest advantage of the share swap is that it limits cash transactions. Even cash-rich companies find it challenging to set aside a large pile of cash to carry out the transactions for mergers and acquisitions. Hence, a no-cash deal mechanism of share swap helps firms eliminate the need to carry out cash-based transactions. It helps them, in turn, save borrowing costs and eliminates any opportunity costs. For cash-strapped firms, it is a boon as it helps them utilize the current market value of their assets to carry out such deals.
Share swap mechanism attracts less tax liability, and the newly formed firm can save itself from regulators' scrutiny who are often watching these deals very closely. Sometimes, the new firm structure is much less tax liable, helping the acquiring firm benefit from low taxes. An essential factor in this regard is that such a deal is only an equity exchange. So technically, regulators can't classify them as tax-liable transactions.
In accounting terms, the firm with its new structure can benefit from the goodwill created. It can benefit from the government policies as it will employ more people now, it can command a better premium from its clients. It can negotiate better with the suppliers because of increased market share.
Disadvantages
Despite the various advantages, there are a few factors of the share swap ratio that prove to be a hassle for companies and shareholders alike. Let us understand the disadvantages through the explanation below.
There is an exchange of equity in share swap – aka cashless transactions when equity exchanges 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 equity exchange, 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 become prone to hostile takeovers and acquisitions.
By helping in hostile takeovers, a share swap can be a nightmare for the target firm's management. They can be acquired anytime if they hold on to their management. Thus, economists often criticize Share swaps for being capitalist friendly swaps 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 eat into each other's market share or lead to discontent among the workforce due to contrasting work cultures. Such a scenario can lead to disastrous results.
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