Share Swap Ratio

30 Oct 2019

Recently, seven of the 10 public sector banks slated for merger have invited independent experts to determine their share swap ratios.
The valuer will adopt all market prevalent practices/principles for arriving at the valuation (including principles specified by the Reserve Bank of India and the Ministry of Finance).

Seven Banks

Allahabad Bank, United Bank of India, Oriental Bank of Commerce, Punjab National Bank, Union Bank of India, Canara Bank and Syndicate Bank.

Objective

Improving Investor Sentiment: The share swap ratio that the government would hammer out for the merger of the three public sector banks would go a long way in improving investor sentiment.

Share Swap Ratio

When a company pays for an acquisition by issuing its own shares to the shareholders of the target company, this is known as a share Swap.
The number of shares to be issued in lieu of their existing holdings in the target company is known as Swap Ratio.

Basis of Calculation

To calculate the swap ratio, companies analyze financial ratios such as book value, earnings per share, profits after tax as well as other factors, such as size of company, long-term debts and strategic reasons for the merger or acquisition.
If the target company is listed, the market value of its shares is often a key consideration to arrive at the right price to be paid.

How it Works?

Suppose, if company A is acquiring company B and offers a swap ratio of 1:5, it will issue one share of its own company (company A) for every 5 shares of the company B being acquired.
In other words, if company B has 10 crore outstanding equity shares and 100% of it is being acquired by company A, then company A will issue 2 crore new equity shares of company A to the shareholders of company B, proportionately.

Benefits of Share Swap

Risk Sharing Benefit:

As shareholders of the target company will also be shareholders of the merged entity, the risks and benefits of the expected synergy from the merger will be shared by both the parties.
In a cash deal, if the acquirer has paid a premium and the synergies don’t materialise, shareholders of the acquiring company alone bear the fallout.
Benefits would also flow as a result of wider reach and distribution network, and reduction in distribution costs for the products and services through sub-sidiaries.

Saving of Borrowing Costs:

In a share swap, there is no cash outgo involved for the acquirer, saving the acquirer borrowing costs.
The acquirer companies, in turn, can put their cash to use for investments in the business or for other buyouts.

No Capital Gains Tax:

In case of a share swap, when shareholders of the acquired company are given shares of the acquirer company as part of the deal, this is not considered a transfer of shares.
Hence, capital gains tax will not arise in the hands of the shareholders (including minority shareholders) of the acquired company. The tax liability will arise only when the shares of the merged entity are sold.

Way Forward

Share Swap is not always beneficial to shareholders. For ex- In the recently concluded merger of Bank of Baroda (BoB) with Dena Bank and Vijaya Bank, shareholders of Vijaya Bank and Dena Bank got 402 and 110 equity shares, respectively, of BoB for every 1,000 shares they held, hurting both the shareholders of Vijaya and Dena bank.
The share swap regime also entails certain practical challenges involving shareholders’ rights and governance issues concerning the incoming shareholders. Since both acquirer and target tend to have investors at different stages of lifecycle, friction may arise if incoming shareholders secure the same terms as are available to existing shareholders. Thus, balancing rights of various investors and finding the right leverage becomes crucial.
However, the share swap framework is becoming common as it facilitates acquisitions even when the transaction is unviable due to cash crunch.
A swap ratio also brings to lights many aspects of the Merger and Acquisition (M&A) transaction between two companies. Firstly, it shows the relative size and strength of both companies. In general, if more shares of the target company are exchanged for one share in the acquiring company, then the latter is likely to be bigger and stronger.
Secondly, it determines the control that each set of shareholders has on the combined company. For example, the acquiring company may have greater control over the firm if the swap ratio is high and, therefore, its Board of Directors could have a larger share in the new Board.