A swap ratio is a rate that an acquiring company will offer its own shares in exchange for the target company’s shares during a merger or acquisition. Of course, M&A transactions don’t only have to be conducted with a cash purchase of the target company’s equity shares. Instead, the acquiring company can pay cash outright, convert the target company’s stock to its own or use a mixture of cash and stock. In order to convert stock of one company to that of another company, however, both companies need to agree on a particular exchange rate: the swap ratio.
Since there’s no precise formula for calculating the swap ratio in every situation, a great deal of work and thought goes into determining the swap ratio before carrying out the M&A transaction.
In order to calculate the swap ratio, there are certain financial ratios of the companies that are analysed in the share swap ratio formula. This includes profits after tax, earnings per share, book value, and other factors like company size, strategic reasons for acquisition or merger, and long-term debts. The share market value is considered a key factor when the target company is listed. The final swap ratio may also take into account factors such as the size of the companies and the target company’s long-term debts, as well as subjective aspects such as the companies’ reasoning for the M&A transaction.
The exchange ratio only exists in deals that are paid for in stock or a mix of stock and cash as opposed to just cash.
The calculation for the exchange ratio is:
Exchange Ratio = Target Share Price / Acquirer Share Price?
The target share price is the price offered for the target shares. Because both share prices can change from the time the initial numbers are drafted to when the deal closes, the exchange ratio is usually structured as a fixed exchange ratio or a floating exchange ratio.
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.