Cash vs. Stock Acquisition

Source: Thomson Reuters

Cash vs. Stock Consideration in M&A

In acquisitions, buyers usually pay the seller with cold, hard cash.

However, the buyer can also offer the seller acquirer stock as a form of consideration. According to Thomson Reuters, 33.3% of deals in the second half of 2016 used acquirer stock as a component of the consideration.

For example, when Microsoft and Salesforce were offering competing bids to acquire LinkedIn in 2016, both contemplated funding a portion of the deal with stock (“paper”). LinkedIn ultimately negotiated an all-cash deal with Microsoft in June 2016.

Why Pay with Acquirer Stock?

• For the acquirer, the main benefit of paying with stock is that it preserves cash. For buyers without a lot of cash on hand, paying with acquirer stock avoids the need to borrow in order to fund the deal.
• For the seller, a stock deal makes it possible to share in the future growth of the business and enables the seller to potentially defer the payment of tax on gain associated with the sale.

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Risk and Reward

In cash deals, the seller has cashed out. Barring some sort of “earn out,” what happens to the combined company – whether it achieves the synergies it hoped, whether it grows as expected, etc. — is no longer too relevant or important to the seller. In deals funded at least partially with stock, target shareholders do share in the risk and reward of the post-acquisition company. In addition, changes in acquirer stock-price fluctuations between deal announcement and close may materially impact the seller’s total consideration (more on this below).

Control

In stock deals, sellers transition from full owners who exercise complete control over their business to minority owners of the combined entity. Decisions affecting the value of the business are now often in the hands of the acquirer.

Financing

Acquirers who pay with cash must either use their own cash balances or borrow money. Cash-rich companies like Microsoft, Google and Apple don’t have to borrow to affect large deals, but most companies do require external financing. In this case, acquirers must consider the impact on their cost of capital, capital structure, credit ratios and credit ratings.

Tax

While tax issues can get tricky, the big-picture difference between cash and stock deals is that when a seller receives cash, this is immediately taxable (i.e. the seller must pay at least one level of tax on the gain). Meanwhile, if a portion of the deal is with acquirer stock, the seller can often defer paying tax. This is probably the largest tax issue to consider and as we’ll see shortly, these implications play prominently in the deal negotiations. Of course, the decision to pay with cash vs. stock also carries other sometimes significant legal, tax, and accounting implications.

Let’s take a look at a 2017 deal that will be partially funded with acquirer stock: CVS’s acquisition of Aetna. Per the CVS merger announcement press release:

Aetna shareholders will receive $145.00 per share in cash and 0.8378 CVS Health shares for each Aetna share.

CVS/AETNA merger announcement press release

Fixed Exchange Ratio Structure Adds to Seller Risk

In the CVS/AETNA deal consideration described above, notice that each AETNA shareholder receives 0.8378 CVS shares in addition to cash in exchange for one AETNA share. The 0.8378 is called the exchange ratio.

A key facet of stock deal negotiation is whether the exchange ratio will be fixed or floating. Press releases usually address this as well, and CVS’s press release is no exception:

The transaction values Aetna at approximately $207 per share or approximately $69 billion [Based on (CVS’) 5-day Volume Weighted Average Price ending December 1, 2017 of $74.21 per share… Upon closing of the transaction, Aetna shareholders will own approximately 22% of the combined company and CVS Health shareholders will own approximately 78%.

While more digging into the merger agreement is needed to confirm this, the press release language above essentially indicates that the deal was structured as a fixed exchange ratio. This means that no matter what happens to the CVS share price between the announcement date and the closing date, the exchange ratio will stay at 0.8378. If you’re an AETNA shareholder, the first thing you should be wondering when you hear this is “What happens if CVS share prices tank between now and closing?”

That’s because the implication of the fixed exchange ratio structure is that the total deal value isn’t actually defined until closing, and is dependent on CVS share price at closing. Note how the deal value of $69 billion quoted above is described as “approximately” and is based on the CVS share price during the week leading up to the deal closing (which will be several months from the merger announcement). This structure isn’t always the case — sometimes the exchange ratio floats to ensure a fixed transaction value.

Learn More → Investment Banking Primer

Strategic vs. Financial Buyers in M&A

It should be noted that the cash vs. stock decision is only relevant to “strategic buyers.”

• Strategic Buyer: A “strategic buyer” refers to a company that operates in or is looking to get into, the same industry as the target it seeks to acquire.
• Financial Buyer: “Financial buyers,” on the other hand, refer to private equity investors (“sponsor backed” or “financial buyers”) who typically pay with cash (which they finance by putting in their own capital and borrowing from banks).