Research SpotlightFixed vs. Floating Exchange Ratios
When an acquirer chooses to use its stock as currency in an M&A transaction they are faced with a decision on how they are going to present that offer to the target and its shareholders. The acquirer has two basic choices, they can offer either a fixed exchange ratio or a floating exchange ratio. A fixed exchange ratio is a pre-defined amount of acquirer stock for each share of target stock outstanding, such as .5467 acquirer shares for each target share outstanding. A fixed exchange ratio guarantees the target shareholders a certain level of ownership in the acquirer once the transaction completes, but the actual value the target shareholders will receive upon completion of the deal is unknown until the deal completes as it is based on the fluctuating value of the acquirer's stock. A floating exchange ratio is based on a specified dollar amount of stock, but the actual exchange ratio is undetermined until completion. For example, the target shareholders may receive $24 in acquirer stock for each share of target stock outstanding. This guarantees the target shareholders a defined value for their shares, but the actual level of ownership they will have in the acquirer is unknown until completion of the deal as the actual number of shares they will receive is based on the fluctuating price of the acquirer's stock.
Since the height of the M&A market in 2007, the percentage of agreed, all cash transactions involving full acquisitions of US public targets has dropped considerably and the percentage of deals with stock as all or part of the consideration offered has increased proportionally. Given this rise in deals with stock as all or part of the consideration offered, we used MergerMetrics to examine the distribution of fixed and floating exchange ratios based on a number of different factors to see if any trends emerged.
The first area we reviewed was to compare the percentage of deals where fixed and floating exchange ratios were offered in all deals announced versus only those where a definitive agreement was reached to see if there was any significant difference between those two sets of deals. Not surprisingly, the percentage of fixed and floating exchange ratios was about the same, regardless of whether a definitive agreement had been reached. We then examined agreed deals involving full acquisitions of US public targets to see how fixed and floating exchange ratios compared over time. Between 2003 and 2005, the percentage of deals involving fixed and floating exchange ratios stayed relatively constant. In 2006, when the M&A market started to fire on all cylinders, we began to see a decrease in fixed exchange ratios and an increase in floating exchange ratios with the percentage of deals involving floating exchange ratio increasing over 7% between 2005 and 2006. By 2007, when the volume of M&A deals reached its zenith and cash was the preferred consideration offered, and then into 2008, the percentage of floating exchange ratio deals continued to increase as targets wanted to be assured of a specific dollar value of consideration offered, even if they were choosing to accept stock as some or all of the consideration offered in lieu of cash. In 2009, the percentage of floating exchange ratio deals has dropped dramatically and the percentage of fixed exchange ratio deals has increased in response.
We then compared the percentage of deals where fixed and floating exchange ratios were offered based on the size of the deal. The percentage of deals with fixed exchange ratios varied somewhat depending on the deal size, ranging from between 80% to 88% for deals under $1 billion, but increased steadily as the deal size increased above $1 billion and accounted for almost 94% of deals valued over $10 billion. This intuitively makes sense given that deals over $10 bil are frequently transformative for both parties and target shareholders are generally sold on the expected future benefits of the combined company and that the value of the stock they are receiving will increase over time once the expected benefits are realized. Therefore, target shareholders will be more concerned with the amount of ownership they have in the combined entity and will want to assure themselves of having as big a piece of those future benefits as possible. Smaller transactions are frequently bolt-on acquisitions in which target shareholders want to maximize the value they receive when the transaction completes as opposed to relying on the future value of the combined company's stock, which explains the higher percentage of floating exchange ratios for lower valued deals.
The last area we examined was the distribution of fixed and floating exchange ratios relative to the type of stock consideration offered. Fixed exchange ratios accounted for over 90% of deals where stock was the only consideration offered. Deals where a mixture of cash and stock were offered saw a 10% increase in the percentage of deals where a floating exchange ratio was included and choice deals, also referred to as 'cash election' deals because the target shareholders have the choice of selecting to receive either cash or stock, saw a further increase in the percentage of deals where a floating exchange ratio was included relative to stock only deals. Given that cash & stock and choice deals involve target shareholder receiving, or having the option to receive cash, it is not surprising that a significantly higher percentage of these deals would involving a floating exchange ratio where the dollar value of stock to be received is specified from the beginning of the transaction so that target shareholders can easily compare that to the cash component being offered.