The offer price is the price at which the acquirer is prepared to pay for the stock of the target company. In an all cash deal, this is a straightforward number given as the value per share. Initially, the price per share offered to the target stockholders significant above the current value and represents an acquisition premium to the unaffected target price. This unaffected price then becomes known as the floor price and represents a value void by rumors or stories regarding the takeover.
The acquisition premium is calculated to be sufficiently large to convince the target shareholders to sell their stock to the acquiring firm whilst still leaving enough profitability in the deal for the acquirer to make economic sense. In calculating an offer price, the acquirer will look at a number of valuation methods such as discounted cash flow or Precedent Transaction Analysis. These methods help ensure a fair value is offered. This increases the chance of acceptance from target shareholders, a friendly takeover response from the target board of directors, and also discourages rival bidders.
After the deal announcement is made, the target stock generally trades below this price depending on the level of risk and the deal closing probability (DCP). Depending on the negotiations between the acquirer and the target, it is possible the value of the offer may be increased, especially if the buyout is a hostile takeover. Additionally, if two or more potential acquirers are involved, the contest may result in a bidding war. This may move the offer price beyond all expectations and even possibly be the cause of buyers remorse also known as the winners curse.
Offer Price Calculations
If the deal is structured as a stock swap of stock offer, or is a combination with cash as well, the stock price of the acquirer must be included in the calculation by using the exchange ratio of shares offered. See our article of stock swaps, on how to calculates this dynamic offer price and how traders can profit from the merger arbitrage investment opportunity. Other components such as CVR’s or earn outs may further complicate the calculation of the offer price.
These offer structures can often provide a greater return but at the expense of additional risk. Readers can use of our FREE proprietary merger arbitrage spread calculator to help make these calculations. This tool can also be used in relative value or pairs trading systems.
