In large mergers and acquisitions, the suitor company may offer the buyout company a cash and stock deal. Knowing the difference between the cash portion and the stock portion is important to properly value mergers and acquisitions.
Cash and Stock Deals Allow Companies to Buy Beyond Their Cash Buying Power – For large mergers and acquisitions, many companies do not have enough cash on hand to finance such a large buyout. They can expand their debt to increase the cash deal, but not too much, because they risk being downgraded. By offering the company stock in the suitor company, companies can buy out companies beyond their financing capabilities.
The Stock Portion is Contingent on the Stock Price of the Suitor Company – If the suitor company wants to buyout a company at $100 per share, they may offer $50 in cash and $50 in stock of the suitor company. The cash portion is guaranteed, but the stock portion will fluctuate based on the suitor company’s stock. Usually, the suitor company’s stock drops several percent because it has to “overpay” by 25% or more in order for the board to approve the offer. For example, if the suitor company’s stock drops by 10%, then the stock portion of the offer would only be worth $45 rather than $50. Therefore, the value of the deal dropped from $100 per share to $95 per share.
Cash and Stock Deals Are Generally More Risky Than All Cash Deals – With all cash deals, the bought out stock usually closes just under the buyout price, because cash is a guaranteed amount. The stock portion, however is subject to volatility, making the stock price discounted from the buyout price.