All you wanted to know about share swap

Last week, Hindustan Unilever (HUL) announced the merger of Glaxo SmithKline Consumer (GSK Consumer) with it, in a deal valuing the latter at ₹31,700 crore. The deal has been structured as a share swap, with shareholders of GSK Consumer being eligible to exchange each one of their shares for 4.39 shares in HUL on a decided record date.

When a company pays for an acquisition by issuing its own shares to the shareholders of the target company, this is known as a share swap. The number of shares to be issued in lieu of their existing holdings in the target company — called the swap ratio — is determined by valuing the target company after looking into metrics such as its revenues and profits, as well as its market price. If the target company is listed, the market value of its shares is often a key consideration to arrive at the right price to be paid. Paying a premium to the market usually indicates healthy prospects and high potential, while a discount could indicate a distress sale.

The HUL-GSK Consumer deal is not the only one in recent times to be structured as a share swap.

A share swap has its advantages. As shareholders of the target company will also be shareholders of the merged entity, the risks and benefits of the expected synergy from the merger will be shared by both the parties. In a cash deal, if the acquirer has paid a premium and the synergies don’t materialise, shareholders of the acquiring company alone bear the fallout.

In a share swap, there is no cash outgo involved for the acquirer, saving the acquirer borrowing costs. Cash rich companies can put their cash to use for investments in the business or for other buyouts. On the flip side, issuing fresh shares could lead to reduction in promoter holding and dilution in earnings for shareholders of the acquiring company. However, the acquiring company can benefit from lower taxes, if there is goodwill created out of the merger which it writes off over the years. Goodwill arises when the acquisition price is higher than the value of assets and liabilities of the acquired company.

If you are a shareholder in any of the companies that is part of such mergers or acquisitions, you then need to take a fresh look at the prospects of the stocks after the swap is announced. Take the HUL-GSK Consumer merger for instance. In this case, HUL is paying close to the market price of the GSK Consumer stock after consumer goods stocks have had a good run in the market. With a diversified product portfolio and market leadership in several categories, HUL has good long-term prospects too. Hence, GSK Consumer shareholders have got a fair deal.

Although HUL has perhaps paid top dollar for GSK Consumer, HUL investors can take comfort in the fact that the consideration is being paid, not in cash, but in highly priced HUL shares. The acquisition will immediately add to the EPS despite the equity dilution of about 8 per cent from the share swap.

Generally, these transactions take about a year to complete, needing the approval of creditors, stock exchanges, shareholders, Competition Commission and National Company Law Tribunal. The tax aspect also needs your attention. In case of a share swap, when shareholders of the acquired company are given shares of the acquirer company as part of the deal, this is not considered a transfer of shares. Hence, capital gains tax will not arise in the hands of the shareholders (including minority shareholders) of the acquired company. The tax liability will arise only when the shares of the merged entity are sold.

Acquisitions are dicey, but share swaps sweeten the deal.

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