What it means
When one company buys another using its own shares instead of cash, the shareholders of the target need to know how many new shares they will receive. The swap ratio answers that.
A ratio of 1.5 means every target share becomes one and a half shares of the buyer. The ratio is built from two numbers: the price per share the buyer is willing to pay for the target, and the buyer's own share price.
Dividing the first by the second gives the ratio. Because both sides own a stake in the combined business afterwards, the ratio also determines how ownership is split.
The ratio can be fixed or floating. With a fixed ratio the number of shares is set in the agreement, so the value delivered to target shareholders rises and falls with the buyer's share price until closing.
With a floating ratio the value is fixed and the number of shares adjusts, which protects the target but exposes the buyer to issuing more shares if its price drops. Analysts watch the swap ratio because it affects earnings per share (profit divided by the number of shares) of the combined company.
Issuing many new shares can dilute existing owners, meaning each share represents a smaller slice of the business. Boards often test whether the deal is accretive, which means earnings per share rise after the deal, or dilutive, which means they fall.
Many agreements add collars, which are limits that stop the ratio moving too far if the buyer's share price swings. Without such protection a sharp fall in the acquirer's shares before closing can transfer a lot of value in a way neither side intended.
For a non-finance reader, the easiest way to see the logic is to think of it as a currency conversion between two sets of shares. The ratio is the exchange rate, and the agreed offer price is the amount being converted.
Lawyers write the ratio into the merger agreement to several decimal places, and it is adjusted for share splits or bonus issues that happen before closing.
In practice
Real-world examples.
Example
A software group offers shares for a smaller rival at $30 per target share while its own shares trade at $60. The swap ratio is 0.5, so a holder of 1,000 target shares receives 500 shares in the buyer.
Example
Two regional banks agree to merge in an all-share deal. The ratio is set at 0.8 buyer shares per target share, and the boards publish a table showing how many shares each investor would hold afterwards.
Example
A retailer buying a food producer fixes the swap ratio at 1.2 in the agreement. When the retailer's share price falls 10% before closing, the deal is worth 10% less to the producer's shareholders, who had accepted a fixed ratio.
Formula
Calculation
Swap ratio = Offer price per target share / Acquirer share price
Suppose a buyer offers $60 for each share of a target, and the buyer's shares trade at $40.
Swap ratio = $60 / $40 = 1.5
If the target has 10,000,000 shares outstanding, the buyer must issue 10,000,000 x 1.5 = 15,000,000 new shares. The total deal value is 10,000,000 x $60 = $600,000,000, which also equals 15,000,000 x $40 = $600,000,000, confirming the figures agree.
If the buyer already has 85,000,000 shares, target owners end up with 15,000,000 / (85,000,000 + 15,000,000) = 15% of the combined company.Case study
Seen in the real world.
Brightwater Foods is an illustrative, fictional listed company that agreed to buy Orchard Lane Beverages in an all-share deal. The two boards settled on an offer of $24 per Orchard Lane share when Brightwater traded at $48, giving a swap ratio of 0.5.
Between signing and closing, Brightwater's share price slipped to $42. Because the ratio was fixed, Orchard Lane shareholders received shares worth only $21 each, and some argued that the deal now undervalued their company.
In the illustrative outcome the boards added a collar for a revised agreement, which adjusted the ratio if Brightwater's price moved outside a set range. The story shows why the ratio is only half the picture, and why the way it behaves while the deal is pending matters.
Watch out
Common mistakes.
- Reading the swap ratio as a statement of value, when it is just a count of shares and its worth depends on the buyer's share price.
- Forgetting that issuing new shares dilutes existing shareholders of the buyer.
- Assuming a fixed ratio protects the target's shareholders, when it fixes the share count and leaves the value exposed to the buyer's price.
Questions
People also ask.
Is swap ratio the same as exchange ratio?
In most deals the two terms mean the same thing and are used interchangeably.
Can the swap ratio be below 1?
Yes, a ratio of 0.5 simply means each target share receives half a buyer share, which happens when the buyer's share price is higher than the offer price.
Why do boards sometimes use a floating ratio?
To give the target shareholders a fixed value, so a fall in the buyer's price does not reduce what they receive.
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