Exchange Ratio or Purchase Price: What Each One Fixes

A purchase price is a sum of money agreed for a business. An exchange ratio counts how many of the buyer's shares go across for every one of the seller's, so it settles a share of the combined business rather than an amount. A price is finished on the day it is paid. A ratio keeps moving in value with the buyer's share price until the shares are issued.

What is a purchase price, and what does agreeing one settle?

Start away from transactions altogether. A woman who has run a wedding catering business for twenty years agrees to sell it to the caterer two streets away for a fixed sum. On the day the money moves, she is out. Whatever the kitchens go on to earn, whatever the new schedule of orders looks like next winter, none of it reaches her. She swapped a business for an amount, and the swap is complete.

A purchase priceThe amount of money agreed for a business, expressed as a sum in a stated currency, payable on a stated day. does the whole of that and nothing more. A price is an amount, in a currency, on a date. The price carries one obligation, that the buyer has to find the money, and one silence: a price says nothing about who holds the buyer afterwards.

Put the recorded transaction underneath it. Harivansh Packaging Limited is buying the whole of Sundarban Polymers Private Limited. The enterprise value agreed is Rs 1,320 crore, or 10.0 times the target's earnings before interest, tax, depreciation and amortisation (EBITDA) of Rs 132 crore. Rs 1,320 crore is not the price. Run the bridge: Rs 1,320 crore less Sundarban Polymers' own net debt of Rs 180 crore leaves an equity value of Rs 1,140 crore, and Rs 1,140 crore is the sum that actually reaches the sellers. The price on this transaction is Rs 1,140 crore, and every per share figure that follows is struck on that number rather than on the Rs 1,320 crore that a headline is more likely to carry.

Agreeing that amount immediately creates a second problem. The Rs 1,140 crore has to come from somewhere. Harivansh Packaging funds it with Rs 140 crore of its own cash and Rs 1,000 crore of new borrowing at the company's own contracted rate of 9.0 per cent. The borrowing costs Rs 90 crore of interest a year, and at an effective tax rate of 25.0 per cent that is Rs 67.5 crore after tax. The considerationWhat the buyer actually hands over: cash, its own shares, deferred amounts, or a combination. The form is a separate question from the amount. here is cash and nothing but cash, so the funding question and the price question arrive together.

Now notice what did not happen. Harivansh Packaging still has 18.00 crore shares. The promoter and promoter group still hold 58.0 per cent of them. The people who held shares in the buyer the day before the announcement hold exactly the same fraction of the buyer the day after completion. A cash price leaves the register exactly as it found it. The whole of the risk that the purchase disappoints therefore stays with the holders who were already there. Nobody new has been let in to share it.

What is an exchange ratio, and what does agreeing one settle instead?

Two brothers each run a tea stall. One stall is bigger. Instead of one buying the other for money that neither has, they agree to put the two together and to split the combined thing two parts to one. Nothing was paid. No sum was named. The brothers agreed a proportion, and the proportion is the deal.

An exchange ratioThe number of the buyer's shares handed over for each one share of the seller's. It fixes a proportion of the combined register rather than an amount of money. is that agreement written in shares. The ratio is the number of the buyer's shares handed over for each single share of the seller's. Multiplying the ratio by the seller's share count gives the number of new shares the buyer issues. Adding those to the buyer's existing count gives the register of the combined business, and the sellers' slice of it. A ratio does not settle an amount at all; it settles what fraction of everything that follows each side is going to hold.

The consequence is the mirror image of the cash one, and it is worth stating slowly because it is the reason boards argue about this. When the sellers walk away with shares in the buyer, they have not left. The sellers are inside the combined business. If the purchase disappoints, part of that disappointment now lands on them. If it goes better than anybody expected, part of that lands on them too. The buyer's existing holders carry proportionately less of both.

There is a second property of a ratio that catches people out, and it follows from the same one line of definition. A ratio fixes a number of shares. A ratio does not fix what those shares are worth. Suppose, purely as a construction on these figures, that Harivansh Packaging had settled the same Rs 1,140 crore by issuing shares at its illustrative price of Rs 300/-. The issue is 3.80 crore shares. At Rs 300/- those shares are worth Rs 1,140 crore. At Rs 270/- they are worth Rs 1,026 crore. At Rs 330/- they are worth Rs 1,254 crore. The agreement did not change. The count did not change. Under a ratio, the value of what the sellers receive is decided by the market on a day nobody controls. A cash price can never do that.

Where do the two differ, once both of them are defined?

Both sides are now on the table, so they can be set against each other honestly. A price is an amount. A ratio is a proportion. Everything else in the grid below is a consequence of that single difference, and it is worth reading the rows as consequences rather than as a list of unrelated facts.

Take them in turn. Because a price is an amount, the sellers receive money and are finished; because a ratio is a proportion, the sellers receive shares and continue. Because a price is an amount, the buyer must find the money and the count of its shares does not move; because a ratio is a proportion, no money is found and the count moves by exactly the shares issued. Because a price is an amount, the value of what the sellers get is settled the moment the money lands; because a ratio is a proportion, the value of what they get is not settled until the shares are actually issued.

There is only one difference between a purchase price and an exchange ratio, and it is that one fixes a quantity of money while the other fixes a quantity of shares; every other line of the comparison is that difference showing up somewhere else. A reader who holds onto that will never have to memorise the grid.

Why does the same price give opposite answers on earnings per share?

Here is the part that surprises people the first time they see it, and it is worth building slowly because a lot of published reasoning gets it wrong.

Take the recorded transaction first. The transaction is settled in cash. Harivansh Packaging earns profit after tax of Rs 225 crore. Sundarban Polymers brings Rs 61 crore of its own. Against that, the Rs 1,000 crore of new borrowing costs Rs 90 crore of interest, or Rs 67.5 crore after tax at 25.0 per cent. Combined profit after tax is Rs 225 crore plus Rs 61 crore less Rs 67.5 crore, or Rs 218.5 crore. Divide by an unchanged 18.00 crore shares and earnings per share is Rs 12.14/-, down from Rs 12.50/-. The fall is a dilutionA fall in a per share figure after a transaction, compared with the same figure before it. Here it is earnings per share that falls. of 2.9 per cent.

One honest note on that figure before going on. The rounding does real work later. Sundarban Polymers' profit after tax computes to Rs 61.35 crore, not Rs 61 crore: earnings before interest and tax (EBIT) of Rs 98 crore less Rs 16.2 crore of interest on its own borrowings gives Rs 81.8 crore, and at 25.0 per cent tax that is Rs 61.35 crore. Rs 61 crore is the rounded value this sequence uses everywhere, and it is what reproduces Rs 12.14/- and 2.9 per cent. On the exact Rs 61.35 crore the chain gives Rs 218.85 crore, Rs 12.16/- and 2.7 per cent. The transaction is dilutive on either figure, so the rounding changes the size of the headline and never the direction of it, and nothing in the arithmetic turns on the last decimal.

Now build the constructed alternative. Suppose the identical Rs 1,140 crore had been settled in shares instead. At the illustrative Rs 300/-, that is 3.80 crore new shares, taking the count from 18.00 crore to 21.80 crore. No borrowing, so no interest, so nothing is deducted. Combined profit after tax is Rs 225 crore plus Rs 61 crore, or Rs 286 crore. Divide by 21.80 crore and earnings per share is Rs 13.12/-, up about 5.0 per cent. The rise is accretionA rise in a per share figure after a transaction, compared with the same figure before it. The opposite of dilution.. Label it clearly every time: Harivansh Packaging Limited did not do this. The share route here is a construction on the recorded figures, put beside the recorded transaction so the two can be read together.

Same price. Same business bought. Same multiple paid. Opposite answer. Nothing about the target changed between those two columns. The sign of the earnings per share effect was never a fact about the target at all.

Three numbers, one base, and why the base is the whole trick

The reason for the reversal is one line of arithmetic, and it only reads if every number in it sits on the same base. The base is the Rs 1,140 crore paid.

The business bought earns Rs 61 crore. On Rs 1,140 crore that is an earnings yieldProfit expressed as a percentage of the amount paid for it. It is the reciprocal of a price to earnings multiple. of 5.35 per cent. The 5.35 per cent is the return the purchase delivers before anything is deducted for how it was paid for.

Funding it with debt costs Rs 67.5 crore after tax. On the same Rs 1,140 crore that is 5.92 per cent. The 5.92 per cent is the after-tax cost of debtThe interest on borrowed money after allowing for the tax deduction the interest attracts. Here Rs 90 crore of interest costs Rs 67.5 crore after tax at 25.0 per cent. restated as a rate on the amount paid rather than on the amount borrowed. Rs 67.5 crore is more than Rs 61 crore, so the cash route loses Rs 6.5 crore of profit. Over an unchanged 18.00 crore shares that loss is Rs 0.36/-, and it takes Rs 12.50/- to Rs 12.14/-.

Funding it with shares costs 3.80 crore shares multiplied by the buyer's own Rs 12.50/-, or Rs 47.5 crore of the buyer's existing earnings now shared with somebody else. On the same Rs 1,140 crore that is 4.17 per cent, and 4.17 per cent is precisely Harivansh Packaging's own earnings yield at Rs 300/- and 24.0 times earnings, arriving by another route. Rs 47.5 crore is less than Rs 61 crore, so the share route gains Rs 13.5 crore. Over the enlarged 21.80 crore shares that gain is Rs 0.62/-, and it takes Rs 12.50/- to Rs 13.12/-.

The ordering of 4.17, 5.35 and 5.92 per cent is the entire result, and it is only readable because all three are struck on the same Rs 1,140 crore. Set what the purchase earns on Rs 1,140 crore against what the interest costs on the Rs 1,000 crore actually borrowed and the two numbers are not comparable at all. The comparison gives 6.75 per cent, a rate struck on a different base, and it cannot reproduce Rs 12.14/-. A spread presented without a statement of what each of its two halves is divided by is a decoration.

The same three numbers turned upside down

There is a second way to say the identical thing, and some readers find it lands harder. Divide the Rs 1,140 crore paid by each of the three earnings figures instead of the other way round. The business being bought costs 18.69 times its earnings. The debt used to buy it is effectively priced at 16.89 times. The buyer's own shares are priced at 24.0 times, simply its market multiple as of the illustrative date on which Rs 300/- was struck.

Read across. Paper priced at 24.0 times is dearer than a business acquired at 18.69 times, so paying with paper leaves the buyer ahead. Money priced at 16.89 times is cheaper than that same business, so paying with money leaves the buyer behind. Whether a purchase lifts or lowers earnings per share is a comparison between the multiple of what is bought and the multiple of what is handed over, and neither half of that comparison is a statement about how good the business is.

What does the multiple comparison settle, and what does it not?

The sentence that gets written most often about this transaction is true: Harivansh Packaging is paying 10.0 times EBITDA for Sundarban Polymers while its own shares change hands at 12.58 times enterprise value to EBITDA, on the illustrative Rs 300/- struck for this sequence. Buying something at a lower multiple than the one attached to the buyer's own business is a real observation about relative pricing, and it is worth making.

Here is the sentence that gets written next, and it does not follow: therefore earnings per share must rise. The conclusion does not follow. The multiple comparison and the earnings per share question are asking about different things. The multiple comparison asks what the purchase costs relative to the buyer's own valuation. The earnings per share question asks what the money used to pay for it costs relative to what the purchase earns. The two questions have two different denominators, and this transaction is the clean demonstration that they can point in opposite directions on the same day about the same deal.

The two multiples in the comparison are not even the same kind of multiple. The 10.0 times is enterprise value over the target's EBITDA. The 12.58 times is enterprise value over the buyer's EBITDA. Both are enterprise level figures, so the comparison is at least consistent, but neither of them touches profit after tax, interest or a share count, and earnings per share is built out of exactly those three. How either multiple is arrived at is settled a layer below and applied here.

Both questions deserve an answer and neither answers the other. An analyst who writes down only the multiple comparison has said something about pricing and nothing about earnings. An analyst who writes down only the funding comparison has said something about earnings and nothing about whether the price was sensible relative to the buyer's own. The discipline is to write both down, separately, and to resist the pull towards making one of them the verdict.

What does share consideration do to who holds the buyer?

Now the consequence that a price simply does not have, and it is the one that gets argued hardest in the room even though it never appears in an earnings model.

Harivansh Packaging's promoter groupThe founding shareholder or shareholders and the persons and entities the disclosure rules group with them, shown as one block on a listed company's shareholding statement. holds 58.0 per cent of 18.00 crore shares, or 10.44 crore shares. Under the constructed share route, 3.80 crore new shares go to the sellers of Sundarban Polymers. The promoter group still holds 10.44 crore shares. Nobody took anything from them. But the count those shares sit inside has gone from 18.00 crore to 21.80 crore, and 10.44 over 21.80 is 47.89 per cent, or 47.9 per cent rounded.

Run the rest of the register the same way. The free floatThe part of a listed company's shares held by everybody outside the promoter group, and therefore available to trade. was 42.0 per cent of 18.00 crore, or 7.56 crore shares, and 7.56 over 21.80 is 34.7 per cent. The sellers arrive holding 3.80 over 21.80, or 17.4 per cent. Add them: 47.9 plus 34.7 plus 17.4 is 100.0 per cent, so the split closes.

The whole of the movement is in the denominator. A denominator movement is a different mechanism from the earnings dilution above, where the whole of the movement was in the numerator. In the cash route, profit fell and the share count held still. In the share route, profit rose and the share count moved further. A cash purchase moves the top of the fraction and a share purchase moves the bottom of it. Confusing the two is how people end up saying that debt does not dilute, and on these figures that is exactly backwards.

And there is a hard asymmetry between the two consequences. An earnings per share effect is a statement about one year. A better year, a synergy that arrives, a repayment of the borrowing, and Rs 12.14/- can be back above Rs 12.50/- without anybody doing anything structural. A changed register is not like that. Once 3.80 crore shares have been issued, the promoter group is at 47.9 per cent permanently, and the only way back is to buy shares in the market with money the company or its promoters would have to find. The permanence is why share consideration gets negotiated by people who are not thinking about earnings per share at all.

What moves between announcement and completion under each route?

A transaction is not an instant. Something is announced, conditions have to be satisfied, and then it completes. On this transaction the conditions period ran nine weeks, an elapsed time particular to this deal rather than a statement about how long anything takes.

Under a fixed cash price nothing about the consideration moves through that stretch. Rs 1,140 crore was agreed and Rs 1,140 crore is paid. The buyer carries funding risk instead: the Rs 1,000 crore has to actually be available on the day, on the terms assumed, and if the cost of that money moves against the buyer in the meantime, the buyer absorbs it. The sellers do not care. Their number was fixed the day they signed.

Under a ratio it is the other way round. The number of shares was fixed and the value of those shares was not. Every day between announcement and issue, whatever happens to the buyer's share price happens to the sellers. The buyer has no funding to arrange, so the buyer carries almost none of that particular risk. The two routes do not remove the risk of the waiting period; they hand it to opposite sides of the table.

The waiting-period exposure is exactly why share deals attract drafting that a cash deal never needs: collars that stop the ratio if the price moves beyond a band, floors under the value the sellers receive, and mechanics that reset the ratio if a threshold is crossed. Collars, floors and reset mechanics are the paper's answer to that exposure, and they belong to the drafting of consideration terms rather than to the arithmetic.

When can an exchange ratio not be computed at all?

Everything above has been careful to say 3.80 crore shares rather than to quote a ratio, and the reason is not stylistic.

An exchange ratio needs a share count on both sides. The buyer's count is needed to know what a buyer share is worth per unit of the buyer's business, and the seller's count is needed to say how many buyer shares each seller share is worth. Harivansh Packaging's count is recorded: 18.00 crore shares. Sundarban Polymers is a private limited company and this record carries no share count for it at all. There is therefore no exchange ratio on this transaction, and no honest way to produce one. The missing half of the arithmetic is not a rounding detail but a whole input.

Everything that does not need that input can still be computed. The equity value of Rs 1,140 crore, the illustrative share price of Rs 300/-, and therefore the 3.80 crore shares of consideration. From that, the enlarged count of 21.80 crore and the split at 47.9, 17.4 and 34.7 per cent. All of that stands. None of it needs to know how many shares Sundarban Polymers has. The number of buyer shares issued depends on the amount and the buyer's price and nothing else.

Inventing a seller share count and printing a tidy ratio would be easy, and it would look more finished. Such a ratio would also be wrong in a way that is very hard for a reader to detect afterwards. A printed ratio carries no mark saying which of its two inputs was made up. Naming what cannot be computed, and saying exactly which input is missing, is better work than producing a figure that has the shape of an answer. The same discipline applies well beyond this transaction: any time a ratio, a multiple or a per share figure appears, the useful question is which inputs it needed and whether the record actually holds all of them.

Which of the four numbers is a headline actually quoting?

All of this arrives at a practical instruction, and it is the one to take away if nothing else survives.

Four different numbers get reported about a transaction in exactly the same sentence shape, and only one of them is money reaching sellers. The transaction is valued at Rs 1,320 crore: that is an enterprise value, the whole of the business including the debt inside it, and nobody receives it. The consideration is Rs 1,140 crore: that is the equity value, and that is the sum that reaches the sellers. The ratio is such and such: that is a proportion and not an amount at all. Shares to be issued, 3.80 crore on the constructed route here: that is a count, and its value depends on a price nobody has fixed.

When a number is quoted about a transaction, the first question is not whether it is big but which of those four things it is. The sentence shape gives no clue, and the four are not interchangeable in any direction. The gap between the first two on this transaction is Rs 180 crore, Sundarban Polymers' own net debt, and reading the enterprise value as the price overstates what the sellers received by nearly sixteen per cent.

How does a lender, an analyst or a holder read the choice differently?

Three people look at the same fork and none of them is looking at earnings per share first.

The lender is looking at leverage, and the choice of consideration moves that far more than it moves earnings. Under the recorded cash route the acquirer's own net debt goes from Rs 600 crore to Rs 1,740 crore, and a full purchase also brings Sundarban Polymers' own Rs 180 crore across, so consolidated net debt is Rs 1,920 crore. Against combined EBITDA of Rs 609 crore that is 3.15 times. On a standalone basis it is Rs 1,740 crore over the acquirer's own Rs 477 crore, or 3.65 times. Opening leverage was 1.26 times. Under the constructed share route nothing is borrowed at all: the acquirer keeps its Rs 140 crore of cash, its own net debt stays at Rs 600 crore, and consolidated net debt is Rs 780 crore over Rs 609 crore, or 1.28 times. The consideration decision moves leverage from 1.28 times to 3.15 times on the same purchase at the same price, a bigger movement than anything it does to earnings per share. Whichever figure is quoted, the basis has to be named in the same sentence. A standalone numerator over a combined denominator is a real error that understates leverage.

The analyst is looking for whether both comparisons have been run. Was the multiple comparison written down? Was the funding comparison written down, on one base? If only one of the two appears in a note, the note has answered half a question and presented it as a whole one.

A holder in the buyer is looking at the register. Cash consideration leaves their proportion alone and puts the borrowing on the balance sheet of the company they hold. Share consideration leaves the balance sheet alone and reduces their proportion permanently. Neither of those is the safe one; they are different exposures, and a holder who cares more about control than about a year of earnings will read the fork the opposite way round from one who does not.

The sellers read it last and most simply. Cash is finished business. Shares are an ongoing position in somebody else's company, with a value that keeps moving and, in a listed buyer, whatever restrictions apply to how and when they can sell. Shares are a completely different thing to accept, and the negotiation over form often takes longer than the negotiation over amount.