Question

You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company. UnderWater's stock price is $18 and it has 1.75 million shares outstanding. You believe that if you buy the company and replace its management, its value will increase by 44%. You are planning on doing a leveraged buyout of UnderWater and will offer $22.50 per share for control of the company.

a. Assuming you get 50% control, what will happen to the price of non-tendered shares?
b. Given the answer in part (a), will shareholders tender their shares, not tender their shares, or be indifferent?
c. What will your gain from the transaction be?

Answer 1

a.

Value of firm is 1.75 milliion shares* 18= $31.5 million.

Increase in value, 31.5*144% = $45.36 Million, so now this is the value of firm

If you buy 50% of the shares for $22.50, you will buy 0.875 million shares, so total amount you will be paying is $19.69 million.

Now you will borrow the money against shares as collateral. This means that the new value of the equity will be $45.36 million – $19.69 million = 25.67 million.

1.75 million shares are there so now the price of the share will be $14.67 (25.67/1.75)

b.

The price of the shares has decreased from $25.67 to $14.67 after the tender offer, everyone will want to tender their shares for $22.5

c.

If suppose everyone tenders the shares and you will buy at $22.5 per share, you will pay $39.375 (22.5 per share *1.75 million shares) to acquire the company and it will be worth $45.36 million. gain will be $45.36 million – $39.375 million = $5.985 million.