A stock swap is a strategy used during a merger or acquisition of a company. The motivation is an opportunity to pay with stock rather than with cash.
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Overview
The acquiring company essentially uses its own stock as cash to purchase the business. Each shareholder of the acquired company will receive a pre-determined amount of shares from the acquiring company. Before the swap occurs each party must accurately value their company so that a fair swap ratio can be calculated. Valuation of a company is quite complicated. Not only does fair market value have to be determined, but the investment and intrinsic value needs to be determined as well.
The acquiring company may also need to add a little extra incentive in the form of shares to make sure that the board of directors of the acquired company approve the takeover. After all the valuation is complete, the parties will agree upon a swap ratio. The ratio will determine the amount of shares each person will receive from the company that is taking over. When this swap is realised, the shareholders receive the new stock and own a share in the new company. Sometimes, a part of the agreement will not allow the new shareholders to sell for a certain time period to avoid a sudden drop in share price. This is a form of a shareholder rights plan or poison pill strategy that is used to combat hostile takeovers. When all things come together and are fair, then the takeover will proceed without incident.
In South Korea, the merger ratio is defined by a certain formula according to the law, if both companies are listed on the KRX.
Example
For example, in 2010, two companies came together to form GenOn Energy, Mirant, and RRI Energy. The Mirant shareholders were given 2.885 shares of RRI for every share of Mirant that they owned. This stock swap helped facilitate the takeover by making the Mirant shareholders an attractive offer, thus convincing Mirant's board of directors to allow the takeover.
In 2014, South Korean Internet giant Daum Communications merged with Kakao Corp to form Daum Kakao in a stock swap deal. The merger ratio was approximately 1.14 so it is regarded as backdoor listing for Kakao.
Internal swap
Stock swaps can also happen internally within a company. Starbucks has used this strategy in the past. When the stock options they offered to their employees dropped so low in price that they became virtually worthless, Starbucks offered a swap option. The company allowed the employees to swap their worthless shares for more that had a higher value.