Question:

Example:

You work for a leveraged buyout firm and are evaluating a potential buyout of UnderWater Company. UnderWater's stock price is $25 and it has 1.25 million shares outstanding.You believe that if you buy the company and replace its management, its value will increase by 45%. You are planning on doing a leveraged buyout of UnderWater and will offer $31.25 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? a. Assuming you get 50% control, what will happen to the price of non-tendered shares? The current value of the company is $22.50 million, which is found by multiplying the number of shares, 1.25 million, by the price per share of $18. The value should reflect the expected improvement that you will make by replacing the management, so the value of the company will be $32.63 million ( $22.50 million (1+45%) ). If you buy 50% of the shares for $22.50 apiece, you will buy 0.63 million shares, paying $14.18 million. However, you will borrow this money, pledging the shares as collateral and then assigning the loan to the company once you have control. This means that the new value of the equity will be $18.45 million (\$32.63 million - \$14.18 million). With 1.25 million shares outstanding, the price of the equity will drop to $14.76. b. Given the answer in part (a), will shareholders tender their shares, not tender their shares, or be indifferent? They will all want to tender their shares. Since the price of the shares will drop from $18 to $14.76 after the tender offer, everyone will want to tender their shares for $22.50. c. What will your gain from the transaction be? Assuming that everyone tenders their shares and you buy them all at $22.50 apiece, you will pay $28.13 million to acquire the company, and it will be worth $32.63 million. You will own 100% of the equity, which will be $4.50 million gain (\$32.63 million - \$28.13 million)