Understanding Mergers: What They Are and How They Work?

• A merger is a common corporate action with far-reaching implications for a company's structure, its shareholders, and the stock market overall. Whether you're an investor or a trader, understanding how these transactions work—and how they may impact your investments is essential
  
• A merger occurs when two or more companies combine to form a single entity. Mergers are usually undertaken to achieve economies of scale, expand market reach, or create shareholder value. When two companies merge, the shareholders of the combining companies receive shares in the newly formed company based on a predefined ratio.

Impact on Shareholding Pattern: When companies merge, the shareholding pattern undergoes a change. If you hold shares in one of the merging companies, you may receive shares in the new entity. The shareholding of each investor depends on the ratio, which determines how many shares they will receive in exchange for their existing shares. As a result, the overall ownership structure of the new company is redistributed among the shareholders of the pre-merged companies.

For example, Company A merges with Company B, and the ratio is set at 2:1 (i.e., for every 2 shares of Company A, you will receive 1 share of the newly merged entity). 

Cost of Acquisition & ratios 

Ratios are essential while calculating mergers, the average price post merger is calculated based on the ratios defined by the company

Example: Deriving the Average Price of Shares After a Merger

When two companies merge, shareholders often receive shares in the merged entity in exchange for their holdings in one or both of the original companies. This can affect the cost basis of your holdings, and it's essential to understand how to allocate the acquisition cost of your original shares to the new shares you receive.

Let's walk through an example of the merger between ABC Ltd  and XYZ Ltd. to demonstrate how to calculate the new average price of shares in the merged entity.

Step-by-Step Example:

1. Original Holdings:

You own 100 shares of ABC Ltd at an acquisition price of ₹1,500 per share.

You also own 50 shares of XYZ Ltd. at an acquisition price of ₹2,500 per share.

Therefore, the total value of your holdings is:

Merger Ratio:

In this merger, for every 25 shares of XYZ Ltd., shareholders will receive 42 shares of ABC Ltd .(1:1.68)

Since you own 50 shares of XYZ Ltd., the shares you will receive from ABC Ltd are:

50*(42/25) = 84 new shares of ABC Ltd.

After the merger, your holding will be:

100 original shares of ABC Ltd.

84 new shares of ABC Ltd(received for your XYZ Ltd. shares).

So, your total holding in ABC Ltd  after the merger will be:

100 + 84= 184 shares

2. Apportioning the Cost of Acquisition:

Now, let's allocate the total acquisition cost (₹2,75,000) between the original ABC Ltd shares and the new ABC Ltd shares received from XYZ Ltd. based on the number of shares.

3. Final Average Cost per Share:

Since both sets of shares (original and new) have been acquired based on the same apportionment cost, the average price per share for all your 184 ABC Ltd shares is:

2,75,000 / 184 shares = ₹1,494.57 per share.

Conclusion:

After the merger between ABC Ltd and XYZ Ltd., your total holding is now 184 shares of ABC Ltd. The average cost of these shares is ₹1,494.57 per share, calculated by proportionally distributing the acquisition cost of your original holdings in ABC Ltd  and XYZ Ltd. based on the merger ratio.

Note: In the event that any fractional shares result from the calculation of a merger or demerger, the usual procedure is to round down the fractional amount. The value of the fraction is then credited directly to your linked bank account by the RTA (Registrar and Transfer Agent) appointed by the respective companies.

Related article:

What is Demerger?