Company A has a market value of R6 billion and an issued share capital of 60 million shares. Company B, a company in the same industry as Company A, has an issued share capital of 20 million shares and a market value R1 billion. Company A wishes to take over Company B and believes that the combined company value will be R8 billion. Company B has agreed to a takeover value of R1,5 billion.

Question

Required:

Discuss the effects the takeover of company B will have on the existing shareholders of company A, if company B is acquired by:

(a) An issue of new shres to existing shareholders: (15 Marks)

(b) An issue of shares to new shareholders: (5 Marks)

(c) Borrowing; (10 Marks)

Answer 1

(a) An issue of new shares to existing shareholders:

If Company A decides to acquire Company B through an issue of new shares to existing shareholders, the existing shareholders of Company A will see their ownership diluted. This is because the new shares issued to acquire Company B will increase the total number of shares outstanding, reducing the percentage ownership of each existing shareholder. This dilution may result in a decrease in the share price of Company A as investors may perceive their ownership as less valuable.

However, if the acquisition is successful and the combined company value increases to R8 billion as projected, the potential benefits of the acquisition may outweigh the short-term dilution effect. The increased size and scale of the combined company could lead to cost savings, increased market share, and improved competitiveness, which could ultimately benefit the existing shareholders in the long run.

(b) An issue of shares to new shareholders:

If Company A decides to acquire Company B through an issue of shares to new shareholders, the existing shareholders of Company A may not experience direct dilution in their ownership. The new shares issued to new shareholders will not impact the existing shareholders' percentage ownership in the company. However, the introduction of new shareholders may affect the company's ownership structure and decision-making processes.

The issuance of shares to new shareholders may result in a change in the company's ownership dynamics and could potentially lead to conflicting interests among different shareholder groups. It is important for Company A to carefully consider the implications of bringing in new shareholders and the potential impact on the existing shareholders' interests.

(c) Borrowing:

If Company A decides to finance the acquisition of Company B through borrowing, the existing shareholders may face increased financial risk. Borrowing to fund the acquisition will increase the company's leverage and interest expenses, which could impact the company's financial stability and profitability. In the event of economic downturns or financial difficulties, the higher debt levels could put pressure on the company's cash flows and ability to meet its financial obligations.

On the other hand, borrowing to finance the acquisition may allow Company A to retain ownership control and avoid share dilution. The success of the acquisition and the ability of the combined company to generate sufficient cash flows to service the debt will be crucial in determining the impact on the existing shareholders. It is important for Company A to carefully assess the potential risks and rewards of using debt to finance the acquisition and to have a clear plan for managing the increased financial leverage.