Usually when an M&A deal is struck, the acquirer and target decide on an exchange rate for the transaction. This exchange rate is calculated based on the latest stock prices of both companies. However, there is the possibility of stock prices fluctuating by the time the deal gets closed. A fixed dollar collar value fixes an upper and lower limit for the exchange rate, depending on extent of movement of the acquirer’s stock price. Thus the target is assured of a minimum exchange rate even when the stock price of the acquirer increases significantly.
Company Sun Electronics plans to acquire Company Newbie Electronics. Sun’s shares are currently trading at Rs.100 and Newbie’s shares are trading at Rs.60. Suppose Sun agrees to pay a 20% acquisition premium to Newbie. This implies that the exchange ratio would be:
Exchange Rate = 60*(1+0.2) / 100 = 0.72
As per the fixed dollar contract between Sun and Newbie, Newbie would be protected against Sun’s stock price movement to the tune of 10%. However, the 10% shift would apply to either side of Rs.100.
Hence, even if Sun’s share price increases above Rs.110, Newbie would still get a minimum exchange ratio of:
(60*1.2)/110 = 0.655
However, when Sun’s shares plunge below Rs.90, the exchange ratio would be capped at: