Introduction
Fully diluted share count and transaction costs resulting from change in control provisions are important considerations for any M&A-related real estate private equity model. This article covers the basics you should absolutely master if you are serious about a career in REPE. As always, we recommend you deliberately practice these questions out loud and without looking at the answers if you wish to fully develop your real estate private equity skills ahead of an interview.
What is a fully diluted share count and why is it relevant to real estate private equity M&A investing?
When you buy a public company, you announce the share price at which you will acquire it. Then, you have to pay every shareholder that price you announced. The most obvious shareholders you need to buy out are the outstanding common shareholders. For any public company, the number of common shares outstanding is published quarterly on the front cover of every 10-K and 10-Q.
However, there are other people that will become shareholders as a result of a take-private. The fully diluted share count considers not just the number of common shares outstanding, but also the other people that convert to common as a result of a transaction. These people include in-the-money warrant and option holders, owners of unvested restricted stock units, and unit holders of the REIT’s operating partnership. This is relevant to REPE M&A investing because your model should always calculate the total buyout cost by using fully diluted share count.
What is the treasury stock method and how does it relate to fully diluted share count?
The treasury stock method serves to calculate the net shares created as a result of buying out all in-the-money holders of warrants and options. For example, what if we have agreed to purchase a company for $100 per share, and this company has 100 outstanding warrants at a $75 weighted average strike price? Well first, every warrant holder is going to exercise at their average $75 price, so the company will receive $7,500 of total proceeds for 100 new shares created. Now this is where the treasury stock method comes in. We will then use that $7,500 to repurchase as many shares as we can at the market price of $100, which means we’ll immediately buy back 75 shares. So we’ve spent the money we made, and we bought back 75 of the 100 new shares with the proceeds. Thus, the treasury stock method would suggest we generate 25 incremental shares to add to our fully diluted share count when we assume a $100 take-out price and there are 100 options at a $75 weighted average strike price.
What is a change in control provision and how might it impact your sources and uses for a take-private M&A deal?
Change in control provisions basically say “if ownership changes, something happens.” That something is detailed in the change in control provision itself. You often find change in control provisions in debt documents, preferred equity documents, and equity awards to management. With regards to debt, a change in control could trigger an assumption fee, immediate principal repayment, or simply require lender consent. With regards to preferred equity, you could see similar provisions as with debt as well as potential conversion to common. Finally, with equity awards, you generally would expect all unvested restricted stock awards and options to immediately vest, effectively increasing your share count at the date of acquisition.
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