While mergers and acquisitions are relatively common in the world of corporate finance, they can trigger corporate events that affect private investors like you.
Knowing how mergers and acquisitions work will help you make better investment decisions in the future.
When two businesses join together, it is called a merger. Increasing shareholder value is a common motivation for public company mergers, whether it be through increased market share or expansion into new product categories.
In contrast to an acquisition, a merger might give rise to an entirely new company. In most cases, mergers often happen between two similar-sized businesses.
Acquiring a company by another, larger organization is commonly referred to as an acquisition. Shares are more commonly traded than cash in a merger.
Mergers and acquisitions can be friendly or hostile, and they can be structured as a reverse takeover or forward takeover. In either case, mergers are often done for the same reasons: to increase market share and reduce costs by eliminating redundant positions in an organization’s structure.
As an example, in August of 2017, Dow Chemical and DuPont, a manufacturer of polymers, merged to become DowDuPont (DWDP) by exchanging shares of Dow and DuPont for shares of the merged business.
How do mergers and acquisitions affect you as a private investor?
When a merger or acquisition takes place, you’ll receive a notice from your broker or fund manager showing whether you’ve been affected by the corporate event.
The notice will indicate whether any of your investments have been acquired by another company and what the new price is for those shares.
The Impact of Merger News on Stock Prices
How the market reacts to news of a merger depends on a number of factors, including the perceived worth of the deal and the chance that it will be finalized.
If the merger is to be implemented through an exchange of shares, the exchange ratio will determine whether or not one company is receiving a premium over its share price prior to the announcement in the agreement.
If the share price of the merged company drops, the initial premium may be reduced even if the price of the company’s shares rises.
Collar clauses, which increase the exchange ratio if a stock being swapped falls below a specified level, are included in some merger agreements to protect against this kind of erosion.
Collars like these are less typical in mergers involving equal or nearly equal companies because they protect the minority’s shareholders against losses at the expense of the majority’s.
The proposed merger premium may also be discounted by the market if there are major potential hurdles to the deal, such as obtaining regulatory permission.
On the other hand, if investors think the deal announcement will attract higher bids from new suitors, the stock price of the target company may rise above the merger premium.
If investors are optimistic that the proposed merger will be finalized, they may bid up the stock of both firms.
Consider the $6.6 billion merger between Spirit Airlines (SAVE) and Frontier Airlines (ULCC) that was announced in February of 2022. Each Spirit share will be exchanged for 1.9126 Frontier shares and $2.13 in cash, under the terms of the agreement.
Spirit Airlines’ stock price increased almost 40%, from about $20 to approximately $28, after the news broke. Frontier’s stock price increased by a more modest $1.50, to $14.25, or about 15%.
There is no acquirer in a merger of equals because both companies are of similar size and stand to benefit from the union.
The Impact of Mergers on Corporate Management
Shareholders of both companies will receive equity in the combined company based on the exchange ratio in a stock-for-stock merger.
When fresh shares are issued to the shareholders of the other firm, the control of the larger company is eroded for the shareholders whose shares are not exchanged. Merger announcements often detail the ownership stakes of the various parties in the merged company.
Businesses in merger talks should also think about how their boards of directors, management teams, and enterprises will be united under a single set of leadership.
Mergers are sometimes driven by a desire to gain or maintain control of the combined firm, and the terms of the agreement can be affected by the manner in which control is distributed.
Change-of-control provisions can be included in executive compensation agreements to guarantee bonus payments in the event of a merger or acquisition.
When two companies merge, what usually happens to their stock prices?
The stock price of the acquired company may fall slightly as a result of the takeover announcement, while the stock price of the acquired company may rise (approaching the takeover price).
Both companies’ stock prices may increase if investors believe the merger will lead to synergies that will be good for the acquirer and the target. Both stock values may go down if the market determines that the merger is a bad idea.
On the flip side, after an acquisition the stock price of the purchasing business often drops.
This is due to the fact that the acquiring firm typically pays a premium for the acquired firm, depleting its cash reserves and/or incurring substantial debt. Yet, the stock price of the purchasing business may fall for a variety of other reasons as well.
Many potential buyers are wary about paying such a big premium for the target company.
Different cultures in the workplace can be difficult to integrate. The timeframe of the merger is complicated by regulatory difficulties.
Productivity is hindered by management power battles. Or maybe the acquisition results in the incurrence of additional debt or unanticipated expenses.
While the purchasing business’s stock price may fall in the short term, it should recover and even rise in the long run if the target company was fairly valued and the two organizations are integrated smoothly.
What Impact Does a Merger Between a Publicly Traded Company and a Private Company Have on the Stock Price?
The share price of a public company that is acquired by a private company tends to increase until it reaches the takeover price. Existing stockholders will receive cash upon completion of the transaction (i.e., their shares will be sold to the acquiring company).
The share price of the acquiring public corporation may drop slightly to reflect the expense of acquiring a private company.
In a reverse merger, what often occurs with stock?
If a private corporation wants to go public, it can do so through a reverse merger (also known as a reverse initial public offering). The target company’s executives then take over management of the shell corporation.
If investors see potential in the new company, demand for its stock could increase.
What determines which stocks increase or decrease?
The stock values of both companies involved in an acquisition typically move in opposite directions, at least in the short term. It is common practice for the acquiring firm to pay a premium for the target company in order to get the target company’s shareholders to vote in favor of the takeover.
There is no reason for shareholders to approve a takeover if the bid price is lower than the current stock price of the target company.
However, there are always exceptional cases. In particular, if the stock price of the target firm has lately collapsed due to negative profitability, the only way for shareholders to recoup some of their investments may be through an acquisition at a discount.
This is especially the case if the target company is heavily indebted and has limited access to debt restructuring financing markets.
Volatility Prior to an Acquisition
Target firms’ stock prices often increase before a merger or acquisition is even disclosed. Investors who buy stocks in anticipation of a takeover can benefit from even the slightest volatility caused by rumors of a merger. Yet, there is always the chance of losing money if a takeover rumor turns out to be false and the stock price of the target business plummets.
The management of the acquiring company is likely optimistic about the target’s profitability, which is a common reason for a takeover. A rise in merger and acquisition activity is typically seen as positive by investors.
What happens to the shares in an acquired company?
Shares of the target company tend to increase after an acquisition because the acquiring company has likely paid a premium for them.
However, in certain cases, the acquired company’s stock price drops in response to merger rumors. Such deals typically occur when the target company has been financially troubled and is acquired at a bargain.
Why does a company’s stock drop after it acquires another?
When an acquiring company pays a premium for the target company, it either has to reduce its cash reserves or increase its debt levels, both of which have a negative short-term effect on the stock price of the acquiring company.
Investors who think the acquiring company overpaid for the target could cause a negative market reaction to a merger.
If you own shares in the target company, your investment may lose value. This can happen for a number of reasons:
The acquirer may pay off the debt of the target company and eliminate it from their balance sheet. In this case, you will no longer receive interest payments on your bonds or dividends on your stock and therefore will not be able to count on those sources of income anymore.
The acquirer may take on more debt than they already have just to pay for the acquisition—and possibly even issue more shares so that existing shareholders don’t have to contribute as much money themselves which would dilute their ownership stakes.
What should I keep in mind when holding stock of a company undergoing a merger?
A merger or acquisition is a complicated process. It can take several months to complete, and there are many steps along the way. The acquirer will need to get approval from the target company’s shareholders and/or board of directors, who may have questions about how the deal will affect them.
The acquirer may also need regulatory approval from governments around the world if it’s based in another country—for example, if an American company buys one with a significant Chinese market.
Keeping this in mind can help you make informed decisions on whether to sell or hold your shares in the future.
Mergers and acquisitions are complex financial transactions that can affect you as a private investor. Knowing how they affect you as an investor will help you make better investment decisions in the future.
The acquirer may buy out the target company’s shareholders, or it may force the target company’s shareholders to sell their shares.
The acquirer might even offer a cash payment in order to encourage them to accept an offer from someone else instead of accepting their own bid for the company (which would probably be higher).
M&A activity is not just for big companies; it can impact private investors, too. A merger or acquisition can trigger corporate events that affect all shareholders, such as:
- Stock splits or reverse stock splits
- Shareholder rights plans (poison pills) being triggered by new ownership interests in the company
- Capitalization table changes due to issuance of new shares
The bottom line is that mergers and acquisitions have significant implications for all shareholders–even those who are not involved directly in any particular deal.
In contrast to mergers, in which two companies of similar size agree to combine to form a new, unified corporation, acquisitions typically involve a larger or more stable company purchasing a smaller or less financially sound company.
Mergers typically involve the exchange of one company’s stock for another’s, while acquisitions involve cash buyouts.
The effects on stockholders of a merger are similar to those of an acquisition. Shares of the target company tend to increase once a merger or acquisition is announced, while those of the acquiring company tend to briefly decrease.
Is there any way I can avoid losses to my portfolio when a company goes through a merger or acquisition?
Mergers and acquisitions are common in today’s business world. And while they can result in great benefits for shareholders, they can also be risky.
A merger or acquisition is the joining of two companies into one larger company. The new company may have more resources, which could lead to better products, services or growth opportunities. It could also result in layoffs, which can affect your portfolio if you own stock in the acquired company.
When one company buys another company, the stock price of the acquired company may fall as investors sell off their shares. This is because some investors may be worried that the new company will not perform as well as expected after the merger, or that they have lost faith in management.
You can avoid this type of loss by investing with a wealth management specialist who has access to resources that can help you manage your portfolio during these times. A wealth management specialist can help you manage your portfolio when a company whose stock you own goes through a merger.
Here are some of the ways a wealth management specialist can help you:
- They can keep you informed about any news related to the merger or acquisition so that you know when to sell your shares or buy more if the price drops due to negative news about the company being acquired or its future prospects after the merger takes place.
- They can help you diversify your portfolio by selling off shares of one company and buying another one that’s expected to do well after an acquisition takes place — this helps spread out your risk exposure across multiple companies instead of putting all of your eggs in one basket by holding only one type of stock for too long or not diversifying at all.
- Wealth management specialists can also help you analyze other potential risks when investing in companies involved in mergers or acquisitions — such as lawsuits or regulatory changes — before making any investment decisions regarding those companies or their stocks.
Business mergers and acquisitions happen all the time. It is crucial for investors to know how mergers and acquisitions affect them since they might set off business events that affect all shareholders. You can improve your future investing decisions by learning the ins and outs of mergers and acquisitions.