TJ Moruzzi
Sometimes, two companies decide to join forces to create a stronger entity. This can happen in various ways, but the most common processes are mergers and acquisitions.
There are many reasons why a company might choose to merge or agree to an acquisition, such as increasing market share, expanding geographically, or reducing competition. These events occur more frequently than we realize, often going unnoticed unless the companies involved are well-known.
Understanding mergers and acquisitions is essential. Learn how they impact stock prices and the key differences between a merger and an acquisition.
In simple terms, Mergers and Acquisitions (M&A) occur when one company merges with or acquires another for several strategic reasons.
M&As can happen for various reasons, including:
- Market Share Expansion
- Asset Acquisition
- Synergy and Diversification
What Happens During a Merger or Acquisition?
Before we get into how mergers and acquisitions (M&A) affect stock prices, let’s break down what actually happens during these processes.
Merger
When two companies decide to merge, they come together to form a new company. This means the old companies no longer exist independently; instead, they create a single, unified entity. As part of this process, the new company issues new shares, and the old shares from both original companies are surrendered. Shareholders of the original companies receive shares in the new company. The idea behind a merger is usually to combine resources and strengths, making the new company more competitive and efficient.
Acquisition
An acquisition works a bit differently. Here, one company (the acquiring company) takes over another company (the acquired company). The shares of the acquiring company stay the same. However, the acquired company’s stocks stop trading in the market because it becomes part of the acquiring company. Shareholders of the acquired company receive shares of the acquiring company in exchange for their original shares. This allows the acquiring company to grow by incorporating the assets, operations, and market presence of the acquired company.
In both cases, significant changes occur within the companies involved. These changes can affect stock prices and how the market views the newly formed or expanded entity. Understanding what happens during a merger or acquisition can give you a clearer picture of the broader impact these activities have on the financial market.
How Mergers And Acquisitions Affect Stock Prices?
Stock Price Volatility In Pre-acquisition Transactions
Simply hearing that a company might be acquired can cause its stock price to fluctuate a lot. This affects both the potential buyer and the target company. Traders and analysts quickly start considering several things:
- What the deal means for the overall strategy of both companies
- How the buyer will finance the acquisition
- Whether the target company is open to or resisting the takeover
- If there might be a higher offer from another company
This speculation and uncertainty usually lead to a lot of movement in the stock prices as everyone tries to figure out what will happen next.
Reaction of Target Company Stock to a Bid
When a company becomes a target for acquisition, its stock price usually goes up.
The reason is pretty simple: buyers often have to offer more than the current market price to make the deal attractive. So, when there’s even a hint that a company might be bought, its stock value tends to rise.
As soon as the proposed deal price is announced, the target company’s stock price will generally move closer to that offer price because traders are looking to get the best return from the potential deal.
Buying Company Stock’s Reaction to a Bid
The reaction of the buying company’s stock to a bid is more complex than that of the target company.
It largely depends on how the shareholders and market traders perceive the deal.
If they think the acquisition will add value, even considering the premium paid, they’ll be more likely to buy the stock, which will drive its price up.
Conversely, if they believe the deal will harm the company’s value, they’ll start selling their stock, causing its price to drop.
In any case, there’s often a need for judgment, and opinions can be divided on whether the deal will be beneficial or detrimental to the buying company.
When Two Companies Combine
First off, true mergers, where two companies combine as equals, are pretty rare. Most of the time, what we call a merger is actually more like an acquisition, where the company being acquired gets more say in the new entity than it would in a straight buyout.
When two companies merge to form a new company, the stock market reaction can be quite telling. If investors and shareholders believe the merger will be successful, they expect the new company’s value, as reflected in its stock price, to be higher than the combined value of the two companies’ stock when they were separate. This is the ideal ‘1+1=3’ scenario that everyone in mergers and acquisitions hopes for, where the new company is worth more together than the two companies were apart.
What Effect Does a Reverse Merger Have on Stock?
A reverse merger happens when a private company buys a publicly traded company. As a result, the private company’s owners become the controlling shareholders of the public company and take over its operations.
When a reverse merger is announced, it often causes an initial rise in the stock price of the publicly traded company due to positive expectations about the merger. However, the long-term impact on the stock price can vary widely based on how investors perceive the private company’s value and growth potential.
If investors believe the private company has strong growth prospects and a solid business model, the stock price of the publicly traded company may continue to climb. On the other hand, if the private company is seen as risky or unproven, the stock price might drop. Additionally, if the shareholders of the publicly traded company are unhappy with the terms of the merger or have concerns about the financial health of the private company, the stock price could also decline.
Purchasing Stock Before A Merger Or Acquisition: Should or Not?
Deciding whether to buy stock before a merger or acquisition can be tricky. It depends on a lot of things, like the companies involved, the details of the deal, and how the market reacts. It’s important to look at the deal closely to see how it will affect both the target company and the company doing the acquiring. For example, if the acquiring company is paying a lot more than the target company is worth, it could be a sign that the deal might not be profitable in the long run. Also, if the acquisition means the acquiring company has to take on a lot of debt, it could hurt its financial health and future growth.
Timing is crucial too. If you buy stock too early, you risk losing money if the deal doesn’t go through. But if you wait too long, you might miss out on potential gains. The key is to find a good balance between timing and managing risks.
