Do you know how mergers affect stock prices? Thanks to ongoing state-level efforts to boost transparency in the financial markets, such effects are easier than ever to tease out. Here are four merger and acquisition implications you need to know as an investor:
1. The Buyout Target’s Stock Price Often Jumps After the Announcement
In a normal takeover situation, the stock price of the firm to be acquired jumps in the aftermath of a buyout announcement. That’s because purchasing firms typically price non-hostile offers at a substantial premium to their targets’ current stock price, mostly to curry favor with the shareholders and directors who have the final say on the deal. Once the acquirer publicly announces how much it’s willing to pay for a particular firm, the firm’s shareholders (and marketmakers looking to profit from the announcement) have every incentive to pile in. After all, as long as they buy the firm’s stock for less than the takeover price, they’ll come out ahead when the transaction closes and they’re compensated for their shares.
2. Uncertainty May Create Opportunity for Risk Takers
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Not every merger or acquisition is cut and dried. This is particularly true in hostile takeover situations, when it’s not at all clear that the acquirer can muster the shareholder support necessary to gain a controlling stake in the takeover target.
Even in non-hostile situations, disputes over what constitutes a fair price for the takeover target often devolve into allegations that the firm’s board misled shareholders, precipitating lawsuits that can delay the transaction for months or years. Larger deals, particularly in industries dominated by a few key players or deemed essential to national security, can face additional delays due to regulatory scrutiny.
All these factors may prevent the stock price of a takeover target from approaching the offer price, creating opportunity for risk-tolerant investors who buy into the uncertainty and profit if and when the deal actually goes through.
3. The Acquiring Firm May not Fare Well in the Short Term
Just as it’s common for the stock price of the firm-to-be-acquired to shoot up in the aftermath of a buyout announcement, it’s not unusual for the value of the acquiring company to drop once the cat is out of the bag. This is largely due to reasonable worries that the firm’s profitability will take a hit as it absorbs the acquired firm’s operations, or that it will need to take on lots of debt to finance the deal. Good news for shareholders, though: Such drops aren’t typically as steep, deep or durable as buyout targets’ price jumps. And an acquiring firm’s stock price could well jump after an announcement if there’s market consensus that it got a good deal.
4. Results Matter
The above mostly applies to the short term — the period between the announcement of a merger and the deal’s closing. Over longer time spans, however, the most important determinant of the newly created firm’s stock price is its financial performance. If the merger produces unexpected headaches or doesn’t spawn the efficiencies and cost savings promised, it could well be viewed as a failure — resulting in a painful price drop (and, often, unemployed executives). On the other hand, a merger that ages well might create millions of dollars in previously unrealized value, boosting the firm’s stock price and keeping shareholders happy.