Mergers and Acquisitions — How they Impact the Company Stock Pricing in Short and Long Run

The term “mergers and acquisitions” (M&A) refers to a broad range of financial transactions, such as mergers, acquisitions, consolidations, tender offers, asset purchases, and management acquisitions, that result in the consolidation of businesses or assets. The desks at financial institutions that participate in such activity are also referred to by the name “M&A.”

Although the terms mergers and acquisitions are frequently used synonymously, they denote slightly different things. An acquisition is a transaction in which one business buys another and positions itself as the new owner. On the other hand, a merger is the coming together of two businesses that are roughly the same size to continue forward as one new organisation rather than continuing to be owned and run independently. A merging of equals is what is happening here. When both CEOs concur that joining forces is in the best interests of their respective businesses, the acquisition agreement is also referred to as a merger. Acquisitions are always considered to be unfriendly or hostile takeovers in which the target company do not want to be purchased. Depending on whether the acquisition is friendly or hostile and how it is disclosed, a deal can be categorised as either a merger or an acquisition. In other words, the difference is in the way the board of directors, staff, and shareholders of the target company are informed about the sale.

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Types of Mergers and Acquisitions

Some frequent deals that fall under the M&A category include the following:

• Mergers: The boards of directors of the merging firms accept the union and request shareholder approval. Purchase mergers take place when one firm buys another. Cash is used to make the purchase, or some sort of debt instrument may also be issued. The taxable nature of the sale draws acquiring businesses, who profit from the tax advantages. Acquired assets can be written up to their actual purchase price, and the difference between their book value and the purchase price can decrease each year, lowering the amount of taxes that the purchasing business must pay. Consolidation mergers involve the creation of a completely new firm, which then acquires and unites the two existing businesses. Similar tax conditions apply as they would in a buy merger.
• Acquisitions: In a basic acquisition, the acquiring corporation buys the majority of the acquired company, which keeps its name and organisational structure unaltered. Both businesses maintain their names and organisational layouts.
• Consolidations: By integrating core companies and doing away with outdated organisational structures, consolidation results in the creation of a new company. Both companies’ stockholders must accept the consolidation before receiving common equity shares in the new company.
• Tender Offers: In a tender offer, one business proposes to buy the other business’s outstanding stock for a predetermined amount rather than the market rate. Bypassing management and the board of directors, the acquiring business makes the offer straight to the shareholders of the target company.
• Acquisition of Assets: One company directly purchases the assets of another company in an asset acquisition. The shareholders of the company whose assets are being bought must consent. It is customary during bankruptcy procedures for other businesses to bid on different assets belonging to the bankrupt company, which are then liquidated upon the ultimate transfer of assets to the purchasing businesses.
• Management Acquisitions: In a management acquisition, sometimes referred to as a management-led buyout (MBO), executives of one firm buy a majority stake in another, thus making it private. These ex-executives frequently collaborate with a financier or former company leaders to assist fund a transaction. The majority of shareholders must consent to such M&A transactions, which are frequently financed disproportionately with debt.

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The Organization of Mergers

Depending on the relationship between the two companies involved in the transaction, mergers can be set up in a variety of ways:

• A horizontal merger is the coming together of two businesses that compete directly and have similar markets and product lines.
• A vertical merger is a merger between a client and a business or between a business and a supplier. Imagine a cone supplier and an ice cream manufacturer merging.
• Congeneric mergers involve two companies that provide the same clientele in various ways, like a TV manufacturer and a cable provider.
• Market-extension merger is the merger of two businesses that sell the same goods in various markets.
• Product-extension merger is the merger of two businesses selling distinct but related items in the same market.
• Conglomeration is the merging of two enterprises with no common business lines.

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Why Do Businesses Keep Using M&A to Acquire Other Businesses?

Growth and competition are two of capitalism’s primary forces. A business must innovate while cutting expenses when it faces competition. Buying rival companies is one way to make them less of a threat. By acquiring additional product lines, intellectual property, human resources, and customer bases, businesses also use M&A to expand. Businesses could also search for synergy. Combining business operations usually results in improved overall performance efficiency and decreased overall costs as one company makes use of the advantages of the other.

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Mergers and Acquisitions — How they Impact the Company Stock Pricing in the Short and Long Run

Academic research on the connection between mergers and acquisitions and stock prices is extensive and diverse. Researchers and traders have been attempting to determine for decades how mergers and acquisitions affect stock prices over the short and long term, as well as whether the process provides value for those involved in buying and selling stocks. We look at some of the key ways that M&A deals are supposed to affect stock prices below.

Stock price volatility: The mere mention of a company becoming a target for acquisition usually causes volatility in both the buyer’s and seller’s stock prices, as traders and analysts try to figure out what the deal means for strategy, how the buyer will pay for it, whether the target company is welcoming or hostile to the takeover, and whether it might even trigger a significantly bigger offer from a third party.

Target company stock’s reaction to a bid: Acquisitions, on average, increase the value of a target company’s stock. The logic is simple, buyers are almost always forced to pay a premium (a price higher than the current market price) to acquire the company. As a result, the listed stocks will appreciate as soon as there is even a rumour of an impending transaction. The stock will converge on the proposed price of the deal as traders seek to maximise their return from the potential deal as soon as it is revealed.

Buying company stock’s reaction to a bid: The reaction of a buying company’s stock to a bid is more nuanced than that of a selling company. In this case, it all comes down to how shareholders and market participants perceive the transaction. If they believe the transaction will generate value, even after the premium is deducted, they will want to buy more of the stock, increasing its value. If they believe the deal will destroy value, they will begin offloading their stock, lowering its value. In either case, an element of judgement is usually required, and sometimes observers are split on whether the deal will create or destroy value for the buying firm.

When two companies merge: The first point to make is that mergers in their purest form are uncommon. Most mergers are, to some extent, acquisitions in which the target company has more leverage in the newly formed company than if it were billed as an outright acquisition. When the new company that combines the two companies is formed, a similar logic to what occurs with the buying company’s stock can be seen. First, if stockholders believe the merger will be successful, the new company’s market capitalization, as analysed by its stock price, should be greater than the total value of the two enterprises’ stock when they were independent.

The impact of a merger announcement on the share price will vary depending on the specifics of the transaction as well as market perceptions of the transaction’s value and the likelihood of completion. If the merger is to be completed through a share exchange, the exchange ratio determines whether one of the companies receives a premium over its share price before the announcement of the deal. Shares of that company may rise, but only if the share price of its merger partner falls, eroding the initial premium. If the proposed merger premium faces significant potential roadblocks, such as regulatory approval, the market may discount it. Shares of a company may trade above the proposed merger premium if investors believe the announcement will result in higher bids from new suitors.

When a publicly-traded company is bought out by a private company, the share price rises to the takeover price. Existing shareholders will receive cash in exchange for their stock when the transaction is completed (i.e., their shares will be sold to the acquiring company). When a public company acquires a private company, the acquirer’s share price may fall slightly to reflect the cost of the transaction.

A reverse merger (or reverse IPO) is a method of going public for a private company by identifying an existing publicly traded shell company to effectively buy the private firm. At that point, the target firm’s executives become the shell company’s executives and run the business. If investors believe there is value in the new entity, the stock price of that shell company may rise.

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How Should You Handle Your Stock in an M&A Situation?

During a merger and acquisition situation, various scenarios could happen. Here, we will examine it using two different case studies.

Case A: When you own the stocks: There are two additional scenarios if you are an existing shareholder and the company in which you possess stocks is involved in the merger and acquisition case. You have two options when a firm is being acquired: you may either take the chance or sell your shares to receive cash. You could also decide to stick with the new business, hang onto your shares, and wait to see if their value rises over time. If you own stock in the firm that is acquiring, it may temporarily lose value, but it will soon pick up steam and rise in value. If a merger occurs, you can stay put because the value of your shares will shortly increase.

Case B: When you don’t own stocks: The situation is a little bit different when you don’t own stocks. It would be advisable to avoid it during the M&A phase because the prices float at a premium for the acquiring business. In the event of an acquired company, the prices are initially rather low and will increase once the commercial operations are fully operational. So, it would be prudent to think carefully before entering the market.

Merger arbitrage, sometimes known as “merge arb,” is the practice of purchasing shares ahead of an anticipated merger and acquisition (M&A) transaction, typically in the target company, with the assumption that the stock price will rise once the deal is confirmed. Here, the justification is rather simple. Any transaction prepared to take a chance on the deal being finalised stands to earn in a relatively short amount of time because most companies are bought at a premium to their trading price (often 30–40 per cent higher). When considering this method, there are a few problems to consider.

When it comes to vested stock, the first thing to keep in mind is that you’ve already earned the right to purchase the stock or, if you’d prefer, to get cash equivalent to its value instead. Legally, the acquiring company must consider this. Additionally, the sum you receive will be based on what they paid for the business during the merger (or acquisition). The premise is the same, however—the stock and/or cash amount must correspond to what you are owed. Alternatively, you could receive the shares in the new firm rather than the old one. Unvested stock presents extra challenges. Since you haven’t earned the shares, what happens ultimately depends on what the firm that wants to buy yours decides to do. Unfortunately, your unvested shares will typically be completely cancelled. The acquirer’s second option is to make the payment sooner to win over the new group of employees. The last option available to them is to convert the previous unvested shares to their stock option plan in some way. You have no say in the matter, so whatever they decide is up to them.

All preferred stock has particular dividend rights, even though the terms of preferred shares vary depending on the firm (it is wise to become familiar with the rights your preferred stock entails before a merger occurs). They lack voting rights; thus, you cannot influence whether the merger proceeds or not. But following a merger, one of the following two things must occur: The preferred stock’s redemption value must be paid out by the buyer, or else the preferred stock’s dividend must be continued.

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Mergers and acquisitions are an integral component of corporate operations and functioning, and many organisations use them to gain a competitive advantage. It will depend on how the firms perform over the long term and how this merger and acquisition procedure will affect the stock prices of the company in the short term. It is expected that the stock price will increase over time if the company operates per its operational objectives. Before investing, it is suggested that you as an investor keep an eye on the market. Download the Entri App to learn more about stock market fluctuations as a result of mergers and acquisitions.