What Happens to Stocks When a Company Takes Over Another?
When one company acquires another company, a process also known as a merger or a takeover, it must be approved by the boards and shareholders of both companies. Reasons for mergers include entering new markets, saving operational costs and achieving diversification. The merged company may trade under a new stock symbol or under the stock symbol of one of the merged companies.
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Facts
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The acquiring company -- acquirer -- pays for the takeover of a target company by cash, stock or a combination. The stock price of the target usually adjusts to reflect the market value of the offer. For example, if a company receives a takeover offer of $20 per share, its stock price after the announcement will usually rise close to the offer price. In friendly takeovers, the acquirer usually offers a price higher than the current stock market price unless the target company is desperately looking for buyers. In a hostile takeover, the target company's board rejects a friendly offer and the acquirer then appeals directly to the shareholders.
Target Company
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According to Fairleigh Dickinson University professor Patrick A. Gaughan, target company shareholders generally earn positive returns from friendly and negotiated merger agreements. However, "USA Today" columnist Matt Krantz wrote that the price may actually fall if the markets had anticipated a higher takeover offer. A bidding war usually means a higher stock price because it creates a competitive environment in which the acquirer tries to outbid other suitors. In a cash merger, the target company's shareholders receive cash for their shares. In a stock merger, the shareholders receive shares of the acquiring company or a new entity according to the terms of the merger.
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Acquiring Company
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Professor Gaughan's research found that the acquiring company shareholders tend to earn zero or negative returns from mergers. The acquiring company's share price often falls because investors fear that the company might be paying too much for the target company or that issuing new shares will dilute the value of existing shares. Acquiring companies also tend to be larger than the target company, which might also be a reason for a muted stock response.
Divestitures
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Companies often sell off parts -- for example, a business division or an entire product line -- to other companies as part of a divestiture strategy. Gaughan's research has found that shareholders generally benefit because the market believes that selling off an unprofitable division or one that is no longer a strategic fit is a net positive for the company. These sell offs are usually for cash, although sometimes business units from two or more companies are combined to form a new company.
Considerations
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According to business consultant Gerald Adolph and others, the risks of a merger implementation include an absence of plans to achieve cost savings and a cultural mismatch between the acquiring and target companies. Savvy investors normally accumulate positions in companies in anticipation of potential acquisitions because it is usually too late to take advantage of stock price movements once a formal deal has been announced.
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References
- U.S. Securities and Exchange Commission: Mergers
- Wiley; Mergers and Acquisitions -- An Overview; Patrick A. Gaughan
- "USA Today"; Takeovers Good News for Stocks, Usually; Matt Krantz; August 2005
- Harvard Business School Working Knowledge; Nine Steps to Prevent Merger Failure; Gerald Adolph et al.; March 2006
Resources
- Photo Credit Meeting Merger Arrows image by Scott Maxwell from Fotolia.com
