Impact of mergers and acquisitions on stock price


Are you a trader or an investor in the stock market? Do you know the effect of mergers and acquisitions (M&A) on the price of the stocks that you are holding? If not, have a glance at the following article so that you can take appropriate action before it can erode your money in the stock market.

If you are trading or investing in stocks, you should be very alert towards different actions that are taking place in your holding companies. Even if you take the required precautions while trading stocks, those can easily be nullified by a single action that is being taken by the company. It is not sufficient, if you simply follow the actions. But you should also know the impact of each action. That is, whether an action has positive or negative effect on the share prices. Mergers and acquisitions are such actions, which are very common in the corporate world. M&A activities bring different companies together to form into a bigger one. We see such actions taking place hugely when the stock market bottoms out. This is because the share prices will be at attractive level and companies will use it as an opportunity to eliminate competitors and at the same time, they try to enhance their market share.

Difference between merger and acquisition

In M&A process, when an entity takes control over another entity and the later one ceases to exist, the deal is said to be an acquisition. That means, the stocks continue to trade for the acquiring company but not for the acquired one. But, the case of merger happens between two firms of almost equal size. Such firms come together and move forward to form into a single entity, probably a new one. In this case, the stocks of both the firms cease to exist and in place of that, stocks of newly formed firm will be issued. But such a scenario is very rare in the corporate world. Most of the time, only acquisitions happen but the acquired firm often promulgate such deal as a merger because being taken over by another firm may raise some negative implications in the minds of people.

Reasons for M&A activities

Generally, companies expand through either of the two ways, one, by increasing sales and the other by acquiring different companies. Since growing through the first method will take some time, companies resort to the second method for expansion. The other reason for coming together of different companies is to create a combined entity that will be bigger than the sum total of both the entities. Sometimes, companies forcefully take over other companies to eliminate competition and sometimes they acquire others to get into new technologies, currently they are not having, so that they can penetrate much into the market and snatch more of the market share. Similarly, raising of capital and negotiating capabilities will be somewhat easier for a bigger company as compared to smaller individual companies.

Effect of M&A on stock prices

There will always be M&A impact on share price of both the companies in the short term. Let us see how mergers and acquisitions affect stock prices. Generally, the share price of the acquiring entity will fall down whereas the acquired one's will shoot up. This is because the buying firm has to pay somewhat extra premium than what is its worth of the target firm. Otherwise, the target company's promoters may not come forward for the acquisition. For example, if the shares of the target company are currently trading at $20, the buying company has to pay more than $20 per share of the bought up company for the acquisition to happen. If the business deal is confirmed, the stock prices of the bought up entity will automatically move towards the deal price.

The reasons for falling down of the share price of the acquiring firm can be many. The first and foremost reason is that it has to pay more premium for the bought up firm which in turn reduces the net worth of the buying company in the short term. In addition to that, there will be lot uncertainties hovering over the acquisition. There will be fear of job loss in the minds of employees which in turn reduces their productiveness. If the acquired company has debts, that will be a burden for the acquiring firm and there will be extra costs involved in restructuring the whole organization. Sometimes, traders play the game by saying that the target firm is overpriced and hence they try to push the shares of the acquiring company further downwards.

Sometimes, the stock price of the target firm won't even reach the deal price if uncertainties linger over the deal. If the business deal fails to materialize, the stock prices of the bought up company will automatically fall down significantly. In rare situation, the target entity's share price rises above the deal price in the hope that some other firm will come forward to take over that firm. Sometimes, even the stock price of the acquiring entity also rises after announcement of the deal, if the investors think that the buying firm has struck a good deal or if the bought up firm has some reputation and brand value.

Conclusion

It is always tempting to buy the shares of the target company in the short term when there is an amalgamation activity in the market but sometimes the tables may turn against you. Similarly, it is also tempting to buy the shares of the acquiring company after it falls down significantly thinking that the share price will rise in future after completion of the amalgamation process. But, a proper M&A process along with good management unit can only be able to ameliorate the share price of the amalgamated entity in the long term. If there is any trouble in the merger and acquisition process and the management is not in a position to handle the situation efficiently, the share price of the combined entity can fall further. So, it is always advisable to do a thorough analysis about the deal before buying any of the stocks.


Comments

Author: Partha Kansabanik06 Apr 2016 Member Level: Diamond   Points : 3

A very good article on the impact of merger and acquisition on stock prices. The author has explained the issue in a lucid manner for the benefits of common investors.
I personally feel that merger and acquisition as well as news/rumors on merger and acquisition drastically impact the stock prices of the concerned companies. The prudent investors must wait patiently till such time the din and bustle associated with the merger and acquisition subside, and acquire the script(s) at a fair price considering the intrinsic values of the stocks. The stocks must be acquired from long-time perspective and not for short-term trading.

Author: K Mohan08 Apr 2017 Member Level: Platinum   Points : 2

The author has nicely explained the importance of merger and acquisition of stock market prices and its behavior. I am not going to comment on that. But what I want to say here is different. Recently all the subsidiaries or the local State Bank groups of every state has been merged with State Bank group to remain and function as one entity. For example I was having account with State Bank of Hyderabad which is now merged with SBI. No doubt SBI was a great network group and many have faith in it. But what surprised me that by previous bank that is SBH was working well , good services were provided and customers were happy. The bank was functioning with profit margin also. What prompted the authorities to merge SBH branches with SBI group is yet to be ascertained. Now the staff has been changed and we cannot expect same cordial service from the new staff. Most of the banking works have been done with understanding and cooperation of staff and if they change, the entire equation of relations change and this will have longer and larger impact on bank performance in future.



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