M&A is a popular way for companies to increase market share, reduce competition, expand geographical influence and improve the current market price. But we are talking about different companies becoming one. Each company has its own stock, with its own share value, volume, volatility, and so on.
So what happens to each company’s stock during the merger — and how does it impact shareholders?
How do mergers and acquisitions affect the stock prices of two companies?
The M&A influence on the target company’s and acquiring company’s shares varies due to several factors. Let’s discuss what happens to a corporate stock when the company merges with another company or takes over another company and describe all the scenarios on the changes to the share price during mergers and acquisitions.
The main questions about M&A’s influence on target and acquiring companies’ stocks are answered below.
- Is there a pre-merger volatility of stocks?
- How does the M&A deal affect the target company’s stock?
- How does the mergers and acquisitions deal affect the acquiring company’s stock prices?
- What happens to the price of a stock when a publicly-traded company merges with a private company?
- What happens to the stock price in a reverse merger?
- How is the stock price handled among shareholders in mergers and acquisitions?
Is there a pre-merger volatility of stocks?
The target company’s stock can be affected even before the actual deal is initiated.
Mere rumors about the potential merger influence the target company’s stock. As a rule, the target firm’s stock price rises due to the acquiring company’s interest in it. It can often be profitable for investors who usually purchase selling company stocks in expectation of the upcoming merger.
However, such an approach comes with potential risks since rumors about a prospective takeover do not always lead to the deal’s closure. If the merger (or the acquisition) never happens, the target company’s stock falls dramatically, and investors lose large sums.
It is worth noting that the target company’s stock can sometimes drop when discussing the potential merger, usually if it is a hostile takeover or when there is certain vagueness around the deal.
Note: Learn how to pitch a stock in our dedicated article.
How does the M&A deal affect the target company’s stock?
The target company’s stock price usually rises due to the deal; an acquiring company pays a premium on the target shares to win the appreciation of the target company’s shareholders.
Thus, with the premium paid, the selling company stocks get higher and can attract more potential investors.
However, the stock prices of the target company can fall when the merger occurs. It occurs if the firm experiences some financial issues and uncertainties and an acquiring company purchases it at a discount.
How does the M&A deal affect the acquiring company’s stock prices?
As a rule, the acquiring company’s stock tends to fall for a short period when the deal is announced since it pays a premium — either with its cash reserves or with the help of debt.
Another reason for the drop in the acquirer’s share price is the investor’s opposition to the expediency of such a merger or the sum an acquiring company has paid for the target company.
In certain situations, the acquiring company’s shares rise. It usually happens when investors consider the acquisition of the target company as one that can significantly impact the market and competitors. In this case, the premium paid is worth it.
Note: Learn how to finance a business acquisition in our dedicated article.
What happens to the price of a stock when a publicly-traded company merges with a private company?
When a private company acquires a public company, the stock of the publicly-traded target company tends to rise due to the premium paid on the acquisition. After the deal closure, shareholders receive cash for their existing shares.
When a public firm acquires a private company, its share price may decline due to the same reasons and to reflect the cost of the deal.
What happens to the stock price in a reverse merger?
A reverse takeover occurs when a private company acquires a publicly-listed company (which operates as a shell company). Owners of the private company become controlling shareholders of the public company and run the business.
In this case, the stock price of the public shell company rises, as investors tend to believe in the effectiveness of the new entity formation.
How is the stock price handled among shareholders in mergers and acquisitions?
When a company merges, what happens to the stock? There are three scenarios of how the share price of the companies involved is managed during mergers and acquisitions.
Stock-for-stock
A stock-for-stock exchange is also termed an all-stock deal. With this approach, companies exchange stock for stock.
For example, an acquiring Company A purchases the target Company B, and they agree on a specific exchange ratio, for instance, 1:5. It means that for every five shares of Company B existing shareholders will get one share of Company A when the deal is completed.
Cash-for-stock
This scenario is exactly what it sounds like. An acquiring Company A pays a proposed price in cash for the stock of the target Company B. This way, an acquired company’s shareholders receive a certain amount of money for every share they own.
Cash-and-stock
Two companies can agree on particular terms when planning a merger; thus, they may use a hybrid approach for the shares of the acquired company.
Cash-and-stock scenario presupposes an acquiring firm giving the target company’s shareholders a choice — to get cash for their shares in a new company. Such a model could also mean that the buyer pays a mix of cash and shares to the acquired company’s shareholders.
Key takeaways
So what happens to stocks when companies merge? Let’s summarize the information given in the article:
- The stock price of the acquiring and target companies is affected even if there are rumors of a possible deal.
- When two companies merge, the stock prices of the target company are likely to rise due to the premium paid by the acquiring company.
- The acquiring company’s share price tends to drop slightly during a merger as it uses its cash reserves or debt money to pay for the deal.
- If investors do not see the potential effectiveness of the upcoming deal, the stock prices of the companies involved may fall.
- There are three approaches to managing shares among shareholders during a merger: stock-for-stock, cash-for-stock, and cash-and-stock.
Stock purchase
Despite capital markets’ volatility, the most typical way to buy stocks continues to be via stock exchanges, which makes going public a very likely discussion amongst executives and corporate development professionals.
With this in mind, the M&A Community, in collaboration with iDeals, produced the IPO consideration stage whitepaper, supporting professionals in better understanding the key considerations to take before going public.
Download the whitepaper here.
