Merging your public company with another is a common strategy to increase your market share. You not only reduce your competition but also increase your overall influence in the market segment you operate in. If you are an investor in a company that merges with another one, you might wonder what happens with your stock. In this blog post, we will discuss the dynamics surrounding company mergers. We will discuss the different types of mergers, possible effects on the share price, and other potential risks to your own stock.
You might have already heard the term M&A in some situations. It is short for Merger & Acquisition in Wall Street. There is a difference between these two. If you merge with a company, your company is of roughly equal size to the company you merge with. You sometimes call that a merger of equals. If the acquiring company is much larger than the company that gets acquired, you speak of an acquisition. But what happens with your stocks when companies merge or get acquired?
Your outcome is different depending on the deal itself and on which side of the deal you are. Understanding the market dynamics with M&A is important for you as an investor. It can entirely change your investment thesis.
How is Your Stock handled in different types of M&A?
Before a Merger Agreement or Acquisition Agreement is announced, the companies negotiate the terms of such a deal. There are 3 different approaches for an M&A Deal: Stock-for-Stock, Cash-for-Stock, and Cash-and-Stock. Each of these approaches can have different effects on the stock price and how that stock is handled.
Stock-for-Stock Mergers
When you negotiate a Stock-for-stock-based deal, you essentially negotiate an exchange rate of the stock from both companies. Since no real money is exchanged, you refer to this deal as an all-stock deal.
Consider an acquiring company A purchases company B. They negotiate an exchange ratio of 1:3. For every 3 stocks in company B, you get 1 from company A. Your old shares are basically converted into new shares from the combined company, depending on the exchange ratio.
Cash-for-Stock Mergers
In a Cash-for-stock deal, a price is negotiated in the terms of the deal between the merging companies. When the deal is completed, this price is distributed to all shareholders. You also call that an all-cash deal. To acquire a company fully with cash, the company will need enough cash reserves to complete the deal.
Consider an acquiring company A purchases company B. They negotiate a price per share of $20. This means that for every stock you hold in company B, you get $20 paid out. After the deal closes, you will not own any shares anymore. They will disappear from your portfolio.
Cash-and-Stock Mergers
Sometimes, when companies merge or get acquired, they can negotiate a combination of cash and stock in the terms of the deal. Depending on the deal, a portion of your shares will get liquidated, and another will get converted based on the negotiated ratio.
What are the Possible Effects on Shareholders When Companies Merge?
When one of the companies you own merges or gets acquired, there are many possible effects for you as a shareholder. The stock prices of the companies can be volatile in the short term at times, even before the deal closes. Let’s take a look at some ways M&A can affect you.
What happens after the Announcement of a Deal?
When an announcement is made, the stocks of the involved companies will often be more volatile. The direction of the movement is not always the same. If the price goes down, investors might think that the deal is not in the best interest of the company that gets acquired. Maybe the acquiring company is paying a premium that is too high in the eyes of its shareholders? If the reverse is true, investors might see a bigger opportunity for the new entity that gets formed.
There are many different reasons for both reactions. It does depend on the specific situation. I recommend you research both companies when a deal is proposed. This is the perfect time for you to validate your initial investment thesis. When your company gets acquired, it can change or entirely upend your initial investment thesis. As a shareholder of a company, it is your responsibility to stay on top of any relevant developments for the long term.
What happens if the Acquiring Company is not Publicly Traded?
You call a deal like this a Reverse Merger or Reverse Takeover. If the acquiring company is private and acquires a public company, it is an avenue for that company to become a publicly listed company. By doing so, you circumvent the lengthy process of an IPO (Initial Public Offering). The newly formed entity is now a publicly traded company.
Reverse Mergers vs. SPAC – Two Alternative Ways for Private Companies to Get Listed
Reverse Mergers and SPACs (Special Purpose Acquisition Companies) are two ways private companies can get listed on the stock market without a traditional IPO. These processes are much less complicated and much cheaper. They currently lack some oversight in comparison to an IPO. It’s why we’ve seen a tidal wave of market listings in 2021. Recent changes in economic conditions have cooled down this trend, though.
In a Reverse Merger, a private company takes over a public shell company and becomes a publicly traded new company on stock exchanges. It is a way to raise capital and increase visibility.
On the other hand, a SPAC is a company that raises capital through an IPO to acquire a private company. After the IPO, the company searches for a valid private company to acquire.
What happens when the Company is the target of a Hostile Takeover?
Let’s start with what a hostile takeover actually is. Instead of negotiating a deal, the acquiring company goes directly to the shareholders of the target company against its wishes or by fighting to get the management of the target company replaced. You often observe such takeovers with activist investors. Sometimes they invest heavily in a company because they want to see changes in its management.
Depending on the motivation of the attempted takeover, you might see different effects on your stocks.
Perhaps the most prominent recent hostile takeover was Twitter. Elon Musk acquired Twitter for $44 billion, and shareholders were happy to get $54.20 per share. The company has been taken private after the takeover.
One important characteristic you often see in hostile takeovers is the role financial force plays. The acquiring company has to appeal to the investors. It does that with much capital to get the votes required to succeed. Often, they increase the offer price for the cash transaction until they get shareholder approval. This puts you as an investor in an interesting and favorable position. Even if you don’t agree with the takeover, you can exit at a favorable strike price for your stocks.
How successful are M&A Deals?
According to studies, between 70% to 90% of all M&As fail. And the acquiring companies very often overpay for the acquisition, making it even harder for the deal to succeed.
After the financial crisis of 2008, companies were in an environment of more stability. They had more capital available to achieve their business goals. M&A was trending upwards and has seen an uptrend until recently. The rising interest rates in 2022/23 complicated the M&A strategy since money isn’t as cheap in recent years.
It isn’t hard to see why so many acquisitions are failures. It is a highly disruptive process for both parties. Established processes to do business are disrupted, company culture changes, and priorities shift. It takes time, effort, and strong leadership to fully execute an acquisition. Another danger is losing the most important assets of the acquired company: Its employees. Sometimes, the employees aren’t as excited about the deal as the acquiring company. Some of them might resign as a result of the acquisition. If these employees hold key positions and are essential for running the business, it can present major roadblocks.
Final Thoughts – What Happens With Your Stocks When Companies Merge
M&A activity and events are turbulent times for the stocks and companies involved. You can make a better investment decision if you understand all the dynamics. It’s a good idea to reevaluate your investment thesis to protect your portfolio. Remember that M&A is a widely used strategy companies use to expand their reach. An announcement of such a strategic move does not necessarily need to be bad news for you as a long-term investor. It can actually be good news in a lot of cases.
In this blog post, you learned about different deals, like all-stock deals or cash-for-stock deals. You also learned about how you can be affected as a shareholder depending on the circumstances. In the last section, we have taken a look at the overall M&A environment and recent trends.
Disclaimer: The information in this blog post should not be considered tax advice or a replacement. They are solely provided for informational purposes. Please consult with a tax professional for any specific questions on your taxes. Also, none of the mentioned stocks or companies are to be understood as recommendations. Don’t buy yourself something solely based on what you read here.
