How Mergers and Acquisitions Affect Stock Prices?

The theme of merger and acquisition is a common phenomenon across the companies and industries. Even if you’re merely browsing the news web or flipping the pages, you must have heard about the news of companies going for mergers and acquisitions. But what really is merger and acquisition and does that affect the stock prices in the market? We here will look into this aspect. Read along.

What are Mergers and Acquisitions?

In layman terms, mergers and acquisitions are about the consolidation of companies or assets via a financial transaction or asset transfer. These are a common theme for companies and many opt for it various reasons like business expansion, growth, market capture and more. (We’ll discuss more it down below)

Mergers and acquisitions are often used along interchangeably around but they do hold different meanings if we look at it. A merger is more about two companies coming together or amalgamating into one. For Say, X Ltd and Y Ltd merge. After the merger, they become XY Ltd and continue operating the business operations as planned. Whilst in the case of acquisition X Ltd takes over Y Ltd and Y Ltd ceases to exist after the acquisition. In the case of acquisition, for say, continuing the above example, X Ltd will take over Y Ltd and will pay off the stockholders and owners as prescribed in the mandate during the acquisition.

Why do companies perform M & A?

There are a host of reasons as to why companies opt for mergers and acquisitions. But the major reasons are to scale up the economics of the companies and gain different grounds that were previously hard to access. M & A gives a company increased capability in terms of performance. They can call upon increased research and development, or manufacturing facilities or new technologies that will help them to gain a vital advantage in the industry. Some of the companies also opt for the merger and acquisition so that they can diversify their product portfolio and expand the horizons. Two different companies with different product lineage can merge and expand their product lineups. Another major reason is also the cut back of the costs. If two companies are in the same line of the field then mergers or acquisitions will allow them to cut back on the costs significantly and help improve the profit range for them.

How does M & A affects the stock prices?

Merger and acquisition have quite an impact on stock prices and the stock market. The major onus is how the market reacts to the news of the merger and acquisition. Sometime it may be favourable while sometime it may tread on the line of unfavourable.

In the case of acquisition, the typical theme is that the stock prices of the company which is about to be acquired generally increases in the short term and the share price of the acquirer company decline in the short run. Whenever an acquisition occurs, the acquirer company tends to pay the premium for the acquisition. The reason being that if the acquiring company does not pay a premium then the shareholders of the company to be acquired will not approve the takeover. The share price of the acquiring company will grow around in the long run once the acquisition is completed as the company’s business operations come into the expected growth line. The acquisition also helps a company to acquire economic moat and allows the company to exercise greater ability in terms of performance and all. This will show the flex in the share price as the prices will increase along with time.

When it comes to the merger, the share price of the new company after the merger will significantly be higher than the previous levels. The chances are likely to see the new company gain a stronghold on the economic condition and market after the merger. This will allow them to generate long term performance and result in substantially increasing the value of the company. That will showcase in the share price too resulting in the share price to increase along.

What to do with your Stock during M&A Situation? 

There are different scenarios that may occur during the merger and acquisition situation. We here will analyze it via two different scenarios. Let’s find out.

  • When you own the stocks: If you are an existing shareholder and the company you own the stocks are involved in the merger and acquisition case then there are two scenes further. When the company is getting acquired then you can either take the opportunity or trade-in the shares for cash out. Or you can simply opt to go with the new company and hold the shares and see if the value increases in the long run. If you are the shareholder of the company who is acquiring then you share may dip in value for a short while but will look to gain the momentum and increase pretty soon. In the cases of merger, you can stay put as the shares will rise in value soon.
  • When you don’t own the stocks: When you don’t own the stocks then the scene is a bit different. During the phase of M & A, the prices float at the premium for the acquirer company so it would be wise to stay away from it. In the case of a company that has acquired, the prices are a bit low at the beginning and will go up once the business operations run fully. So it would be wise to take a hard look and only then venture into the market.

Final Words:

Mergers and acquisitions are part and parcel of the business operation and functioning and many companies opt for the same in order to provide an upper hand to tier business. This process of merger and acquisition tends to affect the stock prices of the company in the immediate aftermath and will be based on how the companies tend to perform in the long run. If the company runs in line with its operational goals then it is likely that the stock price will grow with time. As an investor, it is advised that you should be watchful of the market before investing.   

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