How do Mergers and Acquisitions Affect Stock Prices

Difference Between a Merger and Acquisition

The primary difference between a merger and an acquisition is that a merger occurs between two well-off companies, usually by a mutual decision between both companies. They meet to synergize and strengthen the market share as a new company.

An acquisition occurs when a company with more influence in structure, size, and position in the market acquires another company. An acquisition may not necessarily be a mutual decision; there can be hostile takeovers too.

Here is an example of a hostile takeover: India Cement Limited bid for Raasi Cements Limited and offered 20% of RCLs share.

How do Mergers and Acquisitions Affect Stock Prices?

Now that you know what happens during M&A let us understand the effect of such an event on stock prices.

• Volatility in Stock prices

Since such deals do not happen regularly, the impact of such mergers and acquisitions is visible in all areas of both companies.

Firstly, the stock prices are affected as the news of such a merger or acquisition is enough to create volatility in the market.

Once the reasons for such a step taken by the companies are known, that reason will act as a driving force for the stock price. 

For example, when Walmart acquired 77% of Flipkart for $16 billion, many experts questioned the deal. This was because paying such a price justified when Amazon is standing tall in the Indian E-Commerce market. The stock of Walmart’s price then stumbled by 4.2% in the New York Stock Exchange because of the pessimism around the deal. 

• How is a target company affected by a Merger and acquisition deal?

Acquiring a company comes with a cost, which is called a premium. The acquiring company pays the premium for the work that built the company from scratch. The stock prices of the acquired/target company tend to rise as they receive a premium from the acquiring company.

Example: 

Tata Steel Ltd. had talked about acquiring British Steelmaker Corus Group in an M & A deal. Because of this, the stock price of Corus shot up as the premium paid by Tata Steel was high. 

Refer below.

• How is the Acquiring company affected by a Merger and Acquisition deal?

The acquiring company gets affected differently from the target company. In a general sense, we can see that the stock prices of the acquiring company tend to go down as the company has to pay a premium to acquire the other company. 

Considering the above example, the heated bidding between Tata Steels and a Brazilian Company to buy Corus went down the wire. Tata steel finally outbid Brazil’s Cia and offered to pay 608 pence for every share of Corus. 

The effect of such a deal was evident as Tata’s share price fell by 16%, as the heavy debt burden on the company might not have been reasonable.

However, this might not be true in all cases.

Suppose the acquisition is genuine and can have a profound impact on the competitors and the market. In that case, the premium is worth it, and, in such a case, people buy the stock, and the price rises.

Key Takeaways

• It is essential to evaluate the reasons and the details of the Merger and Acquisition deal. The decision to participate in the agreement in terms of investing depends on this research about the merger.
  
  
• Mergers and acquisitions are made for several reasons: rapidly growing your business, taking advantage of the synergy by merging with other companies, etc.
  
  
• Mergers and acquisitions deals affect stock prices to a large extent. 
  
  
• There are no set rules on how the stock prices will react to an M&A event, and it entirely depends on the type of deal.
  
  
• There are two ways of looking at the effects of mergers and acquisitions on stock prices – short-term and long-term. While the short-term view is preferred by traders seeking volatility to book profits, long-term investors need to spend more time assessing the profitability of the deal before taking a long-term position in the companies undergoing a merger or acquisition.

Disclaimer: This blog is solely for educational purposes. The securities/investments quoted here are not recommendatory.