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How do Mergers and Acquisitions Affect Stock Prices

13 January 2022

There are times when two companies decide to combine to form a stronger company in one form or another. While there are many ways in which two companies can combine, two of the most common processes are Mergers and Acquisitions. 

There are various reasons behind a company opting for a merger or agreeing to an acquisition like increasing the market share, geographical outreach, reducing competition, etc. In fact, this happens more often than we realize because, on most occasions, such mergers/acquisitions don’t make it to the headlines unless the companies involved are big and popular. 

Learn the fundamental meaning of mergers and acquisitions. Discover how they affect the stock prices of individual companies. Know the difference between merger and acquisition. 

Mergers and Acquisitions (M&A), in simple terms, is when a company merges with another company or acquires a company for several purposes.

An M&A can take place for several reasons such as:

  • Expansion of Market share– Merging and acquiring companies saves time and helps in increasing the market share.
  • Asset Acquisition – By acquiring assets, a company gets an upper edge in expanding its reach in the market.
  • Synergy and Diversification– When Vodafone and Idea merged and formed Vodafone Idea Ltd, they acted as synergy. By doing this, they were able to face the giant, Reliance Jio, which took the industry by storm.

What happens in a Merger/Acquisition?

Before understanding the effect of M&A on stock prices, let us first understand what happens during a merger/acquisition of a company. 

The new company formed as a result of the M&A will issue new shares after both the companies surrender their existing shares.

In the case of an acquisition, the acquiring company’s shares are not affected. The company that gets acquired stops trading its stocks in the market. In addition, the shareholders of the acquired company get the shares of the acquiring company.

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 the 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.

Tata Steel and Corus Group

  • 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. 

Frequently Asked Questions (FAQs) 

Q1. Are mergers good or bad for stocks? 

The reason and the context behind the merger will determine the effects on the stock prices. Generally, it is seen that the acquiring company that pays the premium witnesses a dip in stock prices.

Q2. What if I own the shares of the company which is being acquired? 

In such a case, if the acquiring company distributes cash for those shares, you will receive the said amount, and the acquired company’s shares will disappear. 

If the acquiring company distributes shares of their company, the shares as per the deal will be credited to your account.

Q3. Is it good to buy stocks before a potential merger? 

The acquired company usually gains from the deal as they receive a premium from the acquiring company. The news of such a deal is sufficient to affect the stock prices even before the event. There should be a detailed analysis of the agreement before taking such an investment decision. 

Q4. Why does M&A work? 

Mergers and acquisitions are necessary for combining individual strengths of companies and bringing something unique to the table.

M&A is required for big companies to take advantage of the technologies and innovations of smaller companies to keep them ahead of the game. 

Disclaimer

The stocks mentioned in this article are not recommendations. Please conduct your own research and due diligence before investing. Investment in securities market are subject to market risks, read all the related documents carefully before investing. Please read the Risk Disclosure documents carefully before investing in Equity Shares, Derivatives, Mutual fund, and/or other instruments traded on the Stock Exchanges. As investments are subject to market risks and price fluctuation risk, there is no assurance or guarantee that the investment objectives shall be achieved. NBT do not guarantee any assured returns on any investments. Past performance of securities/instruments is not indicative of their future performance.
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