Educational resources for each stage of the deal lifecycle. Learn valuable lessons that can be applied to your practice. About DealRoom. Book a demo Log in. DealRoom office hours with halo and paylocity. Lauren Dever. How company stocks move during an acquisition 1. Stock price volatility The mere mention that a company has become a target for an acquisition is usually enough to generate volatility in the stock price of both the buyer and the seller, as traders and analysts try to establish: what the deal means for strategy, how the buyer is going to pay for it, whether the target company is friendly or hostile to the takeover whether it might even trigger a bigger offer from a third party.
A look at the stock price of Red Hat - no longer listed, as it became consolidated with IBM - shows that the stock price began a rapid ascent as soon as the acquisition was formally announced and indeed, a little before, suggesting at least some insider trading 3. In this case, it boils down to how owners of the shares and traders on the market view the deal. When two companies merge The first thing to note here is that mergers in their purest sense are rare.
The CEOs had received a very clear message about what the market thought of the deal. What happens to my stock after a merger and how to calculate stock price? Should you buy stock before a merger or acquisition? There are a couple of issues to consider when thinking about this strategy.
Hence, when talking about merger arbitrage, we urge caution. Example: Merger arbitrage is a common strategy employed by traders. What happens to stock in a reverse merger? The process is also considerably faster: Assuming that a company can fulfill all of the criteria set out by their chosen exchange, a traditional IPO can still take as long as a year to complete.
What does this all mean for your stock? Example: A famous example of a reverse merger it says a lot about the success of reverse mergers that the textbook example is from so long ago occurred in when Ted Turner, the owner of then miniscule Billboard company, acquired Rice Broadcasting.
This was the genesis of his Turner Broadcasting Corporation. What happens to vested and unvested stock after a merger? Unvested stock is more complicated. What happens to preferred stock after a merger?
All Notes. Then if Buyer Inc. Which signal is the market more likely to follow? But if managers believe the risk of not achieving the required level of synergy is substantial, they can be expected to try to hedge their bets by offering stock. Once again, though, the market is well able to draw its own conclusions. Indeed, empirical research consistently finds that the market reacts significantly more favorably to announcements of cash deals than to announcements of stock deals.
In principle, therefore, a company that is confident about integrating an acquisition successfully, and that believes its own shares to be undervalued, should always proceed with a cash offer. Quite often, for example, a company does not have sufficient cash resources—or debt capacity—to make a cash offer. In that case, the decision is much less clear-cut, and the board must judge whether the additional costs associated with issuing undervalued shares still justify the acquisition.
A board that has determined to proceed with a share offer still has to decide how to structure it. Research has shown that the market responds more favorably when acquirers demonstrate their confidence in the value of their own shares through their willingness to bear more preclosing market risk. That leads to the logical guideline that the greater the potential impact of preclosing market risk, the more important it is for the acquirer to signal its confidence by assuming some of that risk.
Therefore, the fixed-share approach should be adopted only if the preclosing market risk is relatively low. Common economic forces govern the share prices of both companies, and thus the negotiated exchange ratio is more likely to remain equitable to acquirers and sellers at closing. But there are ways for an acquiring company to structure a fixed-share offer without sending signals to the market that its stock is overvalued.
Acquirers that offer such a floor typically also insist on a ceiling on the total value of shares distributed to sellers. That might have helped Bell Atlantic in its bid for TCI in —which would have been the largest deal in history at the time. An even more confident signal is given by a fixed-value offer in which sellers are assured of a stipulated market value while acquirers bear the entire cost of any decline in their share price before closing.
As with fixed-share offers, floors and ceilings can be attached to fixed-value offers—in the form of the number of shares to be issued. It just has to compare the value of the company as an independent business against the price offered. The only risks are that it could hold out for a higher price or that management could create better value if the company remained independent. The latter case certainly can be hard to justify. If the bid were rejected, Seller Inc.
So uncertain a return must compete against a bird in the hand. In essence, shareholders of the acquired company will be partners in the postmerger enterprise and will therefore have as much interest in realizing the synergies as the shareholders of the acquiring company. If the expected synergies do not materialize or if other disappointing information develops after closing, selling shareholders may well lose a significant portion of the premium received on their shares. Essentially, then, the board must act in the role of a buyer as well as a seller and must go through the same decision process that the acquiring company follows.
At the end of the day, however, no matter how a stock offer is made, selling shareholders should never assume that the announced value is the value they will realize before or after closing. Selling early may limit exposure, but that strategy carries costs because the shares of target companies almost invariably trade below the offer price during the preclosing period.
Of course, shareholders who wait until after the closing date to sell their shares of the merged company have no way of knowing what those shares will be worth at that time. The questions we have discussed here—How much is the acquirer worth? How likely is it that the expected synergies will be realized? But those concerns should not play a key role in the acquisition decision. The actual impact of tax and accounting treatments on value and its distribution is not as great as it may seem.
The way an acquisition is paid for affects the tax bills of the shareholders involved. On the face of it, a cash purchase of shares is the most tax-favorable way for the acquirer to make an acquisition because it offers the opportunity to revalue assets and thereby increase the depreciation expense for tax purposes. Conversely, shareholders in the selling company will face a tax bill for capital gains if they accept cash.
After all, if the selling shareholders suffer losses on their shares, or if their shares are in tax-exempt pension funds, they may favor cash rather than stock. But if sellers are to realize the deferred tax benefit, they must be long-term shareholders and consequently must assume their full share of the postclosing synergy risk. Some managers claim that stock deals are better for earnings than cash deals.
But this focus on reported earnings flies in the face of economic sense and is purely a consequence of accounting convention. In the United States, cash deals must be accounted for through the purchase-accounting method. This approach, which is widespread in the developed world, records the assets and liabilities of the acquired company at their fair market value and classifies the difference between the acquisition price and that fair value as goodwill.
The goodwill must then be amortized, which causes a reduction in reported earnings after the merger is completed. This approach requires companies simply to combine their book values, creating no goodwill to be amortized. Therefore, better earnings results are reported. Although it can dramatically affect the reported earnings of the acquiring company, it does not affect operating cash flows. Goodwill amortization is a noncash item and should not affect value. Managers are well aware of this, but many of them contend that investors are myopically addicted to short-term earnings and cannot see through the cosmetic differences between the two accounting methods.
Research evidence does not support that claim, however. Studies consistently show that the market does not reward companies for using pooling-of-interests accounting. Nor do goodwill charges from purchase accounting adversely affect stock prices.
In fact, the market reacts more favorably to purchase transactions than to pooling transactions. The message for management is clear: value acquisitions on the basis of their economic substance—their future cash flows—not on the basis of short-term earnings generated by accounting conventions. We present two simple tools for measuring synergy risk, one for the acquirer and the other for the seller.
A useful tool for assessing the relative magnitude of synergy risk for the acquirer is a straightforward calculation we call shareholder value at risk. SVAR is simply the premium paid for the acquisition divided by the market value of the acquiring company before the announcement is made.
The index can also be calculated as the premium percentage multiplied by the market value of the seller relative to the market value of the buyer.
The greater the premium percentage paid to sellers and the greater their market value relative to the acquiring company, the higher the SVAR. In those cases, SVAR underestimates risk. Buyer Inc. In a cash deal, its SVAR would therefore be 1.
But if Seller Inc. To calculate Buyer Inc. The result of a merger could be the dissolution of one of the legacy companies and the formation of a brand new entity. The boards of the companies involved must approve any merger transaction. State laws may also require shareholder approval for mergers that have a material impact on either company in a merger. Stockholders may receive stock, cash or a combination of cash and stock during a merger.
A corporate merger can result in a variety of actions for shareholders. In many cases, shareholders will receive stock, cash, or a combination of the two. Companies in stock-for-stock mergers agree to exchange shares based on a set ratio. For example, if companies X and Y agree to a 1-for-2 stock merger, Y shareholders will receive one X share for every two shares they currently hold.
Y shares will cease trading and the number of outstanding X shares will increase following the completion of the merger. The post-merger X share price will depend on the market's assessment of the future earnings prospects for the new entity.
The share prices immediately following the merger announcement usually reflect the exchange ratio, fears of dilution and prospects for a smooth integration. In cash mergers or takeovers, the acquiring company agrees to pay a certain dollar amount for each share of the target company's stock.
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