What happens to stocks when companies merge?

M&A is a popular way for companies to increase market share, reduce competition, expand geographical influence, and improve the current market price. However, these deals involve complex financial and strategic considerations, especially for investors who hold stocks in the companies involved.

When a public company is acquired, it raises critical questions about the fate of its stock, including changes in share value, volume, and volatility. Understanding the implications of M&A transactions on stocks is crucial for investors, as it directly affects their investment decisions and potential returns.

So, what happens when a public company gets bought? What happens to stock when a company is acquired? And what is the impact of mergers and acquisitions on shareholders? Find out in the article.

How do mergers and acquisitions affect the stock prices of two companies?

Based on our experience, the M&A influence on the target and acquiring company stock varies due to several factors. Let’s discuss what happens to shares in a takeover, and describe all the acquisition scenarios on the changes to the share price.

Let’s start with answering these questions:

• Is there a pre-merger stock volatility?

• How does the M&A deal affect the target company’s stock?

• How does the mergers and acquisitions deal affect the acquiring company’s stock prices?

• What happens to the price of a stock when a publicly-traded company merges with a private company?

• What happens to the stock price in a reverse merger?

• How is the stock price handled among shareholders in mergers and acquisitions?

Is there a pre-merger volatility of stocks?

The target company’s stock can be affected even before the actual deal is initiated. Mere rumors about the potential merger influence the target company stock. As a rule, the target firm’s stock price rises due to the acquiring company’s interest in it. It can often be profitable for investors who usually purchase selling company stocks in expectation of the upcoming merger.

However, such an approach comes with potential risks since rumors about a prospective takeover do not always lead to the deal’s closure. If the merger (or the acquisition) never happens, the target company’s stock falls dramatically, and investors lose large sums.

For instance, if Company A is rumored to be acquiring Company B and the deal falls through, Company B’s stock might drop back to or below its pre-rumor levels. It is also worth noting that the target company’s stock can sometimes drop when discussing the potential merger, usually if it is a hostile takeover or when there is a certain vagueness around the deal.

How does the M&A deal affect the target company’s shares?

Our findings indicate that the target company’s stock price usually rises due to the deal; an acquiring company pays a premium on the target shares to win the appreciation of the target company’s shareholders.

For example, if Company A offers to buy Company B at a premium price of $100 per share while Company B’s current market price is $80, the stock price tends to rise toward the offered price, similar to other acquired companies. This premium can attract more potential investors.

However, the stock prices of the target company can fall when the merger occurs, especially if the firm experiences financial issues or uncertainties, leading the acquiring company to purchase it at a discount. In such cases, even the merger announcement may not sustain a high stock price if the market perceives the acquisition negatively. Shareholder strategies may also change based on these fluctuations.

How does the M&A deal affect the acquiring company’s stock prices?

As a rule, the acquiring company’s stock tends to fall for a short period when the deal is announced since it pays a premium — either with its cash reserves or with the help of debt.

Another reason for the drop in the acquirer’s share price is the investor’s concerns regarding the value of the deal or the sum paid. For example, if Company A acquires Company B at a high premium, Company A’s stock might decline if investors believe the acquisition price is too high or the strategic benefits are unclear.

In certain situations, the acquiring company’s shares rise. It usually happens when investors consider the acquisition of the target company as one that can significantly impact the market and competitors. An example could be when a tech company acquires a startup with innovative technology, potentially leading to a rise in the acquirer’s stock if the market sees strong future growth potential. Monitoring the stock price after acquisition is crucial in these scenarios.

What happens to the price of a stock when a publicly-traded company merges with a private company?

When a private company acquires a public company, the stock of the publicly traded target company tends to rise due to the premium paid on the acquisition. After the deal closure, shareholders typically receive cash for their existing shares, leading to the delisting of the public company’s stock.

Conversely, when a public firm acquires a private company, its share price may decline due to the same reasons and to reflect the cost of the deal. This decline can occur if the market perceives the purchase price as too high or if the integration of the private company poses significant challenges. For example, if a public company buys a smaller, innovative private company but overpays, its stock might drop as investors question the value gained from the acquisition.

Hostile takeovers and reverse mergers

A reverse takeover occurs when a private company acquires a publicly listed company (which operates as a shell company). Owners of the private company become controlling shareholders of the public company and run the business. In this case, the stock price of the public shell company rises, as investors tend to believe in the effectiveness of the new entity formation.

In contrast, hostile takeovers occur when one company attempts to acquire another against the wishes of the target company’s management and board of directors. This type of acquisition is typically executed through a tender offer, where the acquiring company proposes to purchase shares directly from the target company’s shareholders at a premium price, or through a proxy fight. In this case, the acquiring company attempts to convince shareholders to replace the existing management with a team more favorable to the takeover.

So, here’s the key difference between standard merger, reverse merger, and hostile takeover:

• Standard mergers are typically amicable, with both companies’ management teams negotiating terms and agreeing on the merger.

• Reverse mergers allow private companies to become public quickly by merging with a public shell company.

• Hostile takeovers are characterized by a lack of cooperation from the target company’s management, with the acquirer appealing directly to shareholders.

When it comes to the impact on stock prices, reverse mergers often see the stock price of the public shell company rise as investors anticipate the benefits of the merger. In the case of hostile takeovers, the target company’s stock price usually increases due to the premium offered, while the acquiring company’s stock might initially decline.

Regarding shareholder value, reverse mergers can be beneficial as shareholders may profit from the increased stock price if the private company performs well. On the other hand, in hostile takeovers, shareholders benefit from the premium price but face risks if the integration is problematic.

Stock conversion ratios

Stock conversion ratios are essential in mergers and acquisitions, especially during stock-for-stock transactions. They determine how many shares of the acquiring company will be exchanged for each share of the target company. Essentially, this ratio defines the value and the exchange process between the two companies’ stocks.

For example, if Company A is acquiring Company B and the agreed conversion ratio is 1:4, it means that for every share of Company B, shareholders will receive one-quarter of a share of Company A.

Stock conversion ratios are crucial because they directly impact the value of shares for both companies involved. They determine the relative ownership stakes and influence how much of the new combined company’s equity shareholders will receive. This ratio helps ensure that the exchange is fair and reflects the relative values of both companies.

The ratio is usually negotiated between the two companies and is based on various factors, including the market value of each company’s stock, their financial health, and future growth potential. Valuation models, financial forecasts, and strategic considerations all play a role in setting the stock conversion ratio.

How is the stock price handled among shareholders in mergers and acquisitions?

When a company merges, what happens to the stock? There are three scenarios of how the share price of the companies involved is managed during mergers and acquisitions.

Stock-for-stock

A stock-for-stock exchange, also termed an all-stock deal, is a type of stock-for-stock merger. With this approach, companies exchange stock for stock. 

For example, an acquiring Company A purchases the target Company B, and they agree on a specific exchange ratio, for instance, 1:5. It means that for every five shares of Company B existing shareholders will get one share of Company A when the deal is completed, affecting the new company’s shares distribution.

Cash-for-stock

This scenario is exactly what it sounds like. In cash and stock acquisitions, an acquiring Company A pays a proposed price in cash for the stock of the target Company B. This way, an acquired company’s shareholders receive a certain amount of money for every share they own.

The capital gains tax implications for shareholders need to be considered in such deals. Also, shareholder approval is often required in these scenarios to ensure that the merger terms are acceptable to the shareholders.

Cash-and-stock

Two companies can agree on particular terms when planning a merger; thus, they may use a hybrid approach for the shares of the acquired company.

Cash-and-stock scenario presupposes an acquiring firm giving the target company’s shareholders a choice — to get cash for their shares in a new company. Such a model could also mean that the buyer pays a mix of cash and shares to the acquired company’s shareholders.

Key takeaways

So what happens to stocks when companies merge? Let’s summarize the information given in the article:

• The stock price of the acquiring and target companies is affected even if there are rumors of a possible deal.

• When two companies merge, the stock prices of the target company are likely to rise due to the premium paid by the acquiring company.

• The acquiring company’s share price tends to drop slightly during a merger as it uses its cash reserves or debt money to pay for the deal.

• If investors do not see the potential effectiveness of the upcoming deal, the stock prices of the companies involved may fall.

• Reverse mergers allow private companies to go public quickly by acquiring a shell company, while hostile takeovers involve acquiring a company against its management’s wishes, with stock prices and shareholder value impacted differently in each scenario.

• There are three approaches to managing shares among shareholders during a merger: stock-for-stock, cash-for-stock, and cash-and-stock.

• Stock conversion ratios are a critical component of mergers and acquisitions, guiding the equity exchange and influencing how shareholder value is distributed in the newly combined entity. 

Stock purchase 

Despite capital markets’ volatility, the most typical way to buy stocks continues to be via stock exchanges, which makes going public a very likely discussion amongst executives and corporate development professionals.

With this in mind, the M&A Community, in collaboration with iDeals, produced the IPO consideration stage whitepaper, supporting professionals in better understanding the key considerations to take before going public.

Download the whitepaper here.