Mergers and acquisitions (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.
This article explores what happens when a public company gets bought and what investors should watch out for.
Key takeaways
- When a company is acquired, its stock price usually rises because the buyer offers a premium above the market price to convince shareholders to sell.
- The acquiring company’s stock may drop after announcing a deal, as investors may worry about the cost, strategic fit, or potential integration issues.
- Before a merger or acquisition is finalized, the target company’s stock can become volatile due to speculation.
- Stock-for-stock mergers use a conversion ratio to determine how many shares of the acquiring company shareholders will receive in exchange for their current shares.
- Cash-for-stock deals give shareholders a fixed cash payout per share, and once the deal closes, they no longer hold any stock in the company.
- In cash-and-stock deals, shareholders receive a combination of cash and shares, depending on the terms negotiated between the companies.
- In hostile takeovers, the target company’s stock tends to rise due to the premium offered, while the acquiring company’s stock may decline because of deal risks and uncertainty.
- Reverse mergers typically lead to a rise in the public shell company’s stock, as investors expect growth from the private company taking control.
What happens to the company’s stocks during a merger?
When companies merge, their stocks undergo several changes, typically affecting the acquiring and target firms differently:
- The target company’s stock usually rises after the merger announcement. This is because the acquiring firm often offers a premium — a price above the current market value — to encourage shareholders to approve the deal. This premium reflects the value the acquirer sees in the target and often results in an increase in the target’s share price.
- The acquiring company’s stock may decline, especially if investors are concerned about the cost of the acquisition, potential integration challenges, or increased debt levels. However, if the market sees strong strategic value in the deal, the acquiring company’s stock might hold steady or even rise.
Once the merger terms are finalized, the target company’s shares may be converted into cash, exchanged for shares of the acquiring firm, or replaced with shares in a newly formed company, depending on the structure of the deal (cash, stock, or mixed). After the transaction closes, the target’s stock is usually delisted from the exchange.
Example:
In Microsoft’s $69 billion all-cash acquisition of Activision Blizzard, Activision’s stock surged 37% in pre-market trading following the announcement. This reflected the 46% premium Microsoft offered, valuing Activision at $95 per share. Although Activision had faced challenges before the deal, the announcement led to a typical market reaction: the target’s stock rose, while Microsoft’s stock experienced some volatility as investors assessed the scale and implications of the acquisition.
Read our article on IPO vs acquisition to understand the key differences and strategic implications of these two paths for companies looking to grow and access capital
Is there a pre-merger volatility of stocks?
Yes, there is often pre-merger volatility in stocks, particularly for the target companies. Even before the deal is officially announced, rumors and speculation about a potential merger can have a significant impact on the target company’s stock price. As a rule, its 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.
Discover expert tips and strategies on how to pitch a stock effectively in our dedicated article.
What happens to the company’s stock during an acquisition?
When a company is bought, the stock movement follows a similar pattern to a merger, with the target company’s stock generally rising due to the acquisition premium offered by the buyer. The acquiring company offers to purchase the target’s shares at a premium above the current market value, which makes the deal appealing to the target company’s shareholders. As a result, the target company’s stock price typically climbs as the deal progresses.
The key difference between a merger and an acquisition lies in the size and value of the companies involved. Acquisitions often involve one company that is much larger than the other, leading to a more significant impact on the stock prices. In such cases, the target company’s shareholders benefit from the premium, but the acquiring company’s stock may face more noticeable declines as investors evaluate the potential risks of the acquisition.
Therefore, the larger disparity in company sizes often causes more dramatic shifts in stock value compared to mergers, in which both companies are more balanced in size.
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.
Stock price reactions to hostile 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.
Calculating the stock price after an acquisition
To calculate what your stock is worth after an acquisition, you need to know the stock conversion ratio, especially in a stock-for-stock deal. This ratio tells you how many shares of the acquiring company you’ll receive for each share you own in the company being acquired.
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?
There are three scenarios of how the share price of the companies involved is managed during mergers and acquisitions: stock-for-stock, cash-for-stock, and cash-and-stock. Let’s explore each.
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.
You can explore how taxes impact your payout in more detail in our guide on merger and acquisition tax implications.
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.
To understand the differences between these approaches better, read our article on cash vs stock acquisition.
You may also be interested in learning about “What happens to shares when a company goes private?”
Summary
Understanding what happens to a stock in a merger is essential for investors looking to navigate market changes effectively. These events create opportunities for profit, especially when premiums are involved, but also carry risks if deals fall through. The target company’s stock often benefits in the short term, while the acquiring company’s stock may experience temporary declines. Knowing the type of deal — cash, stock-for-stock, or a hybrid — is key to predicting outcomes.
Investors should pay close attention to conversion ratios, tax implications, and overall market reaction to assess the value of their holdings. Volatility before and after announcements can signal both opportunity and caution. In more complex scenarios like hostile takeovers or reverse mergers, stock movement is even more unpredictable.
Regardless of the structure, staying informed helps shareholders make strategic decisions during mergers and acquisitions.
FAQ
Is a merger good for the stock price?
For the target company, usually yes — its stock price often rises due to the acquisition premium offered by the buyer. However, for the acquiring company, their stock may fall in the short term as investors weigh the deal’s cost, potential debt, and integration risks, though long-term performance depends on the success of the merger.
How is the exchange ratio determined in a stock swap?
The exchange ratio is calculated based on the market value, valuations, and financial outlooks of both companies. It determines how many shares of the acquiring company each target company shareholder receives. This ratio ensures a fair trade based on relative company worth and expected performance.
What happens to my shares if the company I invest in is acquired?
If you hold shares in the company being acquired, they may be converted to cash, exchanged for shares of the acquiring company, or a mix of both, depending on the deal structure. After the acquisition closes, the target company’s stock is typically delisted from the stock exchange.
Is it better to invest in a company’s stock before or after a merger?
Investing before a merger offers higher returns if the deal includes a premium, but it carries higher risk, especially if the deal is delayed, renegotiated, or fails. Investing after a successful merger is usually less risky, as uncertainty is reduced, but the potential upside is typically smaller.
