EFFECTS OF MERGERS AND ACQUISITIONS ON STOCK PRICES

Stock prices of listed businesses are highly sensitive to changes in the equity market and this aspect can be attributed to economic and political factors as well as health of an organization in focus. Economic and political factors pertain to monetary & fiscal policy, exchange rates and governance while the health of an organization is gauged by the overall performance of the company (payment of dividends, mergers and acquisition, restructuring-layoffs etc).Thus, investors are always advised to adopt a holistic research approach while investing in equities.

Understanding mergers and acquisitions

“Mergers and Acquisitions” (M & A) concept is one of the key business decisions that have profound effect on stock prices. In simple terms, a merger is a process when two independent firms or entities become one i.e. process of amalgamation. Acquisition, on the other hand, can be termed as buying out of one company by another. Here, the acquirer attains full management control of the other entity. 

Stock prices get affected in two ways when an acquisition takes place, one is the price of the acquirer and other is that of the organization which is being acquired. Usually, the latter is recipient of better advantages. 

A popular example of acquisition is that of European steelmaker, Corus by TATA steel while that of a merger is when Godrej Consumer Products merged with the erstwhile Godrej Sara Lee. 

As a word of caution, all mergers & acquisition do not necessary have a positive outcome. For instance, the buyout deal between Time Warner & AOL, touted to be the most promising one looking at market capitalization of the parties involved, ended on a sour note with both entities breaking the contract (de-merger). The result was the crash in AOL stock prices.

Mergers & Acquisitions can take place for the following reasons: 

• Increase the economies of scale.
• Widen the portfolio and the demographical reach.
• Achieve domination in the market i.e. two relatively smaller companies can merge and take on the market leader.
• Tax purposes: They receive tax sops but this criterion is pretty implicit.

So how do M&A’s affect stock prices?

Here are few pointers which will provide a brief snapshot on the affects that Mergers & Acquisitions have on stock prices.

1. For an acquirer, the impact on stock prices depends on the target being acquired. Accordingly, if the market sentiment is showing positive response and believes that this M&A will lead to an optimistic outcome (growth prospects & profitability), the shares will appreciate accordingly. Conversely, a negative sentiment or a neutral attitude will either reduce the stock price or would not show much variation in the current value.

Elaborating on the example given before, when AOL announced its intention to buy Time Warner, the former’s share soared 800-fold. However, due to certain factors, the deal was broken and AOL was then estimated to be worth 3.4 billion $ (a fraction of what it used to be in its heydays). 

In a separate instance, at the time of being acquired by Google in 2011, Motorola Mobility shareholders received $40 a share in cash, an enticing 63% more than the closing price of the same share on August 12 in New York Stock Exchange. 

And in case an acquisition is made by liquidating the acquirer’s stock, it might see decrease in the pricing since the shares are floated on large scale in the public market but the same can be reduced, if the company can convince the existing share holders to buy back at the same prices.

2. For an entity being acquired, usually the share prices see an increase as the acquirer will be buying out the stocks. Also, if the deal is seen to be beneficial in long –term, there would be an increased demand for its stocks, thereby increasing the unit price.