Effect of Mergers and Acquisitions on Stock Prices

5 mins read
by Angel One

Growth remains a priority for all businesses/entities. Generally, there are two types of growth for any company, first is organic growth which comes from growth within the company and the second one is inorganic growth which comes from Mergers & Acquisitions.

In inorganic growth i.e Mergers & Acquisitions (M&As) there are the two commonly used business strategies, companies go for to take advantage of economies of scale, improve their market competitiveness, enable diversification, enter the global market among others.

What is in it for an investor if two companies decide to go for M&As?

The process of M&As has an impact on the stock price of the companies involved right from the whispers of an announcement in the market to the execution of the process and aftermath.

As an investor, it would be helpful for you to make an informed choice during a M&A if you know how the stock prices of companies move during M&A.

Here we are to let you know the impact of M&A on stock prices.

How do company stocks move during an acquisition?

  1. Volatility in stock prices

The mention of the acquisition across the stock market can trigger volatility affecting the stock prices of the buyer and seller company as the traders and stock market analysts get busy trying to establish what the deal means for strategy, how the buyer is going to pay for it, whether it will trigger a bigger offer from a third party and so on.

For example, when the news of Walmart acquiring 77% of Flipkart’s holding for $16 billion was out, the share prices of Walmart fell by 3.1% as the stock market analysts viewed the price tag as hefty. (source: Economic Times)

  1. What happens to Target company’s stocks during the acquisition?

It is seen in general that the acquisition tends to increase the stock prices of the target company i.e, the company about to be acquired. The rationale here is that the acquiring company has to pay a premium to acquire the company. Thus, the listed stocks of the target company tend to shoot up for a short term as the impending deal of acquisition is about to bring in the premium.

For example, the closing of the Tata Steel-Corus acquisition deal in January 2007 led to the rise of Corus(target company) shares by 7% to 603 pence on London Stock Exchange (source: Business Standard)

But there are always exceptions. Say, if the target company’s stock prices crashed recently due to negative earnings or if the company is being acquired at a discount then the chances of stock prices of the target company going up is minimal.

  1. What happens to Acquiring Company’s stocks during the acquisition?

In general, the stock price of the acquiring company tends to fall as it has to pay the premium to the target company by taking out of its cash reserves or may incur a debt to finance the acquisition deal.

From the above example, on striking the acquisition deal with Corus, Tata Steel stock fell almost 11% on the Bombay Stock Exchange in January 2007 and continued to fall up to 16% as the stock market viewed the deal as not reasonable due to the heavy debt incurred by Tata (source: Business Standard)

However, the stocks of the acquiring company during acquisition are driven by the terms of the deal, funding sources, traders’ and analysts’ opinions on the deal, investors’ sentiment about the deal, etc. Considering these factors, if the acquisition deal is believed to generate a positive impact and consider the premium paid is worth, the stocks of the acquiring company may rise in such cases. On the other hand, if it is believed that the acquisition deal may bring down the value, the stock prices of the acquiring company may see a fall or not see an expected rise.

  1. How do the stocks move after acquisition?

After the acquisition, it is generally perceived that the stocks of the acquiring company gain momentum and grow in the long run only if the acquisition is proved to be efficient and effective. The acquisition of Jaguar Land Rover by Tata Motors* is one such example.

The other way round can happen if the acquisition doesn’t meet the expectations, creating losses for the acquiring company. The acquisition of Corus by Tata Steels* is seen as an example of an acquisition that went wrong down the road. (* source: Economic Times).

How do the merging companies’ stocks move during a merger?

Like in acquisition, the speculation of mergers in the stock market may lead to price volatility. For example, the share price of Idea shot up to ₹ 120 from the average of ₹ 72.5 when the talks about the Vodafone-Idea merger deal began. (source: Livemint)

Again, the stock market’s view(+ve or -ve) towards a merger, the terms of the deal and other factors drive the stock prices(up or down) of the companies involved in a merger. The share price of Idea fell back to ₹ 93 after the announcement of the merger deal as the investors turned skeptical due to a lot of operational issues reported. (source: Livemint)

What happens to your shares if you are a shareholder in the merging companies?

A merger results in the creation of a new entity. Say, if company ‘X’ and’Y’ are merging to form a new entity and have decided to hold the shares of the new entity in the ratio 55:45 respectively, then the 100% of ‘X’s stocks would be diluted into 55% of new entity’s stocks and 100% of ‘Y’s stocks would be diluted into 45% of new entity’s stocks.

Conclusion – Beginning from the spread of news of M&As in the stock market to the closure of deals and the performance of the entity aftermath, M&As affect the stock price of the company. You should be watchful of the market and do your due diligence before making any investment decisions.