When one company acquires another, who usually has the more valuable stock?
In general, when one publicly held company buys out another, which stock is better to buy and when?
There are a number of ways that mergers and acquisitions are accomplished, which all have various consequences. However, the basic logic is that an acquiring company will offer a premium (often called the “takeover premium”) above current equity valuation in an effort to entice a target company’s shareholders to agree to relinquish control of the company.
Say you own a share of company X. If company X is currently trading in the open market – with reasonable liquidity – at $100 per share, and a party contacted you directly and offered you $80 cash per share, you’d probably say “If I wanted to sell my share, why would I sell it to you for $80 when I could sell it right now in the open market for $100?!”
Now, if the same party came to you and agreed to buy your share – while your share is still trading publicly for $100 – and said, “I’ll pay you $120 cash by the end of next month for your share if you agree to my offer right now,” you’d likely, at the very least, consider their offer. If others became aware that someone was offering to buy shares of the company for 20% above market value, they may be tempted to purchase shares at the current market price in hopes that they receive the same offer. This might elevate the share price of the target company.
If this same interested party, instead of targeting individual share-holders (known as a “tender offer”), takes their offer directly to management and/or the board of directors in an effort to purchase all shares of a target company, and this offer becomes known to the public, it is easy to imagine that – depending on the legitimacy of the offer – shares would begin trading much closer to the $120 offer in hopes of capturing the gains provided by any potential difference between current market price and the eventual sale price.
So, for cash offers, the near-term gains are usually accrued to the company being acquired, because shareholders will need to be incentivized to sell. However, offers to purchase a target company are also sometimes made in the acquiring company’s stock, or a blend of stock and cash, which, in the near-term might produce a similar effect on the stock price of the target (acquired) company, but has a multitude of considerations for the intermediate to longer-term.
As for the acquiring company, the idea should be that they are buying the target company to produce value for the shareholders of the acquirer through present or future synergies. One would think that if there were supposed to be a net-financial gain to shareholders because of the synergies created, that the stock of the acquiring company would also increase. Unfortunately, for the shareholders of the acquiring company in the near-term, this is not typically the case – with the exception of purchases that do not materially affect the financial condition of the acquiring company (like your favorite online mega-retailer buying, your local Mom & Pop one off, for whatever reason). Generally, the costlier the purchase, relative to the acquiring company’s market cap, the larger the potential near-term downside market value impact on the acquirer’s shares. Again, the means of purchase (cash, stock, hybrid) will also have various impacts on the perceived value of the acquirer’s shares.
While it is sometimes more difficult to determine what will happen to the acquirer’s shares when they are trying to acquire a company, logic alone tells us that – except under exceptional circumstances – the shareholders of a target company would not willingly relinquish control of their company for less than the price established by public exchange of liquid shares in the open market.
As for the timing of a potential purchase or sale of acquiring and acquired companies, there are a substantial amount of professional investment assets dedicated to buying and selling companies based upon their potential to acquire other companies and/or their potential to be bought and sold. But, even for the pros, timing can be hard.
If you believe that a company is a potential target for acquisition, and that company is purchased, the reward could be great. But you should remember that if you have identified the company as a potential target for takeover, then a lot of other investors probably have too, perhaps building in a potential takeover premium into the current market price; which could increase downside exposure if an offer doesn’t materialize. Unless, of course, you have material inside information about a potential takeover, in which case, if you act upon that information, you could face a not inconsequential amount of jail time.
If this is something you are interested in investing in (Mergers & Acquisitions, not jail time), there are several publicly traded funds that attempt to produce returns via M&A activity. You can drop “merger and acquisition funds” into your search engine of choice for a fair starting point.