How Do Mergers Affect Stocks?

Author: Jim Pretin

| Posted: 14-01-2008 | Comments: 0 | Views: 24 | Rating: (50)

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From time to time, companies merge with one another. Sometimes, a merger involves a company that you are currently invested in and there are usually rumors of the proposed alliance before it actually takes place. So, the question is, how will this event affect the value of the stock and what should you do?

Mergers are made when the result of joining two companies together will increase the value of both companies. This process is also often referred to as an acquisition. Sometimes two businesses that are close to or equal in value come together and form a new corporation with new stock.

Other times, one company in the transaction is significantly larger than the other, and it buys the stock of the other company and absorbs all of its assets and businesses by issuing stock from the larger company to shareholders of the smaller company. Sometimes cash is paid, but stock-for-stock swaps are more common.

Knowing how a merger will affect your investment in a certain stock requires that you first understand the circumstances and the conditions of the buyout. You should ask yourself three important questions:

1) What is the current financial condition of each company? (If both companies are in good shape, then joining them together will likely make each entity stronger; if one company is in trouble, then the other will be saddled with the problems of the other)

2) How many shares will you have after the merger takes place? (Sometimes, if one company is eliminated after the alliance takes place, the shareholders of the eliminated company will not receive shares equal to what they currently have; you might only receive 1 share in the new company for every 4 shares you had in the old company, and depending upon the current market price, this could actually decrease the overall value of your investment, so you might want to sell before the merger takes place)

3) How much is the acquiring company paying for the smaller company? (If the acquirer is paying less than or equal to what the smaller business is worth, this might not be a good sign, but if they are paying a premium for the other company, this is a sign that the acquisition is remunerative and will increase their overall worth)

Shareholders will typically be given the opportunity to vote on a merger before it takes place. Each share you own will count for one vote. The management of the corporation usually holds most of the shares, so their votes count for the majority, but you should still consider your vote carefully.

You should exercise your right to vote, and your decision should be based upon what will be best for the future value of your shares. You should examine the income statement and balance sheet of the other company involved in the acquisition to get a sense of whether the merger will be beneficial or detrimental.

I hope this information will assist you with reviewing the pros and cons of a merger. Put together all of the relevant facts discussed in this article and you should be able to ascertain what the consequences will be. Just use your common sense and you should do fine.

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How Do Mergers Affect Stocks?

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