LEVEL: BEGINNER
Corporate acquisitions, sometimes called “buyouts” or “takeovers” are simply when one company buys another company. Acquisitions form the latter-half of the “M&A” acronym (the “M” stands for “mergers”), and are an important development for a publicly traded company.
While an acquisition sounds like a good thing–after all, the company is performing so well that someone else wants to buy it out and get in on the profits–that isn’t always the case. Some acquisitions are unwanted, and take the form of a what’s known as a “hostile takeover.”
These different types of acquisitions will have predictable impacts on a stock price, and several investors will buy up companies that they expect will be purchased by larger companies in the hope of capitalizing on that interest.
Friendly and Hostile Takeovers
A friendly takeover is when one firm offers to buy another firm on terms that the to-be-acquired firm finds acceptable. These sorts of acquisitions are usually announced by both firms at the same time and the announcement will stress that the acquisition was agreed upon by both sides.
Hostile takeovers, on the other hand, occur when a company does not want to sell itself, but an acquiring firm still buys a majority amount of shares in the company. When they have a majority, they effectively own the firm.
To stop this from happening, a board of directors will often release only a minority amount of shares to the general public, although this strategy is not always effective.
Both friendly and hostile takeovers will result in a higher stock price. To entice shareholders to sell their stocks, firms looking to buy a company will usually offer to buy shares at a much higher price than the current market price.
Acquisition Premiums and Discounts
There is a significant delay between the moment when an acquisition is announced and the deal is closed and finalized. During that time, the value of a company may go up or down.
For example, imagine Company A offers to buy Company B for $40 per share on January 1st, but the deal will be completed on May 1st. During those four months between the time the deal is made and the deal closes, many things can happen both to Company B and to the marketplace. If Company B suddenly becomes less valuable–let’s say it’s worth $35 per share for some reason–Company A is still legally obligated to buy it at the price already agreed upon. This is known as an acquisition premium.
Things can work the other way, where Company B is worth more than Company A offered to pay. Since the price remains fixed, Company A gets to buy B at an acquisition discount.
Acquisitions and Stock Price
In the cases of friendly takeovers, the purchasing firm will almost always buy the purchased-company at a price higher than its market value as reflected by its market capitalization. In other words, the purchaser offers to buy the company at a higher stock price than its current price on the market. This difference can be sizable, and once they are announced, investors will usually bid up the stock of a company to match that amount.
For example, if Company A says that they will buy Company B for $40 per share but the company is currently trading at $30 per share, the stock will almost always jump to at least $40. Often, the stock will jump much higher. This jump happens in a matter of seconds after the announcement is made, and will invariably happen before the news is released by mainstream media sources and websites.
Since investors cannot easily capitalize on this premium after the merger has been announced, they will try to invest in companies that they think are perfectly positioned for a takeover. This particularly applies to small-cap and mid-cap companies, although large-cap companies have acquired other large-cap companies in the past.