How Mergers And Acquisitions Affect Your Investment

A merger combines two existing companies into a new company while an acquisition involves one company acquiring controlling shares of another company, thus gaining control and ownership of it.

There are various corporate actions companies take during the normal course of business. Many of these actions have direct impact to the stock price and consequently, your stock investment.

One corporate action that has an impact on your investment is when a company is part of a merger or an acquisition. A merger combines two existing companies into a new company while an acquisition involves one company acquiring controlling shares of another company, thus gaining control and ownership of it.

There are so many reasons why a company would choose to be part of a merger or an acquisition and they range from the consolidation of market share, leveraging their goodwill, forward or backward integration, and so on.

Mergers and acquisitions have a direct impact on the value of your stock investment as the value per share would change. This is particularly because the end result of a merger is most likely the dissolution of one of the old companies and the creation of a new one.

To determine the exact value of the new shares to shareholders or investors, the company or companies involved in the deal would announce a swap ratio.

A swap ratio is an exchange rate for shares of companies that would be in a merger. The ratio shows what amount the acquiring company offers its own shares in exchange for the other company’s shares.

This is usually calculated by the valuation of the many assets and liabilities of both of the companies involved. An example of how the swap ratio works is that one company would offer a swap ratio of 300:500.

This means that the investors would now get 500 shares in the new entity for every 300 shares they had in the old one.

The reason for having a merger or acquisition in the first place is to increase the share price or value of the new entity based on the synergistic effect of both. So more often than not, this means an increase in shareholding value for the investors.

However, there are situations where this doesn’t work. For one, stock prices might fall when inappropriate valuations had been made.

There is also the risk that comes with uncertainty. It is possible that the acquired company’s shares drop after the acquisition has taken place. This is even worse when the takeover was a hostile one.

Asides the sentiments that come with it, nobody really knows what to expect and any little detail can affect the market perception of the acquired stock. As such, the difference between the acquisition stock price and the new stock price could be high.

The best ways to assess it is to go beyond the price itself. If you are still interested in the merged entity, you have to go a step further to assess this new company as you did for all other stocks in your portfolio.

In other words, you are interested in the business model, the financial track record of the acquired company or the company that has been merged with the one you had shares in, the management and their track record, the new or proposed market value of the entity and so on. Also watch out for red flags.

Written by Lawretta Egba.