1. The purchasing company will need to pay a premium for the target company in order for the board of directors and majority stake owners to agree to the deal.
2. The purchasing company will also have to pay a premium in order to out bid any other potential buyers.
3. Market sentiment. A large percentage of mergers and acquisitions do not turn out as hoped. Research analyst and institutional investors (or minority interest share holders) may not feel that the acquisition will be profitable in the long run for the acquirer.
4. Arbitrage positions. Since investors know that the stock price of the acquiring company usually falls, and the price of the target company usually rises, they will buy stock in the target company and sell stock (short the stock) in the acquiring company to create a risk free profit (also know as arbitrage). This will result in more volatile changes in the stock prices.
For the reasons above being able to predict possible mergers or acquisitions can be very profitable.
Example:
On August 16, 2010 Dell announced a bid to acquire a company named 3Par, for $1.15 billion ($18/share). On August 13, 2010 (Friday) the stock price of 3Par closed at $9.65. On Monday morning before the market opened, Dell announced its bid to acquire 3Par for $18/share, causing the stock price to surge 86.5% to $18. On August 23, 2010 Hewlett-Packard came into the picture announcing a $1.6 billion or $24/share bid for 3par causing another surge in the stock price, increasing from $18 to $26/share on August 23, 2010. The bidding continued with Dell coming out with a $27/share and finally H-P announcing a $2 billion or $30/share bid that finally closed the deal. Looking at the chart below, you can identify the dates that each bid came out and the approximate amount of the bids by analyzing the increase in stock price.
Now lets see how this altered the stock prices of Dell and HP. From the charts below, during the period of bidding, both HP and Dell contained decreases in stock prices, even though these fluctuations were not as significant as with 3Par.
As shown from the above example, mergers and acquisitions can significantly change a company’s stock price. This is why many institutional traders try to predict possible transactions, such as the above, in order to take advantage of the huge price movements.
I agree with the fact that it would be a great idea to invest in the target company. For example, when Palm was in the process of selling itself, the company's stock closed on April 12, 2010 nearly 18% higher at $6.08. Later that same month HP bought Palm, but my question is why the acquiring company's stock value would fall instead of rising? Shouldn't acquiring another company cause the stock value to go up instead.
ReplyDeleteThanks Karan. Per your question on why the acquiring companies stock price decreases, please see numbers 1-4 above. The acquiring company will be paying a premium to purchase the target company, the research analyst and institutional traders may have negative sentiment towards the purchase or purchase price, and traders may be taking advantage of an arbitrage position. All of these reasons may have a negative effect on the short term stock price of the acquiring company.
ReplyDeleteI completely agree with Karan. It would seem like a good idea to purchase stock in the target company. After reading, it now makes sense to me why the purchasing company's stock would go down after such purchases. It seems that this article downplays the positives of merging and/or acquiring businesses. I would hope that there are businesses that end up better as a result of merging/acquiring another company. My question is: which of the bids for 3Par are fair bids? It seems to me that the initial bid of $18 per share is quite an increase in stock price. The final purchase was at $30 per share. Are monetary increases in bids done just to win the right to buy the company? Is it truely worth it to buy out a company for that large of a price?
ReplyDeleteA "fair bid" is in the eye of the beholder. Valuation of a company is arguably more an art than a science. Especially when it comes to a potential acquisition, as you have to predict how well it will fit into your existing business and the value of the benefits of doing so (synergies) in addition to your estimated valuation of the target alone.
ReplyDeleteUsually a buyer comes up with a "valuation range" to allow for the potential inaccuracies of their assumptions, and also to get the numbers for a first bid and highest amount they would be willing to bid.
"Are monetary increases in bids done just to win the right to buy the company?"
If your competitors are bidding against you for the same target, you also have to add the value of being at a competitive advantage in your industry with the target, or more directly, the value of not being at a disadvantage if your competitor obtains the target.
Is it worth it? It depends on your own valuation. Everyone's valuation will be different because there are so many assumptions that must be made to come up with a value. This ties into #3 of Mr. Cunix's post, the acquiring company could come up with a positive valuation, while shareholders or analysts could come up with a not so great one.
great discussion! Let me add a point or two. Karan makes a very good point: if a company makes a good acquisition, shouldn't its stock go up instead of down? The answer is, as Mr. Ruttenberg suggests.....it depends! One would hope that all acquisitions are made at prices that are lower than what the acquiring company thinks the target is worth (even if others disagree with that assessment!) Such investments ought to add value to the business of the acquiring company and cause its stock price to rise. It is true that some acquisitions are made at prices that exceed the acquiror's valuation of the target, but I doubt that this happens very often. However, other stock market participants may have a less favorable view of the value of the target and see the acquisition price as excessive. Paying too much, in those investors' minds, is a bad management decision and, therefore, a great reason to sell the stock of the acquiror (putting downward pressure on its stock price.) Remember that market prices--the prices at which actual trades take place--are the result of a buyer and a seller having different views of the value of the same thing: in this case, the value of a stock.
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