Mergers and acquisitions (M&A) are described as the stabilization of companies. Separating the two terms, Mergers is when two companies to form one. Acquisitions are when one company took over by the other. M&A is one of the major aspects of the corporate finance world. The reasoning behind M&A usually is that two separate companies together create more value as opposed to being alone. With the purpose of wealth maximization, companies keep evaluating different opportunities through the program of merger or acquisition.
A merger or an acquisition ordinarily begins with a set of casual conversations among the boards of the companies. The further protocol is an official meeting, a letter of intent, agreement, and finally, the transfer of payment.
Difference between Mergers and Acquisitions
Mergers and acquisitions generally come as synonyms. However, take a look at the explanation above. The two unions are different in subtle ways.
In a merger deal, a new company is formed by two companies. After the merger, these separately owned firms become a single object and are collectively owned. During the process of merger, the stocks of these companies are abdicated and the new company issues the new stocks. It is usual that companies of similar sizes implement the process of merger.
When Merger A + B = C
In the case of an acquisition, one company takes another company. The consequence is, establishing a unique owner. Mostly, a powerful and larger organization takes over a smaller and less powerful company. The larger company keeps its whole authority and the smaller company has to lose its presence. In contrast to the merger, stocks of the company are not surrendered at all. The shares of such companies continue to be traded in the stock market.
When Acquisition A + B = A
There are several reasons for mergers and acquisitions. Take a look at the table below.
There is a regularly increasing value created after the merger of two companies. This can be noticed either through higher revenues, lower expenses, or decreasing the overall cost of capital.
The effects of mergers and acquisitions on stock price behavior
A corporate merger has an influence on shareholders. In many cases, shareholders will receive stock, cash, or a combination of these two.
Here is one example.
The Walt Disney Company bought Marvel Entertainment, Inc. for $4 billion in 2009.
At the time of the agreement, Marvel shareholders would have received $49.3998 per share at closing. But, before the merger finished the share price of Marvel Entertainment, Inc was just $48.37. The difference is obvious, the full point below.
This isn’t unusual in mergers. But how the traders can catch advantage of it?
You should watch the market bottom. When activity begins to slow it is a sign that prices in the market may start to run lower. M&A activity is in general at a market bottom because lower stock prices are desirable to future investors.
Stock prices can change even after a merger is announced
An arising question is why the acquisition objective’s stock price does not equal in the value the acquirer will pay.
In other words, if company XYZ is buying company ABC’s stock for $15 a share in several weeks, why doesn’t company ABC’s stock equal $15 after the announcement?
Here is the answer.
This difference between the price per share, at the beginning of the M&A and its actual trading price, consider the risk about the merger. If the acquisition never really occurs, the stock of company ABC will probably fall.
That is a delta, that differential.
For instance, if the company was subject to an unfriendly or unwanted takeover, the disparity between the acquisition stock price and the current stock price will be extremely big. That will show that management tries to protect the company from the potential acquirer.
Or to lure a rescuer to protect it from the bigger firm.
The acquisition target’s stock may rise above the takeover offer
This can occur when traders assume that there may be some other bidder that will give more for the company. This will not happen so often, but still.
You should think before trading, even twice if you are not a gambler.
It may be beautiful to take benefit of the differential by shorting the ratio of the acquirer’s stock. But, as I said, think twice.
The risk/reward ratio can be very low. It is possible to build a great but doubtful portfolio of highly-leveraged trade.
This is notably dangerous but the chaos could be very generous if the merger not occur.
Never try this strategy before practicing with paper money.
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What the formula in the lesson is shown as the example of a merger?
What the formula in the lesson is shown as the example of an acquisition?
The reasons for M&A could be…