A buyout is when a company or a group of investors acquire a publicly traded company by purchasing the majority of its voting stock. The buyer must offer a premium over the current stock price to ensure that the shareholders of the selling company agree to sell their shares. When a buyout is announced, the stock price usually jumps to the buyout offer price.
The buyout premium must be sufficient to win over the selling shareholders. For example: If shares of XYZ are currently trading at $28, a buyer may offer $36 for them.
Stock Price Gap Up
The moment the buyout is announced, the stock price jumps and stays close to the buyout offer. Buyouts are usually announced outside regular trading hours so as not to disrupt regular trading. A company that closed at $28 the day before a buyout announcement of $36 per share would open at around $36 the day after the buyout announcement.
Stock Price Prior to Buyout Announcement
Since a buyout creates an instant profit for the existing shareholders, investors are always on the lookout for buyout candidates. Buyers therefore try to keep their plans secret until the announcement is made, but sometimes the information leaks out and a stock may suddenly begin to drift upward on no news but persistent rumors.
Stock Trading After Announcement
A buyout may take months to complete because it must be approved by the shareholders or may require government approval, because other buyers come up with a better offer and start a bidding war or because the board of directors of the company being bought out objects to the offer. This element of uncertainty would keep the shares of the company trading at just under the buyout amount. Shareholders who want to take their profits now, without waiting for the last penny, may decide to sell their shares for slightly less than the buyout price to speculators who purchase them on the expectation of a few cents a share profit if they buy enough shares and the buyout goes through as planned.
Since rumors of a buyout can make a stock price go up, stock market manipulators sometimes try to spread false rumors about a stock just to push up the price to make a profit. As lucrative as buyouts can be to the existing shareholders, it is risky to buy stocks on buyout rumors, because for every actual buyout there may be dozens of rumored buyouts that never materialize.
- “Technical Analysis of Stock Trends”; Robert D. Edwards and John Magee; 2010