Companies sometimes merge to cut costs, combine skills and resources or to gain a competitive advantage over other companies in the same market. The effect of a merger on the stock prices of the companies involved depends to a great degree on the mechanics of the merger – particularly whether it's truly a merger or just an acquisition dressed up as one. Prices may rise, fall or stay the same depending on which company's stock you're looking at and how the deal is structured.
Mergers Are Usually Acquisitions
Most "mergers" you hear about aren't really mergers at all – they're acquisitions. This is why the activity is commonly referred to as M&A, for mergers and acquisitions.
In a true merger, or "merger or equals," two companies combine their operations into a single, brand-new company, says the Corporate Finance Institute. The old companies cease to exist. Their stock is canceled, and stockholders receive shares of the new company.
In contrast, an acquisition is what happens when one company purchases another, either with cash, stock or a combination of both, and integrates that company into its own operations. Going forward, the company may be renamed or rebranded, but it's still the same firm that executed the acquisition.
Read More: Will a Merger Affect Stock Prices?
Merger of Equals
When a merger really is a merger – a merger of equals, that is – stock prices might not change much, if at all. If you own $100 worth of stock in one of the merging companies, the deal will be structured so that you'll receive something like $100 worth of stock in the new, combined company. Unlike with an acquisition, in which the acquiring company typically pays a little something extra for the stock to sweeten the deal for shareholders, there's no "premium" in a merger.
The idea is that shareholders will now own stock in a stronger company with greater growth prospects, which will translate into higher share prices in the future.
Read More: Difference Between Strategic & Financial Mergers
Targeted Company Stock Price
When a merger is actually an acquisition, one company is the "acquirer," while the other is the "target." The acquirer typically has to offer a premium to the shareholders of the target company. If it doesn't, those shareholders – and the board of directors, whose job it is to look after their interests – won't have any incentive to accept the acquisition.
In general, prior to an acquisition, the stock price of the target company will rise to whatever level the acquirer is offering for it. This is just common sense: If someone will soon be paying $80 a share for a certain stock, then any shares available for less than that will be immediately snapped up by investors looking for essentially free money.
Read More: Why Do Stock Prices Drop?
Acquiring Company Stock Price
The stock price of an acquiring company usually falls ahead of an acquisition. For one thing, the premium offered for the target company means that the company is "overpaying," at least on some level. Even if the price is right, the purchase still represents a significant outflow of capital. Investors may also worry that the combined company will struggle to integrate operations or will face new challenges.
Plus, many acquisitions are financed with stock rather than cash, reports the Versailles Group. This means that stockholders in the target company receive shares of the acquirer's stock, rather than cash, in exchange for their own shares. If this is seen as diluting the value of the shares held by the acquirer's current stockholders, then the price may be driven down further.
- Corporate Finance Institute: Merger vs. Acquisition
- Versailles Group: M&A Financing: Debt versus Equity
- International Journal of Automotive Technology and Management. "Structuring and restructuring Fiat-Chrysler: can two weak carmakers jointly survive in the new automotive arena?" Accessed July 12, 2020.
- General Electric. "A Shared Vision: GE and Alstom Continue Their Common History With Latest Acquisition." Accessed July 12, 2020.
Cam Merritt is a writer and editor specializing in business, personal finance and home design. He has contributed to USA Today, The Des Moines Register and Better Homes and Gardens"publications. Merritt has a journalism degree from Drake University and is pursuing an MBA from the University of Iowa.