How Mergers and Acquisitions Affect Stock Prices

The Walt Disney Company (DIS) bought out Marvel Entertainment, Inc. (MVL) in a deal valued at $4 billion in 2009. The purchase price was originally a mix of $30 in cash and .745 of a share of Disney for each share of Marvel. The closing prices at the time of the deal meant that Marvel shareholders would have received $49.3998 per share in value for their stock at closing. However, prior to the merger’s completion the share price of Marvel Entertainment, Inc was only $48.37 – a full point below the merger value.

This happens regularly in mergers but why does this discount exist and is there a way traders can take advantage of it?

One of the things we look for when watching for a market bottom is an increase in merger and acquisition (M&A) activity. This merger – along with several others – in the second quarter of 2009 were a big tip that the bull market was likely to re-emerge. Similarly, when deal-activity begins to slow it is a signal that prices in the market may begin to move lower. M&A activity is common at a market bottom because lower stock prices are attractive to potential acquirers as they look to consolidate competitors and grab more market share.

[VIDEO] How Mergers and Acquisitions Affect Stock Prices

Stock Prices Can Change Even After A Merger Is Announced

A common question relative to M&A activity and its affect on stock prices is why the acquisition target’s stock price does not equal the value the acquirer will be paying. In other words – if company A is buying Company B’s stock for $10 a share in a few months, why doesn’t Company B’s stock equal $10 immediately following the announcement?

Uncertainty Can Lower Prices

The differential between an M&A target’s acquisition price per share and its current trading price accounts for the uncertainty around the merger. If the purchase never actually happens, the target’s stock will likely drop significantly. In the video, I will cover another case study of a stock that was going through a deal of its own at the time of recording.

Hostile Takeovers Are Even More Uncertain

The more uncertain the actual merger is, the wider this delta or differential will be. For example, if the target company is being subjected to a hostile or unsolicited takeover the difference between the acquisition stock price and the current stock price will be very wide as management works to fend off the acquirer or attract a “white knight” to rescue it from the larger firm.

Sometimes the Acquisition Target’s Stock Will Rise Above the Takeover Offer

This can happen when traders believe that there is likely to be another bidder that will offer more for the firm. This is a more unusual situation but it will happen from time to time when the deal would give the winning bidder a significant competitive advantage.

Think Before Trading

It may be tempting to take advantage of the differential by buying the target’s stock and shorting the proper ratio of the acquirer’s stock. That strategy has a very poor risk/reward ratio as the downside can be many times the possible upside. Long Term Capital Management (the trillion dollar hedge fund bailed out by the Fed in the late 1990’s) famously built a problematic portfolio of highly-leveraged versions of this trade.

Options May be a Better Alternative

Alternatively, buying long term puts on the target’s stock may be another way to approach the opportunity. This strategy is extremely speculative but the upside could be very large should the merger not occur. If you decide to test a strategy like this it would be a good idea to start with paper trading. Option premiums can be extremely inflated before a merger is consummated, which will make losses much larger.

  • scott

    hi i own i have some shares in a company that has quite a low bid price but they have signed a deal with a very big company that will pay them ongoing royalties into the future but because there share price is low i believe the big company will just bye lets just say if they 2 billion in royalties or 1 bill by out it makes more sense but is this a good thing for me

  • cltaylor

    So now that Marvel Studios has been thriving, why is Disney’s stock price still so low? Is it all the horrible programming on ABC (except for Agents of SHIELD and Jimmy Kimmel ABC seems to have nothing offer viewers), or is it over extending themselves in the theme park area? Is it time to dump the theme park real estate? I mean, why do people still go to Disneyland in SoCal at all, it’s been ‘dumpy’ since the 80’s. Or are the executives taking the price down somehow? It just seems to me that between Maleficent, Once Upon a Time, Agent’s of SHIELD, and the MCU, Disney’s stock should be much higher. I just don’t get it.

  • coldheartedtrader

    this dissertation, thesis, MBA, PhD..crap I think is bullocks…reminds me of socery or the scribes…whom gained power over the minds of the masses, for having so called secret knowledge…does anybody agree with me that you don’t have to be a quant, or a rocketscientist to profit in the stockmarket business… I believe good ole fashion gumshoe and commonsense is your best bet…find your own way, and don’t follow the gurus…long story short…Learningmarkets is awesome…speaks in such an elementary didactica…you rule..

  • phuko

    This speaker is excellent. I love his style, and he’s very easy to follow.

    • coldheartedtrader

      dissertation, thesis, MBA, PhD..crap I think is bullocks…reminds me of socery or the scribes…whom gained power over the minds of the masses, for having so called secret knowledge…does anybody agree with me that you don’t have to be a quant, or a rocketscientist to profit in the stockmarket business… I believe good ole fashion gumshoe and commonsense is your best bet…find your own way, and don’t follow the gurus…long story short…Learningmarkets is awesome…speaks in such an elementary didactica…you rule..

  • Trade monkey

    If I have 2 Banks Merging. Bank A is currently trading at $14.33(47% after merge in shares) Bank B Currently Trading (11.35 with 53% Shares after the Merge). After the merger goes live in 10 or so days. How would you trade now to take full advantage and why?

    • John_Jagerson

      Well, mergers are a zero-sum deal usually. So by the time the deal is public knowledge, there isn’t any difference in trading the pre-merged entities versus the new or entity.

      • Dommy

        @John_Jagerson
        my Dissertation will be about the Topic M&A and ist effects on stock Prices.
        Could you give me a tip for the best articles, publications and research results in this area, please?

        • johnjagerson

          I don’t have specific references handy but you may want to do a review of the literature in the best finance journals. I suggest The Journal of Finance or The Journal of Financial Economics

          • Dommy

            ok great! thank you very much

  • Ethan2russell

    good information for the layman 
    thanks.
    if you have an august call  option on a stock for $12/share and the acquisition of the company occurs in july for $10/share,  what happens to your investment?

    • lmarkets

      The call would expire worthless in August. This scenario does happen from time to time.

      • Dm

        I have been holding a bank stock for years and it hangs around $10 a share. They just announced that they are merging with another bank whose shares are $12.54. How will that affect my stock? Should I hang in there or sell before the merger takes place?

        • It depends on what the terms of the merger are. If it is an actual merger between equal partners, it will be a different reaction than if it is an acquisition of one of the companies by the other. If you can provide a little more detail on the merger itself, we can give you a more complete answer.

          • rambo

            Now take the scenario of watsapp being merged with facebook facebook bought it for 16 billion … so if i buy stocks in watsapp will it be a postive change for me …?

          • To really benefit from an acquisition announcement, you need to own the stock of the company that is being acquired before the acquisition announcement is made, and the acquisition offer needs to be at a higher price than the stock is currently trading. This will cause the stock to quickly jump up in value. Once it has made its initial move higher, however, it is not likely to continue moving higher…unless a bidding war breaks out for the company.

          • coldheartedtrader

            Bravo, well said…I would would graefully appreciate your wisdom…
            What are the best methods to learn how to spot and predict a potential acquisition before the the annoucement is made, so that One could own the stock in advance,thus benefiting from the announcement and selling before the execution of acquisition…..okay, so I really have a two part question….how to determine the best time to get out the stock…

          • Insidertrader1834

            You stalk CEOs and executives of large listed companies and find out before the announcement.

          • ThePolice

            Then you go to prison.

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