When looking for growth within a company, often there will be money invested in their products or services and boost the sales for years to come. While this is always a plus side, there is another way in order to grow a company. Larger companies tend to pursue company growth by acquiring or take over small(er) companies and therefore expand there market or existing product line. Mergers and acquisitions are happening all year round, and there are a lot of speculations as to when and why companies are showing the ‘signs’ of doing an acquisition or are being preyed upon by other companies. And many times after a take-over, the stock price will take a flight up. For some investors this seems a quick way of increasing profit, but is it?
First if all, how do we define an acquisition? As stated by Investopedia:
An acquisition is a corporate action in which a company buys most, if not all, of another firm’s ownership stakes to assume control of it. An acquisition occurs when a buying company obtains more than 50% ownership in a target company.
Mergers and acquisitions can be some of the biggest and most exciting developments in the stock market. And are sometimes the smartest move a management can make.
Imagine all the possibilities when 2 businesses are being morphed together. There will be instant higher profits due to gaining new data and/or products which can improve the profits. Second benefit is that it’s easier to reducing costs by merging all similar processes and systems. The size of the company will be bigger than is was before, whereas scalable structures will provide even more return on the long term.
As seen in the graph above, over the past years -1985 till 2007 – there was an intensive growth of mergers and acquisitions worldwide. After that the growth balanced out and stabilized over the years until now. Interesting is the fact that the number of deals tend to be a bit in the same range as to the value of the mergers, just check out the 2000 bubble and the 5 years after. But looking at the past few years the number of deals stabilized.
In general, when there is an increase in merger and acquisition (M&A) activity this means we’re reaching a market bottom. A rise in 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.
Also another way to look at market highs! Just check out the peaks in 2000, 2007 and 2015.
The three largest take overs in 2015 were:
- SABMiller PLC by Anheuser-Busch Inbev with a value of 109.28 bil. dollar.
- BG Group by Royal Dutch Shell with a value of 69.45 bil. dollar.
- DuPont by The Dow Chemical CO with a value of 62.11 bil. dollar.
Some deals got up in media blurs, like the Tesla taking over Solar City, Marvel by Disney
Most of the deals are probably mentioned somewhere small and are generally deals where massive companies buy up smaller companies to extend their own growth and eliminate rising competition.
Besides, a lot of companies showing interest don’t even close the deal in the end. Like the stories of Allergan being bought by Pfizer, Twitter by Disney/Google/Salesforce, Netflix by Disney (their really scanning the markets here) and many other. It’s obvious that it’s still a big business.
The impact of M&A’s for investors.
Besides the impact on the business itself, the shareholders of a company are being effected as well. These latter group can be split up in two, namely the shareholders of the acquiring company and the shareholders of the acquired company.
Of these two the shareholders of the acquired company benefit the most. This is because the price being paid for a company is in most cases higher than the stock price it’s trading for at that time. Meaning they use a little excess which eventually leads to a higher stock worth and price.
The shareholders of the acquiring firm have to take into account that most deals are made with debt. Which means that the company of which the own shares, takes on more debt to be able to make the acquisition. On the short term this can affect the profitability of the company, whereas on the long term the effects are less harmful. This means the positive effects are better seen on the long than the short term.
So you could say that if you want to benefit, you better buy some shares of the company which is being acquired. And take profits as soon as the stock prices will match the bid.
However, there are 3 downsides on playing this game:
- You cannot predict the future.
Sounds simple right? Still a lot of investing (or trading) is happening because people expect a certain ‘thing’ to happen. And sometimes it does, and sometimes it doesn’t.
- You cannot time the market
Even if something big is about to happen, how do you know when to step in? Or out? In order to react on time, you have to act before you know when and what exactly is happening. And even with the right info and tools, it’s often happening so fast you miss the boat entirely if you only reason to buy is because you expect a merger or acquisition.
- It’s already priced in
When analysts or investors are expecting a take over, the company being eyed is probably already seeing it’s stock price rise even before the announcement is made. This is because of rumors and media coverage many already predict an acquisition and are trying to benefit from it. Once it’s announced you’re already to late.
- The deal is off
Not all M&A’s are being set through, which could effect the stock price negatively resulting often in a sharp price drop. Especially when bought recently, on short term this will provide in a loss on your investment.
So instead of trying to buy companies which you would believe will be acquired. It’s far easier to just buy companies which have been making acquisitions in the past already. This shows the company is looking for growth outside their own business structure and are expanding their company to boost later revenues.
The key is to find stocks that would be good investments even if no acquisition offer were ever made; simply investing on the hopes of a merger is pure speculation.