The effect of Mergers & Acquisitions on Stock Prices | Lee Chandler

Mergers and acquisitions (M&A) have the ability to positively or negatively affect the
share price of a company for a multitude of reasons. Before delving further, the concept of M&A
should be understood. There are three methods of merging that can be done. The first is statutory
merging, which occurs when company A completely buys out Company B (all assets and
liabilities), and Company B no longer exists. The second is consolidation, which occurs when
Company A and Company B merge into one new entity and the old entities no longer exist. The
third is called subsidiary merging, which occurs when Company A purchases Company B, but
Company A allows Company B to continue with normal operations as a subsidiary under
Company A.
The benefits of an M&A occurrence are many and is responsible for increases in the share
price. The first benefit is the ability for companies to receive higher growth potential. When
companies merge, their income statements and balance sheets merge as well and the adding of
revenue gives the appearance of a larger growth. Furthermore, mergers have the ability to
increase profit margins due to economies of scale. Circling back to higher revenue after
companies merge, it allows them to invest in a larger quantity of products to be produced, which
in turn lowers the cost-per-unit of a product.
Another benefit of M&A is that tax benefits from one company carry forward to another.
This means that, if Company B receives tax benefits, it would reduce Company A’s taxes as they
have merged into one company. Furthermore, M&A is a good way to diversify a company. For
instance, if Company A is in an industry known for its volatility, the acquisition of Company B
(assuming it’s in a non-cyclical industry) would prove beneficial to Company A. This is because
there will be earnings from Company B that will be able to offset losses of Company A during a
trough of the business cycle.
One aspect of M&A, and its effect on stock prices, that investors should be warry about is
the rumors surrounding the potential acquisition of a target company. The target company’s
stock price may become slightly volatile at the slightest rumor. This may prove to be beneficial
in the short-run; however, as time progresses and, if the company decides to not follow through
with the acquisition, it could have a large negative impact on its stock price as well as
shareholders. This is one of the reasons why investing in rumors should not be done; at that
point, it becomes more of a bet than an investment backed by a strong industry, fundamental, and
technical analysis.
To summarize, there are many benefits associated with mergers and acquisitions such as
high growth potential, increased profit margins, tax benefits, and diversification. Each benefit
can be directly associated with increased share price and better long-term performance (provided
the company already has strong financials). However, one aspect of M&A that should always be
followed is to never trade on a rumor of one.
-Joseph Kuta
Sources
Mergers & Acquisitions (M&A) – Overview, Types, Integration, and Valuation. (n.d.). Retrieved
October 21, 2020, from
https://corporatefinanceinstitute.com/resources/knowledge/deals/mergers-acquisitions-ma/

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