How Mergers And Acquisitions Affect A Stock

One of my favorite plays, though hard to capture, is mergers and acquisitions (also known as M&A). Trying to profit off some of these plays (usually the acquisition part) require you to be extremely speculative and/or extremely lucky because the second news becomes public you most likely already missed the move.

While the previous year hasn’t been kind to M&A deals, as the economy gets better and many companies become stronger while others continue to struggle, we can’t help but expect many M&A deals to go down in the coming future. Are you prepared?

What are mergers and acquisitions?

A merger is a combination of two companies into one larger company. Usually mergers are a result of commonly voluntary actions and involve some sort of stock swap or cash payment to the target.

A stock swap is often used as it allows the shareholders of the two companies to share the risk involved in the deal. A merger can resemble a takeover but result in a new company name (often combining the names of the original companies) and in new branding; in some cases, terming the combination a “merger” rather than an acquisition is done purely for political or marketing reasons.

An acquisition is usually coined as another company taking over another. Also referred to as a buyout, most acquisitions happen because the buyer wants to utilize the resources or customer base of the takeover target.

In general, acquisitions are the most profitable trades because the takeover target is usually bought at a premium.

Example: If our takeover stock is valued at $10 a share, the potential bid to buy that company could come out to be $15 per share. This would result in and instant jump in the takeover stock’s value, and possibly making fortunate traders a quick profit of $5 per share.

Usually the same result is not seen in the share price of the company doing the buying. In fact, many times the stock goes lower. Usually the value or benefit won’t be seen until the gains are realized a couple quarters or years later.

While all these plays and moves seem like relatively simple trades, what makes it so hard? One of the mains reasons is that these prices move before the actual event occurs…

If there is even a hint or rumor of a deal the price will sky higher.

…Of course, if the transaction never takes place expect the takeover target’s stock price to plummet right down to where it originally was.

So how do we find buyouts?

Obviously if the answer was so simple, then this M&A play wouldn’t be so difficult to capture, right? That being said, there are some signs or actions that could possibly tipoff a M&A deal is on the horizon.

Unusual sell-off of company assets. Many times when a company is looking to get bought out, they will try to make themselves cheaper by selling off assets. Generally they are raising cash and removing debt to look more desirable to buyers.

Distressed companies with business. An example of this would be Bank of America’s (BAC) buyout of Merrill Lynch. The companies have business, but other problems. Normally, if a big company feels they can take on such risk, the distressed company will get taken over.

Test the numbers. Its just a good business move, but how does this help us? Sometimes its just as simple as running a stock screener with certain parameters and seeing a potential list.

As you can see there are various ways and methods to try and find potential buyout companies, and I believe over the next couple of years the number of M&A activity will increase as the economy improves. If you can stay prepared and track related news, you really never know when the next great buyout tip will jump right in front of you.