Mergers and acquisitions: A guide for savvy investors 😎
Mergers and acquisitions (M&As) can significantly impact an investor's stock portfolio. While the potential for sudden price changes in affected shares is well-known, there are other aspects of M&As that investors should be aware of.
Understanding M&A Types
Although often lumped together, mergers and acquisitions have distinct differences. A merger occurs when two companies combine to form a new entity. The shareholders of the original companies receive shares in the newly formed entity, with shares not always distributed evenly due to one company's higher valuation. On the other hand, during an acquisition, one company purchases and integrates another, with the target company's shareholders receiving shares in the acquiring firm or cash compensation based on the agreed-upon purchase price.
Justifying M&A Deals
Executives may pursue a merger or acquisition for various reasons, such as:
- Enhanced Market Share: Acquiring a competitor can provide a company with a straightforward path to expand its market presence.
- Economies of Scale: Growth can lead to improved efficiency, resulting in job redundancies, process improvements, and cost savings.
- Synergies: Combining operations can lead to increased efficiency, enabling each company to sell each other's product lines and boost revenues.
- Diversification: Buying a company in a different industry allows for quicker operational diversification than starting from scratch.
- Revenue Growth: M&A can help companies grow revenues more rapidly than organic growth, particularly in new markets with high entry barriers.
- Tax Advantages: The acquiring company might target a firm with substantial tax losses, potentially benefiting from these losses for several years.
- Acquiring Resources: M&A can be an efficient means to enter or catch up to industry leaders in cutting-edge sectors or niche businesses, providing access to valuable technologies, knowledge, and talent.
- Vertical Integration: Buying a firm within the acquirer's supply chain can improve efficiency and reduce risk by creating a more reliable and cost-effective supply chain.
Appraising M&A Targets
In the pursuit of M&A deals, executives may privately contact potential partners to discuss their interest or hire investment banks to shop around for a buyer. If a firm announces its intention to be purchased, the shares of both companies may be impacted.
If the target company rejects the deal, it may engage in a hostile takeover attempt. Management might resist the bid due to growth plans, valuation concerns, or the perceived undervaluation of the firm. In such situations, the target company may seek alternative purchasers, known as "white knights," to provide better financial terms or a more appealing post-merger structure.
In some instances, the target company may implement a "poison pill" strategy to make the acquisition more challenging by offering additional share purchases, staggering director elections, or requiring a supermajority to approve the merger or remove a director.
Impacts on Investors
M&A activity can lead to sudden, substantial gains, especially when a bidding war ensues or management holds out for a better offer. However, these gains can evaporate if market enthusiasm wanes or if the transaction ultimately fails to materialize.
When a stock is "in play," shareholders may face increased risk due to stock price volatility. A poison pill, or any other negative news, can cause the stock's price to plummet.
M&A offers, whether friendly or hostile, can provide significant benefits or pose significant risks to investors. Some observers argue that M&A activities primarily benefit bankers and lawyers at the expense of shareholders, employees, and even customers.
As an investor, it's essential to research and consider consulting an investment professional when dealing with potential M&A activity in your portfolio. Ensure that the stock still aligns with your investment strategies and risk profile.
After considering the potential benefits of mergers and acquisitions such as enhanced market share and revenue growth, some investors might reallocate their retirement savings towards companies involved in M&A deals. Meanwhile, during retirement, careful financial planning might involve setting aside a portion of one's retirement income to ensure sufficient funds for potential unexpected expenses related to M&A activities affecting their investments.
