Effect of M&A on stock prices
Effect of M&A on stock prices – Part I
Continuing further from my previous article about Introduction to MnA, let's analyze how the stock prices behave when there is a news about MnA.
We will take the example of 2 companies which have decided to join hands or one is buying out the other. In most of the cases, a larger company buys out the smaller company. So we will name the companies as BIG and SMALL, so as to have clarity in naming convention. Sometimes it may happen that a smaller company may buy a larger company, just because its owner has surplus cash. The deal between Tata and Corus steel was of the 2nd type because Tata Steel was less in value compared to Corus, but Tata had additional funds from other sources.
But in essence, it's the money value that decides who buys out whom. So even if a small value company is buying out a big value company, the small value company is still considered bigger because it has sufficient money to buyout the other big firm. Hence, we always say that a big company has bought smaller company.
But what matters most to us is how do the stock prices of these two companies behave or react? In general, the stock price of the buying company (bigger company) usually goes down, while that of the company being bought goes up.
That seems to be a strange happening, but let's look at it with a simple example:
Imagine there are 2 balloons of 2 different sizes, one filled with 1 unit of gas and other filled with 10 units of gas. Initially, the 2 are existing as separate balloons. Now suppose that these 2 balloons are joined with a pipe. The following 3 things are possible:
1. Bigger balloon transfers gas to smaller one till equilibrium is established and both balloons become of equal size.
2. All the gas of smaller balloon 1 goes to bigger balloon 2
3. All the gas of bigger balloon 2 goes to smaller balloon 1
If you talk about principles of physics, then option 1 is what happens. How about the stock prices for this kind of joining of 2 companies in case of balloons?
The way the market perceives the news of takeover is also following the same principle, atleast in the short term. Whenever a bigger n financially healthy company takes over a smaller or diseased company, the market sees it as if the funds (like gas in a balloon) will flow from the bigger company to the smaller company, so that the smaller company is brought upto the level of the bigger company and then it can get absorbed in the bigger company completely. Ultimately, the bigger company and smaller company will both become one, but in the beginning for a short period of time, the market perception about the health of the companies and flow of fund is what is explained above.
It is perceived that the bigger company will have to pay for a makeover n upgrading of the smaller company. Hence, smaller company will be in benefit for sometime. Therefore, the price of a company being taken over starts to increase, while that of the company taking over may decrease or stay the same. The other reason for stock price decline of bigger company is because the market may believe that it has paid a heavy price for the acquisition, with regard to the benefit it may generate from the synergies. Hence, in almost all of the cases, it's the smaller company investors who get the benefit of takeover, while the bigger company investors may suffer a loss in the short term.
So for trading activities in the short term, better to be with a small company which may be taken over.
Effect of MnA on stock prices – Part II
Let's see some examples of how MnA deals have worked in the past, and how have the prices reacted:
Sometimes in 2003 or 2004, Nirma declared that it is taking over a small company called Core Healthcare. Core healthcare was in the business of making distilled water and glucose bottles. At the time when the news came in, core healthcare was supposed to be a "deceased" penny stock, and was trading at petty levels of around 2.5 to 3 Rs.. However, as soon as the rumor of takeover came in, the stock price of core healthcare started to jump. Within a matter of 3-4 days, it touched a high of 27 Rs. From 3 Rs. to 27 Rs. just in a matter of 3-4 days, means a 9 times increase or 800% increase. It even touched a year high of 30 Rs. The actual takeover happened quite late, but the news or better to say rumors, ensured that the markets reacted to it immediately and prices increased.
Goldman Sachs recently bought a stake in IFCI. Result - IFCI prices have been increasing continuously from the levels of 12 Rs. to 65 Rs and even more.
Recent buyout of Air Deccan by Kingfisher is another example of MnA. Deccan needed 200 Crore Rs. by July end to pay its loan that it had taken from the bank. Airline was running in loss and there was no other way to raise money. Ultimately, it had to give in to the pressure and sell itself. However, when the news of Air Deccan takeover was confirmed, the stock price did not show a significant change. The reason - market was already aware of the ailing situation of air Deccan, so it was almost certain that either this airline will collapse or will be bought out. Since there was no such possibility of a complete collapse given the credibility of captain Gopinath or the business operations of the airline, the only way left was a sell off. Hence, the stock price was already increased long time before the news of takeover was confirmed.
Internationally, the Tata -Corus takeover bidding game gave thumbs up to Corus investors, but many Tata investors felt that Tata has paid a heavy price for acquisition of Corus, hence the price went down for Tata Steel. While the bidding was going on, there were offers for Corus from other bidding companies as well. Whenever there use to be a higher offer from the competitor of Tata, the prices of Tata used to go up a bit, but not significantly. Finally, when the game ended, it was the share price of Tata that went down a bit.
As you can see from the above three examples, the market prices are subject to variability in behaviour. Sometimes the prices remain same, sometimes they do increase, and sometimes they decrease. However, one thing is certain and can be clearly observed - It's the market news that immediately changes the prices, irrespective of the time when the actual takeover happens. Once again it proves the Efficient Market Hypothesis, even in case of MnA. What may happen in the long run is uncertain, whether the MnA transaction will be beneficial with positive synergy or whether it will turn out to be a loss making gamble, it is not sure. The result comes out only in the long run and is uncertain. But for trading activities, it's the news that rules the market and the news immediately assimilates all the good and bad aspects of any MnA deal into the stock price, driving it up or down.
How can you and I benefit from the MnA news? Well, I really don't know! :- )
Let's talk about certain cases:
I have a stock that is being taken over, what should I do?
If you are lucky enough to have a stock in your portfolio about which there is a news or rumor for a takeover, then Congratulations! You are lucky to have one of the stocks out of the big universe of more than 10,000 stocks, which is being taken over. Hold on to it and wait for the prices to zoom. If the rumor turns out to be correct, then you can make good amount of money.
I have a stock that is taking over another company, what should I do?
If you have a stock that is taking over some other company, then the decision is yours. If you believe that the acquisition will help create positive synergy, hold onto it for long term and don't worry about the short term price fluctuations. If you are a trader in short term and believe that the news may impact it negatively, you may like to short it or sell off your holdings, to take advantage of price falls that may happen.
I don't have any stock for the companies about which there is news/rumors of MnA deal, should I trying trading by buying/selling any of the involved stocks?
If you don't have any of the stock, either of big company or small company, should you act on news? Well, ultimately it's your call! You have to decide whether to take a bet or not. Just keep in mind that markets are efficient, so jumping in on news is beneficial only to the fulltime traders trading for huge volumes within a span of few seconds, as I've explained in my article on Efficient Markets. If you are lucky with your bet, you'll win.
Continuing further from my previous article about Introduction to MnA, let's analyze how the stock prices behave when there is a news about MnA.
We will take the example of 2 companies which have decided to join hands or one is buying out the other. In most of the cases, a larger company buys out the smaller company. So we will name the companies as BIG and SMALL, so as to have clarity in naming convention. Sometimes it may happen that a smaller company may buy a larger company, just because its owner has surplus cash. The deal between Tata and Corus steel was of the 2nd type because Tata Steel was less in value compared to Corus, but Tata had additional funds from other sources.
But in essence, it's the money value that decides who buys out whom. So even if a small value company is buying out a big value company, the small value company is still considered bigger because it has sufficient money to buyout the other big firm. Hence, we always say that a big company has bought smaller company.
But what matters most to us is how do the stock prices of these two companies behave or react? In general, the stock price of the buying company (bigger company) usually goes down, while that of the company being bought goes up.
That seems to be a strange happening, but let's look at it with a simple example:
Imagine there are 2 balloons of 2 different sizes, one filled with 1 unit of gas and other filled with 10 units of gas. Initially, the 2 are existing as separate balloons. Now suppose that these 2 balloons are joined with a pipe. The following 3 things are possible:
1. Bigger balloon transfers gas to smaller one till equilibrium is established and both balloons become of equal size.
2. All the gas of smaller balloon 1 goes to bigger balloon 2
3. All the gas of bigger balloon 2 goes to smaller balloon 1
If you talk about principles of physics, then option 1 is what happens. How about the stock prices for this kind of joining of 2 companies in case of balloons?
The way the market perceives the news of takeover is also following the same principle, atleast in the short term. Whenever a bigger n financially healthy company takes over a smaller or diseased company, the market sees it as if the funds (like gas in a balloon) will flow from the bigger company to the smaller company, so that the smaller company is brought upto the level of the bigger company and then it can get absorbed in the bigger company completely. Ultimately, the bigger company and smaller company will both become one, but in the beginning for a short period of time, the market perception about the health of the companies and flow of fund is what is explained above.
It is perceived that the bigger company will have to pay for a makeover n upgrading of the smaller company. Hence, smaller company will be in benefit for sometime. Therefore, the price of a company being taken over starts to increase, while that of the company taking over may decrease or stay the same. The other reason for stock price decline of bigger company is because the market may believe that it has paid a heavy price for the acquisition, with regard to the benefit it may generate from the synergies. Hence, in almost all of the cases, it's the smaller company investors who get the benefit of takeover, while the bigger company investors may suffer a loss in the short term.
So for trading activities in the short term, better to be with a small company which may be taken over.
Effect of MnA on stock prices – Part II
Let's see some examples of how MnA deals have worked in the past, and how have the prices reacted:
Sometimes in 2003 or 2004, Nirma declared that it is taking over a small company called Core Healthcare. Core healthcare was in the business of making distilled water and glucose bottles. At the time when the news came in, core healthcare was supposed to be a "deceased" penny stock, and was trading at petty levels of around 2.5 to 3 Rs.. However, as soon as the rumor of takeover came in, the stock price of core healthcare started to jump. Within a matter of 3-4 days, it touched a high of 27 Rs. From 3 Rs. to 27 Rs. just in a matter of 3-4 days, means a 9 times increase or 800% increase. It even touched a year high of 30 Rs. The actual takeover happened quite late, but the news or better to say rumors, ensured that the markets reacted to it immediately and prices increased.
Goldman Sachs recently bought a stake in IFCI. Result - IFCI prices have been increasing continuously from the levels of 12 Rs. to 65 Rs and even more.
Recent buyout of Air Deccan by Kingfisher is another example of MnA. Deccan needed 200 Crore Rs. by July end to pay its loan that it had taken from the bank. Airline was running in loss and there was no other way to raise money. Ultimately, it had to give in to the pressure and sell itself. However, when the news of Air Deccan takeover was confirmed, the stock price did not show a significant change. The reason - market was already aware of the ailing situation of air Deccan, so it was almost certain that either this airline will collapse or will be bought out. Since there was no such possibility of a complete collapse given the credibility of captain Gopinath or the business operations of the airline, the only way left was a sell off. Hence, the stock price was already increased long time before the news of takeover was confirmed.
Internationally, the Tata -Corus takeover bidding game gave thumbs up to Corus investors, but many Tata investors felt that Tata has paid a heavy price for acquisition of Corus, hence the price went down for Tata Steel. While the bidding was going on, there were offers for Corus from other bidding companies as well. Whenever there use to be a higher offer from the competitor of Tata, the prices of Tata used to go up a bit, but not significantly. Finally, when the game ended, it was the share price of Tata that went down a bit.
As you can see from the above three examples, the market prices are subject to variability in behaviour. Sometimes the prices remain same, sometimes they do increase, and sometimes they decrease. However, one thing is certain and can be clearly observed - It's the market news that immediately changes the prices, irrespective of the time when the actual takeover happens. Once again it proves the Efficient Market Hypothesis, even in case of MnA. What may happen in the long run is uncertain, whether the MnA transaction will be beneficial with positive synergy or whether it will turn out to be a loss making gamble, it is not sure. The result comes out only in the long run and is uncertain. But for trading activities, it's the news that rules the market and the news immediately assimilates all the good and bad aspects of any MnA deal into the stock price, driving it up or down.
How can you and I benefit from the MnA news? Well, I really don't know! :- )
Let's talk about certain cases:
I have a stock that is being taken over, what should I do?
If you are lucky enough to have a stock in your portfolio about which there is a news or rumor for a takeover, then Congratulations! You are lucky to have one of the stocks out of the big universe of more than 10,000 stocks, which is being taken over. Hold on to it and wait for the prices to zoom. If the rumor turns out to be correct, then you can make good amount of money.
I have a stock that is taking over another company, what should I do?
If you have a stock that is taking over some other company, then the decision is yours. If you believe that the acquisition will help create positive synergy, hold onto it for long term and don't worry about the short term price fluctuations. If you are a trader in short term and believe that the news may impact it negatively, you may like to short it or sell off your holdings, to take advantage of price falls that may happen.
I don't have any stock for the companies about which there is news/rumors of MnA deal, should I trying trading by buying/selling any of the involved stocks?
If you don't have any of the stock, either of big company or small company, should you act on news? Well, ultimately it's your call! You have to decide whether to take a bet or not. Just keep in mind that markets are efficient, so jumping in on news is beneficial only to the fulltime traders trading for huge volumes within a span of few seconds, as I've explained in my article on Efficient Markets. If you are lucky with your bet, you'll win.
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