Acquisitions are one of the most impactful events in a company’s lifecycle, and the stock market tends to respond fast and furiously when a new acquisition is announced. Being aware of how stocks behave during an acquisition is critical to spotting opportunities, avoiding surprises, or just maintaining peace of mind while navigating a deal. Let’s explore what typically happens to both the acquiring and target companies’ stock during an acquisition and the forces driving those price swings.
Looking for personalized guidance on navigating an acquisition? Be sure to contact Acquinox Advisors today.
What Is a Stock?
Before we look at how stock prices move during an acquisition, it’s important to understand what exactly a stock is.
A stock, or equity share, is an ownership stake in a company. The price of a company’s stock is a reflection of how much investors think that company is worth, based on earnings, debt, growth rate, and other available information. The higher the price, the more valuable the company, and vice versa.
Acquisitions are typically a volatile time for the stock prices of both companies. During this time, investors will rapidly buy or sell shares as they try to assess whether the acquisition will be good, bad, or neutral. Acquisitions can be incredibly large and involve the combination of employees, products, and cultures, so there’s a lot for investors to digest.
However, this is what typically happens…
The Acquiring Company’s Stock Dips
The stock price of the acquiring company tends to dip during an acquisition. Please note that this is just a generalization, not a guarantee.
There are three reasons why the acquiring company’s stock tends to dip:
- The company pays a premium: In most scenarios, the target company’s stakeholders won’t approve the acquisition unless the acquiring company pays a premium or multiple. Paying a premium can exhaust the acquiring company’s cash reserves and leave less opportunity to invest elsewhere, which can hurt the stock price in the short term.
- The company takes on debt: It’s common for companies to lean on debt when financing an acquisition. Taking on debt creates a financial obligation that the acquiring company now has to repay. This adds a level of risk to the deal, which can also cause the stock to dip.
- Investors are skeptical of the deal: Investors may believe that the acquisition is a bad idea, for reasons like differences in work culture, potential regulatory issues, or management power struggles. Or, investors may feel that the acquiring company is overpaying for the target company. This uncertainty could cause investors to sell shares, which results in a declining stock price.
That said, this dip is usually just a short-term phenomenon. Once the acquisition has been completed and the value generated from the deal is realized, the acquiring company’s stock tends to rise over the long term.
The Target Company’s Stock Rises
The target company’s stock experiences the opposite situation, usually rising during the short term. Again, please note that this is a generalization and not a guarantee.
There are two reasons why the target company’s stock tends to rise:
- The acquiring company pays a premium: The target company’s shareholders will usually only approve a deal if the acquiring company pays a premium. When an acquisition is announced, it means that the current shares are likely undervalued compared to the premium the acquiring company is paying. This can result in a spike in share price as investors buy up shares until a valuation parity is reached.
- A bidding war could emerge: The target company’s stock price could also rise if investors anticipate that another company will bid on the target company, which could lead to a bidding war and drive up the target company’s valuation. This is usually more likely to happen earlier in the deal-making process.
It’s important to note that the target company’s stock price tends to be particularly volatile during an acquisition. This is because many investors will make decisions based on rumors, not confirmed news announcements or press releases. The moment that an acquisition is rumored, investors will buy or sell the stock in an attempt to front-run the official announcement. The same scenario can happen with rumors that a deal may fall through or face a roadblock.
This rapid trading can lead to dramatic spikes and dips in a stock’s price as investors make decisions around the most recent rumor, even if the news isn’t officially confirmed.
Final Thoughts: How Company Stocks Move During an Acquisition
Most often, the acquiring company’s stock will dip during an acquisition, while the target company’s stock will rise. This usually happens because the acquiring company pays a premium for the target company, which impacts both stocks in opposite ways:
- Acquiring Company: The premium paid implies that the acquiring company has used up its cash reserves or taken on debt to finance the deal. This adds a level of risk for the acquiring company and causes its stock price to decline.
- Target Company: The premium paid implies that the target company’s current shares are undervalued compared to what the acquiring company is paying. This incentivizes investors to buy shares until a parity is reached between the current valuation and the valuation paid by the acquiring company.
However, remember that these are just generalizations. There are dozens, if not hundreds, of factors that can influence how a stock price will move during an acquisition. This is why it’s so important to work alongside qualified professionals when navigating a merger or acquisition. For personalized advice, be sure to contact the team at Acquinox Advisor.
We hope that you’ve found this article valuable when it comes to learning about how company stock prices move during an acquisition. If you’re interested in reading more, please subscribe below to get alerted of new articles as we write them.
