When it comes to entering the world of stock trading, there are a lot of different things to learn in such a short amount of time that it can often be extremely difficult to remember everything.
In addition to this, there are times when something might happen or change that will still confuse you, no matter how experienced you are!
One of these changes that can happen is when two companies merge, as there are often a lot of questions that come when this sort of thing happens, especially for people who haven’t witnessed this sort of thing before.
So, if you’re wondering what happens when two companies merge, and more specifically, what happens to stocks when companies merge, then read on as we discuss everything you need to know about companies merging!
What Is A Merger?
A merger is when two companies of roughly similar sizes come together to form one singular entity.
This is done frequently by public companies who want to try and increase their shareholder value, which is done by gaining market shares, or through entering new business segments.
It’s worth noting that an acquisition is different from a merger, as a merger often results in an entirely new entity.
Another difference is that a merger is something done by two firms of equal or similar sizes, whereas an acquisition is when a larger company purchases a smaller company.
Typically, a merger will see an exchange of shares as opposed to a cash consideration.
It is important to note that when a merger of equals occurs, that the companies of similar sizes will come together to agree on mutually beneficial terms, which will mean that neither company will be considered an acquirer of the other.
What Happens To Company Stocks When Companies Merge?
When it initially gets announced that one company is in the process of purchasing another, the target’s company usually tends to rise in value as it begins to reach the takeover price, whilst the company that is actually purchasing the other company will likely see their shares dip, as it takes into account the amount spent purchasing the other company.
If the merger happens to be constructed by the market in order to produce synergies that will not only benefit the acquirer, but also the target company, then there is a chance that both companies will see their shares rise.
However, the opposite can happen too, and if the market deems the deal to be somewhat of a blunder, then there is a chance that both companies’ share values will drop!
What Happens To Stock In A Reverse Merger?
A reverse merger, otherwise known as a reverse IPO, is when a private company goes public by identifying themselves as a currently existing publicly traded shell company that then essentially buys the private firm.
At that point, the people who were the managers of the firm targeted, then became the managers of the shell company, and then ran the business.
The shell company’s shares may increase in value if the majority of investors believe that the new entity has some value.
The sort of effect that a merger can have on a company’s share prices ultimately depends on a few different factors, but really it all comes down to the details of the deal as well as how the market perceives the deal, if the market seems to believe that the transaction has value, then this could mean that the share prices increase, but the reverse is true also.
If the merger deal is set to see an exchanging of shares, then it’s down to the exchange ratio which will determine which of the companies is going to see a premium over its share price prior to the announcement of the deal.
Shares of that company could then rise, but this rise can be limited slightly should the other company see a decrease in its share price as a result of the deal’s announcement.
Which ultimately leads to the initial premium eroding almost completely.
Often, a collar agreement will be put in place to try to prevent this erosion, which will see the exchanging ratio increase if an exchanged stock happens to fall below a certain level.
These sorts of limits do help to limit the downside for the shareholders of one company, but only at the expense of the other company and its shareholders.
This is why in merger deals of companies of similar sizes, these types of limits are less common.
Additionally, if the deal happens to come across something that could potentially roadblock the deal, then the market could actually discount the proposed merger premium.
Furthermore, the shares of a company could also trade above the initially proposed merger premium, but this will only happen if investors believe that the deal’s announcement will lead to new suitors being prompted to place higher bids.
How Does A Merge Affect Corporate Governance?
No matter the exchange ratio that is set in a stock-for-stock merger deal, both companies will have a stake in the new entity.
If a shareholder’s shares aren’t exchanged, then they’ll find that their control in the larger company will then be diluted.
Typically, a merger announcement will specify what percentage of each company a shareholder will then own.
The leadership of this new entity has to be considered too, as well as how each section of management will be integrated.
To summarize, a merger is when two similarly sized companies come together to form a singular entity, this is done to boost their shareholder value, which is done by being able to enter new markets they wouldn’t have previously, or by gaining a larger share in markets they already find themselves in.
So, we hope you now know everything you need to know about mergers, and how it affects stock!