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Home > Mergers and Acquisitions Best Practice > Coping with Equity Market Reactions to M&A Transactions

Mergers and Acquisitions Best Practice

Coping with Equity Market Reactions to M&A Transactions

by Scott Moeller
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Executive Summary

  • Overall, stock returns to acquirers tend to be negative or insignificant—in contrast to target companies, where stockholders can benefit greatly.

  • Companies that believe they may be targets can influence the value of an ultimate acquisition through the design of defensive techniques and by how they react to bids when they occur. Similarly, acquirers can influence the target share prices through their actions prior to the bid.

  • Most acquirers are overconfident in their ability to conduct acquisitions successfully.

  • Careful planning, including a robust internal and external communications plan, is required to mitigate the impact on equity markets of acquirers.

  • Many factors influence equity market reactions to an M&A bid, including how friendly or hostile the bid is, the financing structure of the bid, the relative size of the two companies, and whether the transaction is a merger or an acquisition.

  • Deals conducted in the most recent merger wave appear to have taken some of these issues into account and show better relative performance (relative to the market) than deals conducted in the 1980s and 1990s.

Introduction

It would be nice if the markets were to react consistently in response to the announcement of M&A deals. But they don’t. At least not always. But you can depend on one thing: In the short run, shareholders of target companies benefit more than those of the acquiring company.

It is important to know how to cope with the likely equity market reaction to the announcement of a deal. First of all, you need to understand what those likely reactions will be … and then to work out whether there is anything that can be done to influence the market. Bidders can mitigate the likely negative market reaction to their share price, and targets may be able to provoke even higher bids.

This article discusses public companies only—as these are naturally the only ones with an “equity market reaction.” However, one can properly extrapolate their experience to private companies as well. While most advisers and principals in privately held companies take into account the experience of publicly held companies, the reaction of the equity markets regarding the bidder’s share price is not dependent on whether the target is public or private. Either way, the shareholder value of bidders declines, on average, following the announcement of a large acquisition.

“Most mergers fail. If that’s not a bona fide fact, plenty of smart people think it is. McKinsey & Company says it’s true. Harvard, too. Booz Allen & Hamilton, KPMG, A.T. Kearney—the list goes on. If a deal enriches an acquirer’s shareholders, the statistics say, it is probably an accident.”

New York Times, February 28, 2008

Equity Market Reactions for Targets

Relatively few deals make money for the bidding company’s shareholders. The market rather consistently shows that bidding companies lose money for their shareholders, or at best break even around the time of the announcement of a takeover, whereas target companies attract offer premiums that typically range from 20% to 40%. Stock prices often rise above the offer price if a competing bidder is anticipated.

These returns are relatively consistent in the United States and the United Kingdom, with the data for other countries less clear but indicating similar results. When the bidder and target returns are combined, the overall shareholder wealth effects are typically found to be insignificant over the short term and positive over the longer term.

In the absence of a competing bid, when a takeover is announced the target company’s stock price typically rises to a level below the offer price, but slowly rises to approach the bid price as time approaches the closing date when the final deal is consummated, which for most deals is 3–6 months after the announcement date (Figure 1). This is because there is some risk that the deal will not go through or will be repriced (usually lower) because of negative information that the bidder finds while conducting due diligence on the target (see Due Diligence Requirements in Financial Transactions for a discussion of the best ways to conduct due diligence in M&A deals).

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Further reading

Books:

  • Gaughan, Patrick A. Mergers, Acquisitions, and Corporate Restructurings. 4th ed. Hoboken, NJ: Wiley, 2007.
  • Moeller, Scott, and Chris Brady. Intelligent M&A: Navigating the Mergers and Acquisitions Minefield. Chichester, UK: Wiley, 2007.
  • Sudarsanam, S. Creating Value from Mergers and Acquisition: The Challenges. Harlow, UK: FT Prentice Hall, 2003.

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