4 Ways Which Mergers and Acquisitions Affect Stock Prices

This post was originally published on September 3, 2020 and has been updated for relevancy on September 19, 2024.

There is rich and varied academic literature on the relationship that exists between M&A and stock prices.

For decades, academics and traders alike have tried to pin down how mergers and acquisitions affect stock prices over the short and long term, and whether the process adds value for those on the buying and selling side.

DealRoom helps many companies organize their M&A processes. Below, we look at some of the main ways in which M&A transactions are said to affect stock prices.

How company stocks move during an acquisition

1. Stock price volatility

The mere mention that a company has become a target for acquisition is usually enough to generate volatility in both the buyer’s and seller’s stock prices as traders and analysts try to establish:

• what the deal means for strategy
• how the buyer is going to pay for it
• whether the target company is friendly or hostile to the takeover
• whether it might trigger an even bigger offer from a third party

Example:

What happened to Pinterest in 2021 is a great example of how potential acquisitions can directly affect stock prices.

In October of that year, there were rumors that PayPal was interested in acquiring Pinterest. The news caused Pinterest's stock price to surge by about 13%, led by investors trying to cash in on rumors that PayPal was considering an offer of around $70 a share, which was significantly above what Pinterest was trading at at the time.

But in less than a week, after PayPal publicly announced that it didn’t intend to pursue an acquisition, Pinterest’s stock price dropped back down by 12%.

2. Target company stock’s reaction to a bid

As a rule, acquisitions tend to drive up the value of a target company’s stock.

The rationale here is clear: Buyers are invariably forced to pay a premium (i.e., a price above the current market price) to acquire the company. Thus, the listed stocks will rise in value as soon as there’s even a whisper of an impending deal.

As soon as the proposed price of the deal emerges, the stock will converge on that price as traders seek to maximize their return from the potential deal.

Example:

A good example of this can be seen in Activision’s stock price in January 2022, before its acquisition by Microsoft.

Before Microsoft announced its intent to acquire the company, Activision’s stock had been under pressure due to various controversies and legal issues, causing it to drop from over $100 per share to around $65 a share.

But after the acquisition news broke, Activision’s stock price climbed 25% to over $82 a share. By the time regulators approved the deal, the share price had reached $95, nearly its pre-controversy price.

3. Buying company stock’s reaction to a bid

How the stock of the buying company reacts to a bid is more nuanced than that of a selling company.

In this case, it boils down to how owners of the shares and traders on the market view the deal.

If they believe that the deal will generate value–even after the premium is taken into account–they’ll want to buy more of the stock, pushing its value up.

On the other hand, if they believe the deal will destroy value, they’ll begin offloading their stock, pushing down its value.

In either case, there’s usually an element of judgment required, and sometimes onlookers are split over whether the deal will create or destroy value for the buying firm.

Example:

Broadcom’s recent acquisition of VMware illustrates how the acquiring company’s stock can change just as much as the stock of the company it’s targeting.

After announcing its intent to purchase Vmware for $61 billion, Broadcom’s stock actually dropped by about 4%. This could be attributed to investor concern over the strategic fit of VMware’s business with Broadcom’s, as well as the debt that Broadcom would have to take on.

While there was some initial recovery, Broadcom’s stock continued to fluctuate as the deal progressed.

4. When two companies merge

The first thing to note here is that mergers in their purest sense are rare.

Most ‘mergers’ are, to a greater or lesser extent, acquisitions, where the target company has more leverage in the newly formed company than they would if it were billed as an outright acquisition.

When the new company that combines the two companies is formed, a similar logic to what happens in the case of the buying company’s stock can be seen, as the following examples illustrate.

First, if stockholders believe the merger will be a success, the market capitalization of the new company–as measured by its stock price–should be worth more than the combined value of the two companies’ stock when they were separate (the ‘1+1=3’ that all M&A practitioners desire).

Example:

One recent example of what can happen to stocks before a potential merger is AT&T’s plan to merge its WarnerMedia division with Discovery, Inc. in May 2021. This deal, valued at around $43 billion, helped lift AT&T’s stock slightly since investors saw it as a way for the company to refocus on its core telecommunications business while offloading its media assets.

However, Discovery’s stock fared differently. Despite an initial sharp rise, its stock quickly dropped back down due to investor concerns about the new company’s prospects. This stock remained volatile all the way up until the merger was finalized in April 2022.

Read also

How to Calculate the Acquisition Price of a Company

What happens to my stock after a merger and how to calculate stock price?

In the case of non-publicly traded stock, the answer to this question depends to a great extent on what was agreed to in the terms of the merger.

Recall that transactions can be paid for with cash, equity, or some combination of the two. Assuming first that the merger is agreed to, the merger will involve the creation of a new company (“NewCo”).

Now, your existing stock will be converted into the stock of the NewCo in the proportion that was agreed to in the terms of the transaction.

The reality is that even so-called “mergers of equals” aren’t exactly equal.

One of the companies in the transaction will have more revenue, higher operating margins or a better debt position (to take just three examples). That company will usually take precedence in the deal.

Let’s suppose the terms of the deal meant that NewCo was to be divided in a ratio of 55:45 between the two merging companies.

Now, 100% of your company’s stock would be diluted into 45% of NewCo’s stock (with the extra revenue from the deal compensating for the dilution).

Example:

We can see how stock is divided up when we look at the recent 2024 merger of Six Flags Entertainment and Cedar Fair. 

Under the terms of the deal, Cedar Fair shareholders received one share of the new company per unit of stock owned, while Six Flags shareholders would receive 0.58 shares for each unit of stock owned. 

This meant that, once the merger was complete, Cedar Fair shareholders owned 51.2% of the company, while Six Flags shareholders will own approximately 48.8%.

What happens to the stock when a company is bought?

Like with mergers, the answer to this will depend on the terms of the deal. There are several ways this could play out.

The two most direct scenarios are all-cash purchases and stock-for-stock acquisitions. 

In the first, the acquiring company will agree to pay a certain amount for each share of the company getting purchased. Once the deal is finalized, the stock of the acquired company will be delisted and the shareholders will get their cash. 

A similar process will play out in stock-for-stock acquisitions, except the shareholders of the acquired company will receive shares of the purchasing company at an agreed-upon ratio.

Sometimes, however, an acquisition may involve the combination of a cash and stock offer. In this scenario, shareholders of the target company will receive a certain amount of cash and stock in the purchasing company upon completion of the deal. The exact ratios of each will be determined beforehand. As before, the stock of the purchased company will then be delisted.

Example: 

A good example of an all-cash purchase is Amgen’s acquisition of Horizon Therapeutics in December 2022.

After agreeing to a price of $116.50 per share (a 48% premium on Horizon’s pre-acquisition stock price), Amgen paid over $26 billion to take over Horizon.

What about a stock-for-stock acquisition? ExxonMobil’s acquisition of Pioneer in May 2024 is a great example of this.

In a deal worth nearly $60 billion, ExxonMobil agreed to pay out 2.3234 shares of ExxonMobil for each Pioneer share at closing. That comes out to about $253 per share based on ExxonMobil’s closing price.

Should you buy stock before a merger or acquisition?

Merger arbitrage, sometimes called “merge arb,” is the process of buying stock before an expected M&A transaction–usually in the target firm–in the expectation that the value of its stock will increase when the deal is confirmed.

The rationale here is quite straightforward:

Most companies are acquired at a premium to their trading price (sometimes 30-40% higher), so any trade willing to take a punt on the deal being confirmed stands to make a profit in a relatively short period of time.

There are a couple of issues to consider when thinking about this strategy.

• First, the reality of the markets is that as soon as a deal becomes public, most of the arbitrage opportunity has already been traded out of the deal (following the principle that people don’t usually walk past ten dollar bills on the sidewalk).
• And second, if the deal falls through–as deals have a tendency of doing–you’ve bought into a stock that you took a one-way bet on, rather than holding it for any of its intrinsic value. Hence, when talking about merger arbitrage, we urge caution.

Example:

Merger arbitrage is a common strategy employed by traders. The bigger the premium offered for the target firm, the more likely arbitrageurs will have participated in trading up the stock price.

To take a recent example, pharmaceutical giant AstraZeneca acquired Alexion, a specialist in immunology, at a 45% premium to its price on the index that day.

That’s a respectable premium for anybody looking to “merge arb” but like any pharmaceutical deal, it’s likely to take a while before the deal is cleared by regulators, during which time those traders will have to wait.

What happens to stock in a reverse merger?

A reverse merger is a process through which a private company buys a public company with the intention of going public itself.

Through the transaction, it can avoid many of the legalities and expenses that come with taking a company public through an IPO.

The process is also considerably faster:

Assuming that a company can fulfill all of the criteria set out by their chosen exchange, a traditional IPO can still take as long as a year to complete. A reverse merger takes a fraction of that time.

What does this all mean for your stock?

Well, it depends on which side of the transaction you hold shares. If you hold shares in the private company acquiring the public company, ceteris paribus, your shareholding in that company should remain the same after the transaction has taken place.

But if you hold stock in the public company that is the object of the acquisition, well, it works in the same way that any acquisition would: Your stock is acquired and you’ll receive whatever the buyer pays for it.

Example:

Although reverse mergers aren’t nearly as common as traditional mergers, a recent example can be found in Elicio Therapeutics’ 2023 merger with Angion Biomedica.

After initially canceling plans to go public on its own, Elicio decided to take a different strategy and merge with struggling Angion, which had raised nearly $80 million in an IPO a year earlier but had then gone on to lose nearly all of this value.

In the reverse merger deal, Elicio shareholders retained control of about 66% of the new company, while Angion’s stockholders received the remainder. 

What happens to vested and unvested stock after a merger?

In the case of vested stock, the first point to note is that you’ve already earned the right to acquire the stock or, if you prefer, to receive a substitute cash to its value.

Legally, this has to be taken into account by the acquiring firm. And whatever they pay for the company during the merger (or acquisition) will be reflected in the price you receive.

Alternatively, instead of receiving stock in the old company, you could receive it in the new company, with the idea being the same–the stock and/or cash amount must match what you’re owed.

Unvested stock is more complicated.

Given that you haven’t technically earned the stock, what happens essentially comes down to what the acquirer of your company chooses to do. Unfortunately, in most cases, your unvested stocks will simply be canceled altogether.

The second avenue for the acquirer is to bring forward the payment to create goodwill among the new set of employees. And the final avenue is for them to make some kind of conversion between the old unvested stock and their own stock option plan.

Unfortunately, whatever they decide is up to them–you don’t get a say in the matter.

What happens to preferred stock after a merger?

Although the terms of preferred shares are specific to each company (it’s worth familiarizing yourself about what rights your preferred stock comes with before a merger arises), all preferred stock has special dividend rights.

What they don’t have is voting rights, so you won’t get a say in whether the merger goes ahead or not. However, one of two things must happen after a merger:

• either the buyer has to pay out the redemption value of the preferred stock;
• or, they’ll have to continue paying its dividend. 

Tax implications

The tax implications of a merger or acquisition can vary depending on both the type of deal and its specific terms.

For example, in an all-cash acquisition, shareholders will typically have to pay a capital gains tax on any appreciation of the company’s assets or stock since their initial investment. However, in an all-stock acquisition, they may be able to defer or avoid taxes altogether if certain requirements are met.

In acquisitions that involve both stock and cash, shareholders will be liable for partial capital gains tax on shares they already own, while also potentially differing tax on any stocks they receive.

As with many situations involving taxes, there are various strategies that shareholders can take in order to minimize or avoid their tax liability. Tax specialists and financial advisors can be great resources for learning how to reduce your tax obligations ahead of an acquisition.

Conclusion

Publicly listed stocks provide onlookers in the M&A industry with a great way of telling how the market feels about a transaction.

Although the market isn’t always right about these things, it tends to be one of the best indicators we have.

When managers of listed companies on the buy side of a transaction see that the market is selling its shares after news of an acquisition has emerged, they should be asking themselves: “Are we absolutely sure that this deal makes sense at this price?”

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