Acquisition

Definition: The purchase of one company by another. The acquiring company accomplishes this by buying the outstanding shares of the company it wants to own.

Example: Devour Corp. wants to own Preyco. The share price of Preyco last closed at $10 per share. After the markets close, Preyco announces that it will pay $14 per share of Preyco for any shareholder who wants to sell. Devour offers $4 extra (ie: the ‘premium’ to the stock price) to motivate holders of Preyco to sell their shares of Devour.

Investeach explains: Usually, the price of the target company’s stock goes up when an offer to acquire it is made because the acquiring company offers to pay substantially more for the target company’s shares than they were trading for before the buyout announcement.  In our example, the stock price of Preyco might immediately jump from $10 to, say $13.50. Holders of Preyco who don’t want to hang around until the buyout takes place can immediately sell their shares and collect $3.50 out of the $4 extra that Devour is offering. Who would buy Preyco’s shares at $13.50? Those who don’t mind waiting a few months (for the acquirer to actually begin buying up the shares) to collect a $.50 profit on a $13.50 investment! While this may seem like easy money, there is always a chance that the purchase does not go through. The Federal government might believe the combination of the companies will be too dominant and therefore seek to stop it. If the acquisition is not completed and no other company wishes to acquire the company, its stock will drop right back down to what it was before the buyout offer was announced!

Recognize as well that the price of the acquiring company’s stock usually falls when it announces its intent to buy another company. As we saw above, the acquirer has to overpay to ensure that the holders of target company’s stock agree to sell their shares. While the acquisition may work out nicely down the road, many investors don’t want to endure the temporary reduction in profits per share that can occur from overpaying – formally known as ‘dilutive to earnings’. As a result they sell and temporarily drive the acquiring company’s stock price down. Another reason that the stock price drops is that it can be difficult, time consuming and costly to combine two companies! Imagine trying to merge the duplicate departments of each company, such as Sales, Marketing, Research & Development, and Manufacturing. Imagine trying to combine the different computer systems and software of the two companies. It’s a huge challenge. A third reason the stock may drop is that there is always a chance that the acquisition just won’t work out because, among other reasons, the corporate cultures of the two companies are too different. For example, the acquiring company may put new rules on the acquired company’s employees that they deeply resent. Instead of fighting the new rules, the employees gradually find new jobs elsewhere, taking their knowledge and expertise out the door with them.

How acquisitions are paid for  We would expect the acquiring company to offer to pay cash for the shares of the company to be acquired.  However, it can also offer to pay using the stock of its company. In our example, Devour offered to pay $14 per share of Preyco. If the price per share of Devour is $28, it could offer to pay 1/2 of a share of Devour stock for each share of Preyco. Under this offer, a holder of, say, 100 shares of Preyco would ‘sell’ them to Devour and receive 50 shares of Devour in return. Because acquisitions can take months to be completed, notice that during this time the value of this type of offer will change as the price of Devour’s stock changes. For example, if Devour’s share price falls to $24 per share, then the value to be received for each Preyco share has fallen to 1/2 of $24, or $12 per share.  Finally, the acquiring company can use a combination of cash and stock to buy the shares of the company it wants to own.

Friend or foe  Acquisitions can be made in a friendly manner or a hostile manner. When the acquisition is friendly, the Board of Directors and the management of the company to be acquired agree that this is the best option for its company. Their blessing is important because the last thing an acquiring company wants are the employees and customers of the company it is acquiring to leave because the word is out that once it gains control, it will make changes that will ruin the company it just acquired.

When one company attempts to acquire a company that does not want to be acquired, it is said to have launched a hostile takeover. This is usually followed by a long, drawn out battle as the target company takes various steps to hold off the company that wants to acquire it.

Riddle me this:

1. Why does the share price of the target company in an acquisition go up?
2. Why does the share price of the acquiring company go down when it announces its intent to buy another company?
3. What can the acquiring company use to pay for the shares of the target company?
4. With method of payment for the shares in target company actually causes the offer amount to move around?
5. Why don’t shareholders in the target company have to wait until the acquiring company actually purchases the shares to realize a substantial profit?

Also known as: Buyout.

2017-08-30T00:28:03+00:00