Question

Subject Merger and Acquisition

What is the effect of such amendments on firm’s stock price based on empirical evidence?

What are the financial characteristics that make a firm vulnerable to takeover?

Answer 1

There will always be a m&a impact on share price of both the companies in the short term. Generally the share price of the acquiring entity will fall down whereas the acquired one will shoot up. This is because the buying firm has to pay somewhat extra premium than what is its worth of the target firm. Otherwise, the target company's promoters may not come forward for the acquisition. For example, if the shares of the target company are currently trading at $20, the buying company has to pay more than $20 per share of the bought up company for the acquisition to happen. If the business deal is confirmed, the stock prices of the bought up entity will automatically move towards the deal price.

The reasons for falling down of the share price of the acquiring firm can be many. The first reason is that it has to pay more premium for the bought up firm which in turn reduces the net worth of the buying company in the short term. In addition to that, there will be a lot of uncertainities hovering over the acquisition. If the acquired company has debts, that will be a buden for the acquiring firm and there will be exra cost involved in resrructuring the whole organisation.

Sometimes, the stock price of the target firm wont even reach the deal price if uncertainities linger over the deal. If the business deal fails to materialise, the stock prices of the bought up company will automatically fall down significantly. In rare situation, the target entity share price rises above the deal price in the hope that some other firm will come forward to take over that firm. Sometimes, even the stock price of the acquiring entity also rises after announcement of the deal, if the investors think that the buying firm has struck a good deal or if the bought up firm has some reputation and brand value.

The movement of share prices of companies in exchanges may be attributed to the nature of information accessible to all or a particular group of investors depending on the state of market efficiency from perspective of information economics, M&A announcements atimes may transmit information that lead to share price reaction to it. The returns to the acquiring firms are influenced by a number of factors. Many firms engage in a series of M&A activities overtime thus making it difficult to isolate the influence of single acquisition event. If the time period over which the returns to the shareholders of acquiring firm includes a year or two before a specific acquisition, on average the acquiring firm earn at least their cost of capital.

Share price movement in any stock market is attributed to news, company fundamentals or noise qll of which constitute source of information. M&A announcement may send information to the market and as a result it changes the belief system of the market participants in terms of supply and demand side. This lead to tht movement in share prices of those firms that make M&A announcements.

Financial characteristics that make a firm vulnerable to takeover:

1. High and steady cash flows.

2. Low debt levels

3. Low stock price relative to the value of firm's assets

4. Financial distress business-when it cannot pay its creditors or operate the business efficiently.

5. Firms with low p/e ratios and positive earnings.

6. Highly liquid balance sheet with large amount of excessive cash and unused debt capacity.

7. Firms with good cash flows relative to current stock prices.

8. Undervaluation of the firm.