How Do Company Mergers and Acquisitions Impact Your Investments?

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Mergers and acquisitions are key business activities that bring substantial changes to companies — for both employees and customers. But workers and buyers aren’t the only people who are primarily affected by these changes in leadership and structuring at companies undergoing mergers and acquisitions. If you’re a shareholder of a company that’s participating in a merger (or acquisition), you might expect to see some impacts to your investments due to these business activities.

Mergers and acquisitions can be understandably concerning if you’ve built segments of your portfolio around the stability of a certain company. It’s common to invest in companies for strategic reasons, and mergers and acquisitions can upend those strategies and require some careful consideration. If you’ve invested in a company that’s announced plans for a merger or acquisition, it’s essential to understand what you can expect from this transition — financially speaking — and how you can adapt your investment strategies to respond to these changes.

What Are Mergers and Acquisitions?

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First things first: It’s essential to understand what these activities typically entail so you can see the different levels at which they can impact your investments. Mergers are business arrangements in which two or more existing entities join together to form a completely new company. The new entity owns the combined resources of both previously existing companies. Mergers often become powerful disruptors in the marketplace because they can have more employees, customers and capital than competitors.

For example, in December of 2021, banks SunTrust and BB&T merged together to create one large bank called Truist Financial. Media giants Discovery and Warner Brothers are in the process of merging together to create a new entity called Warner Bros. Discovery. This merger should be complete by mid-2022.

An acquisition happens when one company purchases all or a large portion of another company. The purchased company then becomes part of the purchasing company. While company names and ownership may change during this process, the actual purchasing funds are often transferred through the stock market in the case of a large corporate acquisition. One company may buy more than 50% of the other company’s stock, with the goal of owning more of the acquired company than any other shareholder.

Mergers and acquisitions both refer to ways that resources from one company can either transfer to another company or combine with another company’s resources. Mergers and acquisitions often lead to name changes, changes in product offerings and changes for employees. Of course, when ownership changes, the values of the companies involved — and any new entities that arise — change, too.

How Do Mergers and Acquisitions Affect Stock Prices?

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There’s no rulebook that can accurately dictate the ways mergers and acquisitions will affect stock prices; the results aren’t always consistent or predictable. Often, mergers and acquisitions are symbols of new beginnings and new opportunities, but some companies enter into these agreements under unfavorable circumstances. Thus, mergers and acquisitions can have both positive and negative effects on stock values.

During an acquisition, it’s typical for the purchasing company to buy a large portion of the stocks of the company it’s acquiring. This takes time. Throughout the process, stock prices often decrease for the company that’s making the purchase. Meanwhile, stock prices often rise for the company that’s being purchased. When a merger is complete, stock prices for the new entity often rise higher than the value of both of the previous companies.

Should Shareholders Worry About Dilution of Voting Power?

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When you own shares of a company’s stock, you have the right to vote on certain corporate actions and other matters that affect the company’s operations. One result of mergers and acquisitions is that there’s often a loss of this voting power for shareholders. Consider the example of a pizza party. The pizza is cut into 16 slices. There are eight people at the party, so each guest can eat two slices. Before guests begin to eat the pizza, though, eight more guests arrive. With 16 guests at the party, there’s only enough pizza for each guest to have one slice.

With more people eating the pizza, each person’s portion of the pie shrinks. In mergers and acquisitions, the situation isn’t quite so scarce — but it’s similar. Pizza is a limited resource, but the value and potential growth of a new corporate entity are virtually unlimited. Shareholders can expect to see a decrease in voting power during mergers and acquisitions because a whole new group of shareholders from the second company will now have access to the pool of stocks.

In particular, this decrease can impact shareholders of the purchased company. Depending on the details of the transaction, the purchased company may release additional shares to the market to allow the acquiring company to purchase enough shares to obtain majority ownership. This change can be especially meaningful for shareholders of either company who owned a significant portion of shares of one of the original entities. A shareholder whose votes were at one time very influential may feel more impact of the dilution of their voting power as a result of the merger.

While the thought of losing voting power or even a percentage of ownership in a company may seem negative, the change may not always be so devastating in reality. Teams of experts usually run calculations for years to arrive at agreements for mergers and acquisitions to take place. If all of the predictions come true, shareholders of both companies stand to see their investments gain value over time.

In some circumstances, you can avoid dilution as a shareholder. There are anti-dilution agreements that prevent your percentage of share ownership from ever being diluted by a merger or acquisition. Some corporations also offer preemptive rights with their shares; this means existing shareholders have the first right of refusal if the number of shares available to the market ever increases.

Often, both of these options are only available to investors who purchased large stakes in a company when its stocks were first released to the market. These types of investors typically own large percentages of the companies. When a shareholder has this much voting power, they’ll likely already have voted on the decisions that allowed the merger or acquisition to happen, so it would be unlikely for them to exercise their rights to prevent an acquisition. Unless you’re this type of shareholder, you don’t have much to worry about in the way of making these substantial decisions.

Stock Strategies for Mergers and Acquisitions

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Should you change your stock strategy due to an impending merger? That depends upon both your portfolio and the market. There will be temporary increases and decreases in the value of stocks of both the original companies. You may be able to profit by trading wisely based on the temporary fluctuations in stock value. But you shouldn’t feel like you’ve taken a loss due to these expected fluctuations. Once the merger is complete, stock values should return to normal or even rise in the future.

Mergers and acquisitions can fail, but they can also be a harbinger of both companies’ stocks becoming more valuable together. Remain attentive about learning exactly how the development will impact your investment and your voting power. But, remember that you shouldn’t feel threatened by all mergers and acquisitions. If you’re prepared to hold onto these stocks for the longer term, you may see your investments return to (and even exceed) pre-merger values.