Mergers & Acquisitions

One of the common ways that companies use in order to grow their businesses is a merger. One of the well-known mergers is the one between Dow Chemical and DuPont. The $130 billion merger in 2015 increased their market power and made the consolidated company, DowDuPont Inc, the biggest chemical company in the world.

Merger is often used in place of the term “acquisition”, but there are key differences between the two. One is that while a merger is a process of consolidating two separate entities under a new name and a new management system, an acquisition is a purchase of one company by another. In most cases, an acquired company keeps its name and exists as a daughter company of an acquiring company. A merge occurs through a mutual decision between two companies which are considered to be on equal terms. An acquisition can be a one-way decision of a financially stronger firm without an agreement of the other. By purchasing over 50% of target company’s stocks, an acquiring company takes control of the management of the target company. Because of the negative connotation of the word, many prefer to use the term merger over acquisition.

What are effects of M&As on stock prices? In the short run, a target company’s stock price show a significant positive return around the date of M&A announcement mainly due to the premiums paid to their stocks in a transaction. Conversely, acquiring companies show little positive returns or even negative returns in the short run. According to a paper by Farid Abdelali, The Effects of Mergers and Acquisitions on Stock Prices, data on international M&A transactions from 20001 to 2016 shows that target companies have an average of 19% increase in their stock prices, whereas the effect is not as significant for acquirers with an average increase slightly over 0%. Other studies by Mulherin & Boone in 2000 or by Andrude, Mitchell & Stafford in 2001 also show that target companies have positive return of around 20%.

Acquiring companies may experience a fall in their stock prices for several reasons. First of all, as they pay premiums, they may exhaust their cash or be burdened by debt. Also, there can be management power struggles, regulatory problems and other related issues to integration which may lead to lower productivity. If the acquisition cost is much larger than future gains from it, this can also have a negative influence on the long-term stock price of the acquirer. Therefore a good estimation of the value of a target company is crucial to M&As.

An interesting characteristic of M&As is that it has a cyclical nature. As shown in a study by Martynova and Reneboog, A Cetury of Corporate Takeovers: What Have We Learned and Where Do We Stand?, M&A deals change in numbers along with business cycles. When the economy is in its upturn, along with economic recovery, market innovation and booming capital markets M&A transactions increase and the M&A cycle also end in general with a downturn in markets. In the chart below, you can find 6 main M&A waves. Periods of the waves are approximately 1903~1905, 1920s~1929, mid-1950s~early 1970s, early 1980s~1987, 1993~2000, and 2003~2008.

By Ahrim Kim