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The Corporate Merger:
What to Know About When Companies Come Together

Mergers and acquisitions (M&A) are situations often cloaked in mystery and confusion. Only part of the information is available to the public, while much of the machinations occur behind closed doors.

This process can make it difficult for the shareholders in each of the companies that are undergoing a merger or acquisition to know what to expect and how the share prices of each company will be affected.

There are some ways, however, to invest around mergers and to benefit from the ups and downs of the process.

Key Takeaways

  •  A merger, or acquisition, is when two companies combine to form one to take advantage of synergies.
  •  A merger typically occurs when one company purchases another company by buying a certain amount of its stock in exchange for its own stock.
  •  An acquisition is slightly different and often does not involve a change in management.
  •  Typically, the share price of the company being bought will increase as goodwill is taken into consideration in the purchase price.
  •  Shareholders are able to vote on whether a merger should take place or not.
  •  Analyzing the financial statements of both companies can help determine what the merger might look like.

How It Works

A merger happens when a company finds a benefit in combining business operations with another company in a way that will contribute to increased shareholder value. It is similar in many ways to an acquisition or takeover, which is why the two actions are so often grouped together as mergers and acquisitions (M&A).

In theory, a merger of equals is where two companies convert their respective stocks to those of the new, combined company. However, in practice, two companies will generally make an agreement for one company to buy the other company's common stock from the shareholders in exchange for its own common stock.1

In some rarer cases, cash or some other form of payment is used to facilitate the transaction of equity. Usually, the most common arrangements are stock-for-stock.

Mergers don't occur on a one-to-one basis, that is, exchanging one share of Company A's stock typically won't get you one share of the merged company's stock. Much like a split, the number of the new company's shares received in exchange for your stake in Company A is represented by a ratio.

The real number might be one for 2.25, where one share of the new company will cost you 2.25 shares of Company A.2

In the case of fractional shares, they are dealt with in one of two ways: the fraction is cashed out automatically and you get a check for the market value of your fraction, or the number of shares is rounded down.

Mergers vs. Acquisitions

While the two processes are similar, don't confuse mergers with acquisitions. While in many cases, the distinction may be more about politics and semantics, there are a lot of blue chips that make quite a few acquisitions while maintaining relatively low volatility.
As a general rule of thumb, if the corporate leadership of the company in which you own a stake doesn't change much, it is probably an acquisition. However, if your company experiences significant restructuring, we're looking more along the lines of a merger.1

Understanding the Buyout Circumstances

The circumstances of a buyout can also be very important. The investor should get to know the nature of the merger, key information concerning the other company involved, the types of benefits that shareholders are receiving, which company is in control of the deal, and any other relevant financial and non-financial considerations.
While it may seem counterintuitive, owning the company that's being bought out can be a real windfall for investors. That's because if the company being bought has shown respectable performance and has good prospects for the future, a certain amount of goodwill may be involved.2
When investing around a merger, it is important to note that when a merger is announced, the actual closing price often ends up being different than the announced merger price. This is due to the fact that a merger is usually not completed under the initially proposed terms.
Goodwill usually accounts for intangible assets, though if those assets weren't factored into the stock price when you purchased your shares of the company being bought, you can end up on top. Goodwill is a source of confusion for a lot of people, but essentially it is the amount of money a company pays over the book value of another company to purchase it.3
And let's not forget that because intangible assets aren't always easily valued, you can expect that a certain phantom percentage of most companies that have goodwill on their balance sheets may be overvalued. While that's not a good deal for the individual who owns a few shares of the purchasing company, if you own the company being bought, this can be another win for you.
If the company you've invested in isn't doing so well, a merger can still be good news. In this case, a merger often can provide a nice out for someone who is strapped with an under-performing stock. Knowing less obvious benefits to shareholders can allow you to make better investing decisions with regard to mergers.

Importance and Consideration Regarding Your Vote

Keep in mind that a company's decision to merge with another company is not necessarily set in stone. If you're a shareholder in the company, the decision about whether to merge with another company is partially yours. The typical voting scenario for a publicly-held company will usually end with a shareholder vote on the issue of the merger.4

If your analysis and consideration tell you that a merger is a step in the wrong direction, or if it tells you that it might be a great financial opportunity, voting with your shares is the best way to exercise your power over the decision-making process.

Voting rights can be exercised at a company's annual general meeting, or other specially convened meetings, or by proxy.

Non-financial considerations can also be important when looking over a merger deal. Remember: it's not necessarily all about money. Maybe the merger will result in too many lost jobs in a depressed area. Maybe the other company is a big polluter or funds political or social campaigns that you don't support.

For most investors, the concept of whether or not the newly formed company will be able to make you money is certainly a big deal, but it might be worthwhile to keep the non-financial issues in mind because they might be important enough to become deal-breakers.

Analyze Financial Reports

Even though there aren't a lot of people who enjoy reading financial statements, examining key information for each company involved in the merger is a good idea. Look over and analyze the company if you're not familiar with it, and determine for yourself if it is a good investment decision. If you find that it isn't, chances are that the newly formed company won't be terribly good either.

When analyzing financial statements, make sure to look over the most up- to-date financial statements and annual reports from both companies. A lot can happen since the last time you took a look at your company's financials, and new information can be a key to determining what influenced the other company's interest in a merger.

Understanding the Changing Dynamics of the New Company

The new company will likely have a few noticeable changes from the original. One of the most common situations is the change in leadership. Certain concessions are usually made in merger negotiations, and the executives and board members of the new company will change to some degree, or at least have plans to change in the future. When you cast your vote for a proposed merger, remember that you're agreeing to adjoining conditions like leadership changes as well.4

The Bottom Line

As mentioned before, when it comes down to it, your vote is your own, and it represents your choice for or against a merger. But keep in mind that, as a shareholder of an involved company, your decision should reflect a combination of best interests for yourself, the company, and the outside world. With the right information and relevant consideration of the facts, coming out ahead in the face of a merger can be a realistic goal.