How the Stock Market Responds to Acquisitions and Mergers

Posted: 25th February 2016 09:12

Investing on the stock market is a risky business. This is because stock values fluctuate greatly depending on various factors including natural disasters, government policies, financial results, company balance sheets and more. One important factor that affects the stock market is corporate mergers and acquisitions. When one company mergers with another company, or when one business acquires another, the fluctuations are tremendous.

Businesses have a singular motive: making more profits by minimizing their potential losses. In order to actually achieve this, they come up with a range of financial strategies and develop plans. One strategy that is quite common is to enlarge and expand capacity for production. However, external growth can also be achieved by buying (acquiring) another firm. This is known as an acquisition. If they decide to join forces with another business, it is known as a merger.

When a company wants to grow internally, they can choose their technology, equipment and more themselves. However, implementation usually takes a long time, funds can be lacking and uncertainties are increased. If they opt for external growth – through mergers and acquisitions – there are also some potential difficulties. The cost is often very high and it can be difficult to determine what the exact financial benefit is. Plus, they have to deal with various legal and taxation issues, which are highly complex.

Types of Mergers
  1. Horizontal mergers. This happens when two companies who are very similar in what they do or offer join forces. Usually, they do this in order to reduce or even eliminate competition, which means they won’t be undercut anymore and will have smaller necessary budgets for things like marketing, research and development, and production.
  2. Vertical mergers. This happens when a firm that is either ‘downstream’ or ‘upstream’ is acquired. Downstream companies are suppliers, whereas upstream companies are distributors. These types of mergers happen when a company wants greater control over distribution and supply, stop potential new entrants from getting on the market, guarantee supply and more.
  3. Conglomerate mergers. These happens when two unrelated businesses join forces. Usually, this happens when one business wants to diversify. In most cases, the business that is taken over was failing and even heading towards bankruptcy, which will make it more interesting for another business to take it over. Unsurprisingly, the effects on the stock markets of this type of merger is very significant.
This is a very basic introduction to what mergers and acquisitions are. It is also important to understand the effects of this on the stock values and stock markets. When one business merges with another, the result is a larger firm. This means that, in all likelihood, more money is available to do more things. As a result, stock value can rise. However, a merger always starts with a period of insecurity, which means stock value can go down.
The final effect of a merger or acquisition completely depends on the success of this acquisition. If all goes well, prices go up and vice versa.