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

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, 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.