When a company we own is the subject of a takeover offer, we’re faced with a decision: Should we sell our shares or hold them?
If a deal has been struck on friendly terms, we can count on the CEOs of both buyer and seller to crow about the business logic of the combination and cite the favorable earnings impact they expect from cost savings and new sales opportunities.
We’re under no obligation to take any of these claims at face value, and we don’t. Instead, there are several questions we’ll ask to determine what we should do with our shares:
What is the offer worth? Mergers usually involve cash, stock or a combination of the two. The value of cash is obvious, but the value of stock will vary. Headlines will state that a deal is worth, say, $50 per share, but this will be based on the closing price of the buyer’s shares before the merger is announced. What the value is after the announcement will depend on how the general stock market is doing and how investors react to the news of the merger.
Is the offer reasonable? We compare the offer to what has been paid for similar companies over the past several years. If the price seems low, we’ll consider whether we can expect a rival bid.
Is the deal likely to be approved by shareholders and regulators? Will it be easy to gain all the necessary approvals? Might there be regulatory delays?
When is the deal expected to close? If we know what the offer is worth and when it is expected to be final, we can estimate a rate of return. How does this rate compare to what we can earn elsewhere, whether on cash or another stock?
Do we want to own stock of the acquiring company? Here we apply the same three-part test we always use for a potential new idea. Do we like the economic characteristics of the business? Do we like the way management thinks? Is the stock price reasonable?
What’s the downside? If the merger can’t be completed, what impact do we expect this to have on the stock? If the price is likely to fall, can we expect it to recover over time as the company grows? Is another bidder likely to emerge.
After weighing the answers to these questions, we’ll decide whether to sell or hold our stock until the merger is completed. Having a methodical evaluation process in place is a big help. Read more about how we evaluate companies.
Barry Dunaway, CFA®
Executive Vice President & Director of Research
America First Investment Advisors, LLC
This post expresses the views of the author as of the date of publication. America First Investment Advisors has no obligation to update the information in it. Be aware that past performance is no indication of future performance, and that wherever there is the potential for profit there is also the possibility of loss.