It’s every investor’s dream to own a stock that rises rapidly, and there’s no more rapid source of share price gains than when a company becomes a takeover target.
When you’re lucky enough to own a takeover target, it would be wise to have a plan already in place, so that the excitement of the moment does not interfere with wise investment decisions.
Is the Buyout Offer a Rumor or a Fact?
If it’s just a rumor, the stock price could continue to climb, based upon the market’s expectation of a buyout. It’s not unusual for rumors of a buyout offer to emerge a couple of days before the actual offer. But other times, the rumor fizzles along with the recent stock price gains. Expect volatility. You could use a stop-loss order to protect your capital.
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Last February, a rumor emerged that Allianz was interested in buying XL Group (XL) in my Cabot Undervalued Stocks Advisor Growth Portfolio. XL shot up 12% immediately. There was no further news for four weeks, until suddenly investors learned that XL had agreed to be bought by Axa (AXAHY), at which point XL shares shot up another 30% in value.
If a buyout is happening, shares of the takeover target will often rise quickly to the buyout price. However, sometimes the stock rises to a point below the buyout price. In those cases, there’s a certain amount of doubt as to whether the buyout will receive approval due to anti-trust concerns.
Will There Be A Competing Offer?
Check the news to see whether analysts think there’s a reasonable possibility of a competing buyout offer emerging. In that scenario, you might make more money by waiting a few days or weeks before selling your shares in the target company. Last June, it became clear that Walt Disney Co.’s (DIS) plan to buy most of the assets of 21st Century Fox (FOXA) might be interrupted by a competing offer from Comcast (CMCSA) (though the Disney-21st Century Fox deal was eventually consummated, in late July; Disney stock has been up and down since).
Is the Buyout Price Fair?
Sometimes the buyout offer comes in at a ridiculously high price. Other times, analysts are left wondering why the targeted company accepted such a low buyout price. It’s not your job to decide what price is fair. It’s your job to decide whether to keep or sell your stock, based on the actual buyout price.
When XPO Logistics (XPO) announced an acquisition of Con-Way Inc. (CNW) in September 2015, analysts were stunned at the low price. When Danaher (DHR) announced the purchase of Pall Corp. (PLL), I thought they paid far too much for the company. Either way, it’s not my job as an investor to decide what should happen. It’s my job to look at the facts, accept them, and make a decision.
In the case of a hostile takeover attempt, the first price is often rejected. That happened last March, when a German company, Knauf, offered to buy USG Corp. (USG) for 42 per share. USG turned Knauf away with disinterest.
USG shares rose to 40, not to the buyout price of 42. What investors should have known was that Knauf would likely come back with a higher offer, so as to entice USG to say “yes.” And that’s exactly what happened: in June, Knauf upped its offer to 44 per share, and USG accepted. USG currently trades at 42 per share.
What Happens to My Stock?
Your stock will jump in price on the day the merger is announced. It could climb higher than the buyout offer, as Broadcom (BRCM) did when Avago (AVGO) announced its intended acquisition; or it could climb to a price below the buyout offer, as Pall Corp. did upon the Danaher purchase announcement.
You can sell your stock on the open market, any day between the announcement and the close of the merger transaction. You will receive the market price for the stock, which could be above or below the price of the buyout offer.
Alternatively, you can keep your stock, and wait for the acquisition to take place. (That waiting period could easily take six to 18 months, during which time you’ll likely watch your capital stagnate.)
The risk in waiting for the completed merger is that the acquisition might not receive U.S. or foreign government approval, in which case the merger would fail and the targeted company’s stock price would fall. That’s exactly what happened to Broadcom’s takeover attempt of Qualcomm last March. As it became more and more clear that the deal might not receive approval, QCOM gradually fell from 67 to 49. Imagine being the shareholder who did not sell at 67 and also did not use a stop-loss order to protect their capital! (The stock has recovered since, but currently trades at 56.)
Let’s say that the buyout is valued at $50 per share. Sometimes the investor receives $50 cash, or $50 worth of stock in the acquiring company, or a combination of the two. If you own your stock in a brokerage account, the brokerage firm promptly handles the exchange of stock/cash for you. There’s no red tape.
Do I Want to Own Shares in the New Company Now that It’s No Longer a Takeover Target?
Let’s say that ABC Company is purchasing XYZ Company. If you wouldn’t normally buy shares of ABC Company because the stock’s fundamentals do not meet your investment criteria, then sell your XYZ stock and reinvest the capital in a more appropriate place.
Also, how’s your tolerance for detail when filing your Federal tax return? If you accept the new company’s stock in a taxable account, you’re eventually going to have to report the transaction down the road, when you sell the new company’s stock. Most investors do not keep good records of their cost basis, and cost basis gets complicated when stocks are involved in mergers. If you detest complicated income tax paperwork (or paying an accountant to do extra work), then seriously consider selling your stock, rather than accepting shares in a new company.
Cabot Undervalued Stocks Advisor has spotted many takeover targets over the years and our subscribers were able to grab quick double-digit gains in a matter of months or sometimes just weeks. To see how we did it and how you can profit in the months and years ahead, join my advisory today by clicking here!
*This post has been updated from an original version published in 2016.