Amazon.com, Inc (NASDAQ: AMZN)’s grocery list for June included a $13.7 billion buyout bid for Whole Foods Market, Inc. (NASDAQ: WFM), an unexpected bit of good news for Whole Foods shareholders. The grocer’s stock jumped 29 percent on the day the bid was announced.
But once shareholders finished celebrating the big gain, they were left with a question: What now?
Buyout offers are a constant occurrence on Wall Street. If you trade or invest for a long enough period, there’s a good chance that a stock you own could end up as a takeover target. If one of your holdings receives a buyout bid, here are the factors you need to consider.
Buyers can compensate shareholders of the takeover target in one of three ways:
If the deal is an all-cash deal, shares of the target company’s stock will simply be replaced with the appropriate amount of cash upon the deal’s completion. If it’s an all-stock deal, shares of the target company’s stock will be exchanged for shares of the parent company’s stock. Typically, this exchange doesn’t happen on a one-to-one basis. Instead, the deal will include a conversion ratio that will tell target shareholders exactly how many shares they will get from the parent company for each share of the target’s stock.
Typically, a buyout offer will move the share price of a target stock to within cents of the buyout offer price. That price makes sense because from the moment the deal is completed, shares of the target company will be worth only what the buyer is paying for them. However, sometimes there are other factors in play that could be reflected in the initial market reaction to the bid.
Target company shares often initially trade slightly below the buyout price, as investors consider the possibility that the deal will not be completed as proposed. Global regulators have antitrust laws in place to prevent one single company from gaining too much control over a single market. Since merging companies are usually in the same line of business, some deals are ultimately blocked on antitrust grounds. If a target stock is trading well below its buyout price, it’s typically an indication that investors are concerned about regulatory approval.
On the other hand, Whole Foods shares initially traded slightly above its buyout price. This phenomenon is often due to the potential that another bidder, such as Amazon competitor Wal-Mart Stores Inc (NYSE: WMT), could step in with an even higher bid for the target company, leading to a bidding war.
Generally, it’s risk-arbitrage traders who are dead-set on keeping the trading price either higher or lower than the buyout price by a few cents. These experienced traders are guessing that the proposed merger won’t go through for whatever reason, and could profit if that were to happen.
Sometimes, companies can be taken private, which means shares will be removed from the public market and shareholders will lose their ownership stakes in the company. While a public company going private may seem like a confusing situation, it is nearly exactly the same from a shareholder’s point of view as a cash buyout by another public company. Once the deal is complete, shares of the target company will disappear from your trading account and be replaced by the amount of cash specified in the terms of the deal.
Finally, if you happen to believe that your shares of the target company are worth more than the buyer is offering, you as a shareholder likely have the right to vote to block the deal. Buyout deals can typically only be finalized after shareholders of both the buyer and the target company vote to approve it. Keep in mind, however, that retail investors typically have very little influence over the outcome of these votes since institutional investors often hold millions of dollars of stock in popular companies and are responsible for the majority of the votes.
This article is provided for educational purposes only and is not considered to be a recommendation or endorsement of any trading strategy. The author is not affiliated with Lightspeed Trading and the content and perspective is solely attributed to the author.