When Textron (TXT) announced it was acquiring Beech from two private equity firms, its share price surged from the previous close of $32.57 to $37.29, or 14.4%, the next session. The Street cheered the combination of two long-time rivals with products that should complement each other's portfolio. But, The Street has been cheering acquisition news for a long time.
Historically when a corporate takeover deal is announced, shares of the acquiring company move lower, while the acquisition target moves higher. The reasoning is simple. The company extending the offer has to use currency such as cash on the balance sheet or its own shares, both of which have negative connotations. Cash used or borrowed isn't immediately replaced by the new business so on paper it lowers the value of the company.
When shares are issued, it makes the value of existing shares lower (law of supply and demand). Yet, over the past three years there has been a new phenomenon- shares of the acquiring companies have gone up...huge!
The reasoning for this seems to clearly point to market approval of A) management taking advantage of oversold rivals and depressed valuations, B) the implication that businesses are bulking up to meet demand and C) attempts to grow business in proactive manner rather than "sit on cash." Even though academic research has shown hoped-for synergies and cost savings rarely pan out, acquisitions done in the name of acquiring new business should be viewed differently and recently have been.
Of course, as the overall market continues to increase in value, it's hard to argue there are any bargains out there, but that only slightly changes the interpretation of these deals. There comes a point however, when the knee-jerk reaction will see the acquiring stock down big time even when the deal "makes sense" on paper. For me, that reaction will be the kind of signal that points to overall froth, more so than a megaphone pattern or the VIX being higher or lower.
(For the record, the so-called fear gauge seems to elude proper explanation in financial media which can't decide if it's bad when the VIX goes up or when it goes down. But, I digress.)
Stocks Surged on Acquisition News (just a small sample)
Recommend this article
Wall Street Strategies, Inc. (WSSI), founded in 1991 which provides subscription analytical services to both individual and institutional investors.
TOWNHALL FINANCE DAILY
Follow Townhall Finance!
New Time 11:20 AM PT: Get the Market Movements in Advance: William's Edge Webinar for Wednesday April 23rd, 2014 | John Ransom
New Time 11:20 AM PT: Get the Market Movements in Advance: William's Edge Webinar for Tuesday April 22nd, 2014 | John Ransom