Companies that are set to merge or be acquired often look like strong investment opportunities. This is especially true when their stocks are trading below the stock price proposed in the deal.
However, stock price differentials are rarely due to an uninformed market. Instead, the shares are being discounted because of the large number of risks involved in any merger or acquisition. One of the biggest risks is government involvement.
Why the Government Gets Involved
The Department of Justice has oversight over mergers and acquisitions as part of its duties to enforce federal antitrust laws. The United States has long considered allowing monopolies to be bad economic policy. Concerns include rising prices, poor customer service and lack of innovation.
On the other hand, some economists and business executives say the government often goes too far. With changing technology, businesses that were once competitors may have no choice but to merge to fight against an imminent threat. One common example is retail stores facing competition from online sellers.
While the DOJ legally has to file a lawsuit to block a merger or acquisition, things rarely go that far. Even the threat of a lawsuit is often enough to derail the transaction. Recent high-profile mergers blocked by the DOJ include AT&T with T-Mobile, General Electric’s appliance branch with Electrolux, and Comcast with Time Warner. When the deals fell apart, the share prices of each company dropped significantly.
Reasons for falling share prices include the substantial legal costs involved in a merger or acquisition, which become a wasted expense, loss of the anticipated value of the deal and the possibility that the company isn’t healthy enough to thrive on its own.
Why You May Not Want to Invest
Merger and acquisition trading is a viable investment strategy for some. However, the risks involved leave little room for gains.
Merger and acquisition investors must keep up with the latest details in developments in a deal. If you make a trade even just a few hours after the release of good news, you miss the share price jump associated with that news and gain only the risk of it not coming true. This sounds more like a day trader than a long term serious investor.
Even when deals do close successfully, there’s still the risk that the combined company will not hit the level of performance investors were expecting. For those reasons, you may want to stick to a long-term strategy rather than trading on merger and acquisition rumors.