Takeover Rumours:

The chat rooms are rife with rumours and conjecture, especially those initiated by frustrated shareholders of underperforming companies. But every now and then legitimate discussions take place regarding takeover targets.

Often when takeover rumours first appear many traders will jump on the banbdwagon and buy shares in the takeover target, solely on the assumption that the pending takeover may generate other takeover offers or that the takeover price will improve. I’m not sure if trying to chase companies that might be bought is really a good strategy.

First, there’s no way to know whether the deal will happen. And if the deal doesn’t happen, if other investors bid up the stock expecting a deal, the stock could drop if a deal fails. And of course, if you know for sure the deal will happen, you likely have insider information, which is illegal to trade on.

Most times the shares of a target company rise after the company gets a buyout offer. Most times, but not all the time. The price of a target stock can fall if the buyout terms are disappointing.

And sometimes terms of a takeover dictate that the takeover is an all stock transaction. In this case you, as a shareholder, you will receive a conversion ratio. For instance, you might get a half share of the acquiring company for every share of the target company that you own. Once you know the value of the deal, the ratio is determined by the target company’s number of shares outstanding and the stock price of the acquiring company.

There are variations. Sometimes, in a stock deal, shares of the target company can move above or below the initial per-share buyout price. This can happen, for example, if shares of the acquiring company move between the time of the announcement and the transaction. And sometimes there can be dilution due to acquisitions if a company pays too high a takeover price and issues too much stock to facilitate the deal, then the combined company’s earnings per share could fall. This is a big danger of acquisitions and a reason why many fail to add value for shareholders.