During periods of stock market strength merger activity among companies typically picks up. This has certainly been the case this year, as merger activity has been unusually strong.
One of the key factors that influences the amount of merger activity is the availability of credit. It is the same for companies, as it is for individuals buying a house or a car, when credit is more easily available more transactions take place.
Large companies can typically borrow at a rate a little higher than U.S. Treasuries. For example, the 10 year Treasury is currently yielding just over 2 percent, so a company might be able to issue bonds with a yield of 3 percent.
However, when credit is not readily available those bonds might cost the company 5 percent, and at the higher interest rate the deal might not take place.
Also companies may offer a portion of their stock as payment to the shareholders of the company they are acquiring. When the company’s stock is trading at a higher price that makes it easier to pay for the merger.
The shareholders of the company being acquired normally receive a premium for allowing the merger to take place. A typical premium might be 25 to 30 percent, though there are cases with virtually no premium to some instances where a company might pay double the current price.
For the company making the acquisition their stock oftentimes does not do that well. Research looking at companies that have made acquisitions has shown that these companies tend to under perform the market after the acquisition.
This poor relative performance is due to several of reasons. One is over confidence in that the assumptions of the benefits of the merger are frequently too optimistic.
Another is that business conditions are normally favorable when the merger takes place, and the likelihood of a poorer economy is not properly considered. Also, a company may have just paid too much.
Mergers do have tax consequences. If the stock, or the fund that holds the stock, is in a retirement account, such as an IRA or 401K plan there would be no tax consequences.
For taxable accounts, if you have a gain, and are receiving cash that would be a taxable event. This would be the case whether you own the stock outright, or in a fund. In a fund this would be netted against the other transactions that have occurred.
If you own stock in the company that is making the acquisition, that would normally not be a taxable event. The one exception is an inversion where a company incorporates in another country to lower their taxes.
In this case both the company being acquired and the company making the acquisition would be subject to capital gains taxes.
In taxable accounts these mergers can create unexpected tax consequences. If someone has as unrealized loss, it might make sense to take the loss to offset the gain.
For those who make charitable contributions, gifting a portion of the stock might make sense, as you get the charitable tax deduction and avoid the capital gains tax.
Most mergers tend to be of interest only to investors. However, mergers do have an impact on consumers and employees.
The merger that people in our area would likely be aware of is Direct TV and AT&T. Direct TV is headquartered in El Segundo, so the merger would likely have some impact on their workforce.
Also, for consumers this merger would likely have some consequences on the competitive landscape.
Antitrust policy in the past tended to be less favorable to mergers due to competitive concerns about companies having too much market share. However, regulators realize, with the proliferation of new technologies, that people will still have significant options for television providers even if the Direct TV and AT&T merger goes through.
Allen Wisniewski has been involved in finance for more than two decades. He lives in Culver City with his family.