Merger Securities

Merger securities are non-cash assets paid to the shareholders of a corporation that is in the process of being acquired or is the target of a merger. These securities generally consist of bonds, options, preferred stock and warrants, among others.

Merger securities can become undervalued when large investment firms are required to sell them, due in part to their requirements for holding and sale. For example, a large mutual fund may receive stock options from an acquiring company when one of the companies held in its portfolio is purchased. However, that same fund may have a policy against holding options. In that case, the fund may be required to sell them, which could cause the price of the options to decline.

Merging two companies is a complicated process, and one that can cause significant volatility on a number of different fronts. On the most basic level, the stock price of the acquiring firm and that of the target firm can fluctuate dramatically. Shareholders of the firm making the acquisition tend to experience a temporary drop in share value in the days leading up to the merger. Meanwhile, shareholders of the firm being acquired generally see share value increasing.

Following the merger or acquisition, the stock price of the newly merged company is anticipated to be higher than that of both the acquiring and target firms. This tends to be profitable for shareholders of the target firm, who benefit from the resulting stock price arbitrage. So long as economic conditions are favorable, shareholders of the merged company should experience an improvement in both long-term performance and dividends.

Mergers affect shareholders in different ways, influenced by a number of different market dynamics, such as the broader economic environment, the size of the companies involved, the financial health of the companies involved, the management of the merger process and the specific criteria set for the merger. The conditions of the merger may have different effects on stock prices of each participant in the merger, including the plan for the payment of assets to the shareholders of the acquired company.

For some investors, merger arbitrage, or the business of trading stocks in companies that are subject to takeovers or mergers, is a viable option. Arbitrage looks to take advantage of takeovers typically involving a significant price premium for the company. However, betting on mergers can be a risky proposition. As a general rule, it is a high-risk strategy best undertaken by professionals.