Skip to content
Rob's e2700 Notes

✏️ How do share prices change after the announcement of a merger?

✏️ Suppose Apple Company is acquiring Turnip Company in a stock swap with exchange ratio .75 which means that all the Turnip shares will be cancelled and each will be replaced by .75 shares of Apple. Using the techniques from the core example, you have calculated that the value of the combined company will be $84 billion=A+T+S\$84 \text{ billion}=\text{A+T+S}. Originally, there were 1 billion shares each of Apple and Turnip.

1. What will the price of an Apple share be immediately after the merger is completed?

2. What will the price of an Apple share be immediately after the announcement?

3. What will be the price of Turnip shares immediately after the announcement?

✔ Click here to view answer

After the merger is completed, there will be a total of 1.75 billion shares in the combined company. (ie Apple.) This is because the pre-existing 1 billion shares of Apple will still exist and the 1 billion shares of Turnip will be replaced by .75 billion newly created shares in Apple.

Based on the definition of market cap,A=PA×NAA=P_A × N_A, if we divide both side by NAN_A, we get PA=ANAP_A=\frac{A}{N_A}. Therefore, the price of Apple, the combined company, after the merger is:

PA=ANA=$84B$1.75B=841.75=$48.0P_A=\frac{A}{N_A} = \frac{\$84B}{\$1.75B}= \frac{84}{1.75}=\$48.0

Because traders are forward-looking, if they expect the price of Apple to be $48 after the acquisition is completed, the only fair price for Apple shares immediately after the announcement is also $48. In general, when a lot of time isn’t passing, the fair price for any security is the price we expect it to have in a month.

Likewise, of each share in Turnip will be replaced by .75 of a share of Apple, then a Turnip share will be worth exactly .75×$48=$36.75 \times \$48=\$36 immediately after the announcement.

Caveat: You can use calculations like this in the course, but in applications, the above calculations are only approximations, because different traders will have different estimates for the future market cap of the combined company. Also, there will tend to be many other “frictions” in the system. Finally, traders won’t know whether the transaction will actually be completed and will need to take the possibility of cancellation into account. With that said, this kind of calculation is the only method we have for estimating what the price of an Apple share will be after the announcement.