From time to time, you may read about a company event such as a ‘merger’ or ‘acquisition’. There are a number of reasons why companies may decide to merge or one company decides to acquire another. However, the reason usually involves some form of efficiency. For example, maybe there are two companies that are competing against each other. One could be extremely good at product distribution while the other is known for innovative product features. If the companies decide to “join forces”, the resulting company could be the best of both worlds.
Another major reason for mergers and acquisitions (or M&A), is cost efficiencies. Two companies operating independently will need their own sales and support staff. At their individual sizes, it may be too costly for each of them to invest in automation capabilities. When combined, it could make far more business sense to invest in automation and the sales and support headcount would be reduced.
When companies merge, shares of one company will be converted to shares of another company at some ratio. When a company is acquired, it will almost always be smaller in size (or market cap) than the company doing the acquisition. The larger, acquiring company will buy the smaller, target company using either cash, stock, or a combination of the two. When an acquisition occurs, and both companies are publicly traded, the acquired company’s stock price will usually rise dramatically.
So how does this activity impact the price of stocks you hold?
Let’s look at a fairly recent example: HDFC Ltd and HDFC Bank. In 2023, HDFC Ltd - a housing finance company - merged with HDFC bank to create a singular entity. These companies were relative equals where they each had strengths in their respective financial product spaces. The intent of the merger was to improve operational efficiency and increase their market reach by being able to offer multiple product lines to their customer base.
This is a step-by-step calculation to help you understand how this could have impacted you had you held these companies back then.
Original Holdings:
You own 100 shares of HDFC Bank at an acquisition price of ₹1,500 per share.
You also own 50 shares of HDFC Ltd. at an acquisition price of ₹2,500 per share.
Therefore, the total value of your holdings is:
| Company | Shares Purchased | Acquisition Price | Total Value |
|---|---|---|---|
| HDFC Bank | 100 | 1,500 | ₹ 1,50,000 |
| HDFC LTD | 50 | 2,500 | ₹ 1,25,000 |
| Total | ₹ 2,75,000 |
Merger Ratio:
A merger ratio is also called an exchange ratio, during a merger the ratio is declared by the merging companies basically indicating the number of new shares shareholders will receive as a result of the merger.
In this merger, for every 25 shares of HDFC, shareholders will receive 42 shares of HDFC Bank. (1:1.68)
Since you own 50 shares of HDFC, the shares you will receive from HDFC are:
50*(42/25) = 84 new shares of HDFC Bank
After the merger, your holding will be:
| Details | Shares |
|---|---|
| Original shares of HDFC Bank | 100 |
| New Shares of HDFC Bank (From HDFC Ltd) | 50*42/25=84 |
| Total Shares after Merger | 100+84=184 |
100 original shares of HDFC Bank
84 new shares of HDFC Bank (received for your HDFC Ltd. shares).
So, your total holding in HDFC Bank after the merger will be:
100 + 84= 184 shares
What’s Next?
Now that we have covered mergers, stay tuned for our post where we’ll dive into demergers, what happens when companies decide to split up and go their separate ways!