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In an age where companies like Amazon and Google (Alphabet) can go from garages on residential streets to disrupting billion dollar industries in just a few months or years, major firms are looking to protect their interests – and pursue new ones – through acquisitions.
As a result, a tech company’s purchases can give clues to its overall strategy and direction, and many analysts use information about a firm’s acquisitions as part of a fundamental analysis of future value. For this reason, acquisitions can have a pronounced effect on the share prices of the companies involved, as well as those of their competitors. Here’s how you can make the most out of this price movement:
Consider the cost of acquisition
Acquisitions can be very costly, with firms often needing to pay a premium (a price over and above market value) to ward off competitors and close deals. In the tech industry, these premiums can be particularly high as companies such as Apple, Facebook and Google have extensive cash reserves and compete with each other across many different sectors.
For traders looking to take advantage of the price movements surrounding an acquisition via CFD trading or spread betting, the cost of purchase and premium paid are important factors to consider, as they can signal how the acquiring and target companies’ shares are likely to move in the short term:
The acquiring company’s share price will generally fall during an acquisition, as investors factor in potential issues such as a reduction in the acquiring company’s cash reserves (or increased debt), anticipated problems integrating the two firms, or a premium that has pushed the target company’s price above fair market value.
For example, Facebook shares fell by 3.4% in trading on 21 February 2014, immediately following Mark Zuckerberg’s announcement that the firm would buy Whatsapp for $19 billion. However, it should be noted that the company’s shares had recovered most of their value by the time the market closed.
Conversely, if the price of the acquisition appears to reflect fair value or, in rare cases, appears to be a ‘steal’, the acquiring firm’s shares are likely to rise as additional buyers enter the market.
The target company’s shares will typically rise as the markets adjust to reflect the premium paid. For example, LinkedIn shares jumped by 47% in afternoon trading on 13 June 2016 after Microsoft announced it would be acquiring the firm for $26.2 billion (a 50% premium) – in part because investors could see potential synergies between the two business-focused firms.
However, it is also possible for target companies to lose value as a result of an acquisition, particularly if it is not clear how the acquiring or target firm will benefit. On 9 April 2001, for example, Hewlett-Packard (HP) and Compaq shares both slid after it was announced that the former would buy up and merge with the latter. In this case, it seems investors weren’t sure how the merger would help the new HP compete more effectively in the hyper-competitive world of personal computers, as it would continue to be dependent on Microsoft’s software and therefore struggle to differentiate its offering from its remaining competitors.
Assess the potential effects on competitors
Acquisitions are often made to increase the competitiveness of one or both firms involved in the deal, so rivals’ share prices may fall in anticipation of reduced market share. This can create opportunities for traders to go short on their stocks. The announcement of Amazon’s acquisition of Whole Foods Market for $13.7 billion on 24 August 2017, for example, saw the shares of rival US food retailers – Costco, Kroger, Supervalu, Sprouts Farmers Market, Target and Walmart – fall several percentage points in afternoon trading, as investors weighed up the likely effects of increased competition.
Of course, in some cases the intention is very different and the acquisition is made to reduce competition. In such a scenario, both the acquirer and its competitors may benefit from the acquisition.
Assess the long-term goal
Companies pursue acquisitions for a variety of strategic reasons. Among other things, they can help firms to secure market share, expand into new areas, reduce competition, improve performance, and get new technologies or skills more quickly than they could be developed in house. Microsoft’s acquisition of LinkedIn, for example, was widely regarded as an expansion into social media, while Google’s acquisition of Motorola Mobility was seen by many analysts as a defensive move, made primarily to secure intellectual property for its mobile unit.
While the reason for an acquisition will not always be stated publicly, there may be an opportunity to place a long-term trade if you are able to identify obvious synergies between the acquiring and target firms, or potential problems with the acquisition. Remember, not all acquisitions are made with growth in mind – in some cases the intention is simply to close a potential competitor.
Do your research
Acquisitions are often reported in the media, with rumours likely to spread in advance of any major announcement. For this reason, mainstream news organisations can be useful sources of information on upcoming and current acquisition activity, sometimes even acting as a useful barometer of market sentiment.
But before you start trading company acquisitions, it’s important to get a feel of when and how the markets are likely to move. One of the best ways to prepare for this is to look at previous purchases and practise making predictions about how these might have affected share prices, before comparing these predictions against historic price charts.
Our latest piece of research, ‘Acquisitive Tech’, brings together the acquisitions that Apple, Facebook, Google (Alphabet), Amazon, IBM, Intel, Microsoft, HP, Sony and Cisco have made since 1991 – the year the internet became publicly available – or, for companies founded after this date, since launch. The result is a tool that can be used to view the firms’ acquisitions in four ways:
- Acquisitions: An interactive representation of each firm’s acquisitions that includes the name and cost of each purchase with an option to toggle between real cost and inflation-adjusted figures
- Expenditure: This tab reveals how much, in total, each firm has spent on acquisitions. The data shows that each company is spending very different amounts on acquisitions, which could be the result of differences in spending power or strategy
- CEOs: A graphic, which shows how many acquisitions have been completed by each of the firms’ CEOs. The data can be filtered by company to show which of its leaders completed the most acquisitions during their tenure, and by year to display the average number of acquisitions they made annually
- Frequency: This tab shows which company has made the most acquisitions. The data can also be filtered by year to reveal the average number of acquisitions each company has made annually.