Understanding Stock Price Changes When a Company is Acquired
In May 2024, Johnson & Johnson completed its acquisition of Shockwave Medical offering $335 per share. On 26th March, when this deal first came to light, Shockwave Medical’s share price increased by 10.04%. Thus, acquisitions can cause significant swings in share prices.
When your company becomes the target of an acquisition, you, as a shareholder, will face a pivotal moment. You must decide between not selling your stake, selling your entire stake, or selling a part of it.
If you wish to sell a part of your stake, the effect of the acquisition on the target company’s share price will be a major concern for you. This can be a tough puzzle to navigate because of how different each acquisition deal type is.
Also, before you sell your stake, you must also figure out your tax liability. Only after making all these calculations, you can take a call on whether to sell and how much to sell.
So, to help you answer such queries, in this article, we will discuss the effects of acquisitions on stock and their tax implications. Read on to know more!
Types of acquisition deals and their effects on share prices
Broadly speaking, acquisitions can be of 3 types. Each type of acquisition deal impacts the share price differently. Let’s explore the effects of acquisitions by examining these three distinct types.
All-cash deal
In an all-cash deal, the shareholders of the target company receive cash for their shares. When a healthy organization is being acquired, the acquiring firm will offer a premium on the current share price or the 52-week high share.
However, if the targeted firm performs poorly, the story could be entirely different. Here, the acquiring company may only be interested in the target’s assets and will try to be careful about overpaying. Hence, the acquiring one may make an offer close to or even lower than the current share.
If the acquisition offer is made at a premium to the current, we can expect the target firm’s share price to rise. However, it will not rise as high as the acquisition price until the deal is finally closed. After all, not all announced deals are closed.
All-stock deal
All deals involve an exchange of stocks at a specified ratio. In all-stock acquisitions, the target firm’s shareholders are offered a certain number of acquiring company shares for one of their shares.
For instance, in an all-stock acquisition, the target firm’s shareholders may get 1 share of the acquiring company in exchange for 4 of the target shares.
In such deals, the effect is a little more challenging to quantify since the share prices of both companies can change over time.
When an all-stock deal is announced, typically, the value of shares offered to the targeted firm’s shareholders will be more than the value of shares received from them. For instance, the acquiring firm may offer its shares worth $40 million in exchange for the target firm’s shares worth $30 million.
If the target company is in distress, the acquiring one can make a less lucrative offer. For instance, the acquiring one could offer its shares worth $30 million in exchange for the target firm’s shares worth $36 million. In such a case, the acquiring one share price might increase while the target company’s share price drops.
Cash and stock deal
In many acquisitions, the target firm’s shareholders are offered cash and stock deals were in exchange for the targeted firm’s shares, they receive cash plus a certain number of shares. For instance, in a cash and stock acquisition, the acquiring organization may offer $10 and 2 of its shares for 4 shares of the target company.
Cash and stock deals allow acquiring companies to preserve their cash reserves. Since the sellers will become acquiring shareholders and also receive cash, they have a greater incentive to support the deal.
The effect on stock prices depends on the value being offered for the target one’s shares. If the total value (value of shares plus the cash) being offered is more than the value of the target shares being bought, then the target company’s share might increase.
Tax implications of acquisitions
Let us go over the tax implications of acquisitions in different types of deals.
All-stock deals
If the shareholders of the target company receive only acquiring stocks, there is no immediate tax effect. Instead, these shareholders will carry over their cost basis from the original shares to the new shares. Taxes will be payable only when these shareholders eventually sell the acquiring shares.
Example:
StyleHub Ventures is acquiring TrendWave Apparel by offering 2 shares for every 5 TrendWave Apparel shares. Luther Rigsby had bought 5,000 TrendWave Apparel shares 6 months ago for $30,000. He sold his stake in this acquisition.
5 years have passed since the acquisition and StyleHub Ventures’ share price has increased to $60 from $35.
Let us calculate Luther Rigsby’s tax liability if he sells his stake in StyleHub Ventures.
Step 1: Calculate the value of shares received and sold
Value of shares received and sold by Luther = 2/5 ×5,000 ×$60
= 2,000 × $60
= $120,000
Step 2: Calculate capital gain
Luther’s capital gain = Value of shares received and sold by Luther – Original cost basis
= $120,000 – $30,000
= $90,000
Step 3: Calculate tax liability
In the eyes of the IRS, since Luther held the stocks for 5 years and six months, he needs to pay long-term capital gains tax. Let us assume that Luther’s total annual income as a single taxpayer is $300,000 which requires him to pay 15% long-term capital gains tax.
Luther’s capital gains tax liability = 15% × Luther’s capital gain
= 15% × $90,000
= $13,500
Deals involving cash
If a target company shareholder receives cash, the Internal Revenue Service (IRS) will see this as a capital gain. If it is a cash and stock deal, the target company shareholders must pay capital gains tax on the cash portion and they can defer taxes on the stock portion until they eventually sell those shares.
Let us understand this through 2 examples.
Example 1 – Only cash:
TechFlow Solutions is acquiring CloudCore Innovations by offering $30 per share when the market share price for CloudCore is $20. Samuel Foxx had bought 30,000 of CloudCore’s shares 4 years ago for $5. He will be selling his entire stake in this acquisition.
Let us calculate his tax liability.
Step 1: Calculate the total amount received
Total amount received by Samuel Foxx = 30,000 × $30
= $900,000
Step 2: Calculate the purchase price for the entire stake
Total amount paid by Samuel Foxx = 30,000 × $5
= $150,000
Step 3: Calculate capital gains
Samuel Foxx’s capital gains = Total amount received by Samuel Foxx – Total amount paid by Samuel Foxx
= $900,000 – $150,000
= $750,000
Step 4: Calculate tax liability
Since Samuel Foxx’s holding period was 4 years, he qualifies for long-term capital gains tax treatment. Also, his capital gains alone are higher than $551,350, so he must pay 20% long-term capital gains tax.
Samuel Foxx’s tax liability = Samuel Foxx’s capital gains × 20%
= $750,000 × 20%
= $150,000
Example 2 – Cash and stock:
BioVanta Therapeutics is acquiring MedGenix Biopharma in a deal where MedGenix Biopharma’s shareholders receive $4 and 5 shares of BioVanta Therapeutics for 8 MedGenix Biopharma shares.
Currently, the market price for BioVanta Therapeutics is $50.
3 years ago, Martin Stubbs had bought 10,000 shares of MedGenix Biopharma for $45,000. Let us calculate his tax liability if he sells his entire stake.
Step 1: Calculate the total value received
Cash portion for Martin Stubbs = $4 × 10,000 shares
= $40,000
Stock portion for Martin Stubbs = 5/8 ×10,000 shares ×$50
= 6,250 × $50
= $312,500
Total value received by Martin Stubbs = Stock portion + Cash portion
= $312,500 + $40,000
= $352,500
Step 2: Calculate the cost basis for the stock portion
Assuming Martin’s original cost basis of $45,000 is split proportionally between the cash and stock portions, his portion cost basis is:
Stock portion cost basis = $312,500/$352,500 ×$45,000
= $39,893.62
In the future, when Martin sells his stake in BioVanta Therapeutics, the cost basis will be $39,893.62.
Step 3: Calculate the immediate tax liability
Let us assume that Martin has an annual income of more than $551,350 and must pay a 20% long-term capital gains tax.
First, we need to find the cost basis for the cash portion which is = Total cost basis – Stock portion cost basis
= $45,000 – $39,893.62
= $5,106.38
So, capital gains on cash portion = Cash portion – Cash portion cost basis
= $40,000 – $5,106.38
= $34,893.62
So, immediate tax liability = Cash portion gains × 20%
= $34,893.62 × 20%
= $6,978.72
Secure the right deal with Eqvista’s expert valuations!
In acquisitions, the stock price change, for the acquiring as well as the target company, depends on the value being offered by each side. If you receive shares and cash worth more than the shares you are offering, your company’s stock price is likely to increase.
In deals where the target company’s shareholders are compensated in stocks, partly or fully, it is difficult to know the exact effect of the deal on prices. After all, the target company could also change over time.
Also, the effect of acquisitions is felt gradually on prices since deal announcements do not guarantee that the deal will be executed.
Acquiring companies may offer their stocks in acquisitions to provide tax benefits to the target company’s shareholders.
If you need help in ascertaining the value of your target company or want to know if the acquisition price is right, consider reaching out to Eqvista. We provide accurate valuations from an unbiased position to support investors in various kinds of transactions. Contact us to know more!
