A Sneak Peek Into Mergers And Demergers

The Good And Bad Of Marriage And Breakups

Before you get any excited to gain insights into your married life, let me clarify that this piece is about the marriage of companies, which is done through the process called merger and acquisition (M&A). And if mergers are like marriages, demergers can be termed as breakups. So, let us understand these restructuring ideasincluding M&As, demergers and their wealth-creating potential for shareholders.

Mergers: Simply put, a merger happens when two companies agree to operate together under the same ownership. Ideally, both companies are of similar size. Both companies in this case surrender their shares and new shares are issued.An acquisition happens when a company takes over a company and establishes ownership over that company.The motive of M&As is to help increase synergies.

Demergers: Contrary to M&As, there are often times when a diversified company opts for focusing on its core businesses and transferring its other business operations to a different company. This is the called as Demerger. The spun-off businesses are expected to be worth more as a separate entity than as a part of a larger business. After de-merger, shareholders of parent receive equivalent shares of the new entity.

Impact on the stock prices of such companies

During the process of the merger, the stock price of both companies is impacted in different ways based on a range of factors like their market caps, the merger process, and macroeconomic factors. If the market sentiment is that its market cap will be greater than the sum of individual market caps of both the companies, then this optimism may increase the stock price of the merged company unless the economic scenario changes.

And usually, when a company demerges its business, it announces a distribution of shares from the new company for its existing investors. This leads to a price adjustment in the company’s main stock. After all, the company just gave up part of its business or got separated into two parts. However, the actual quantum of the fall is not fixed. As a result, the stock usually sees extra volatility in the days after the demerger.

Match made in heaven

Marriages are made in heaven and M&As in the boardrooms. Like marriages, the successor failure of merger depends on the synergies and management actions post-merger which could enhance or destroy shareholder value.

In recent years India witnessed some successful mergers like Vodafone-Idea, Oriental Bank of Commerce and Unitec Bank of India merging with Punjab National Bank, Lux Industries merging its group company into itself, L&T Infotech acquiring Mindtree. On the other hand, some examples of recent demergers are Jubilant Pharma & Jubilant Ingrevia, Suven Pharma & Suven Lifesciences – both made some strong gains post listing of the new entities.

And the ones that failed

There have been a few deals that couldn’t get through and did not go in favor of shareholders. One such example is Reliance Retail Ventures acquiring a 26% stake in Just Dial through an open offer. The Just Dial stock price has underperformed post-acquisition. Meanwhile, the demerger of Sundaram-Clayton into Sundaram Clayton and Sundaram Investment spelled a flat return for investors post-demerger.

Generating value for shareholders

There are two ways of looking at the effects of mergers and demergers on stock prices – short-term and long-term.While the short-term view is preferred by traders to book profits, long-term investors need to spend more time evaluating before taking a position in the companies undergoing change.

To sum it up, mergers or demergers can be an effective corporate strategy. They can be used to unlock value as well as to streamline the operations of a firm. As an investor, it is important to be careful while deciding to bet on shares of a company that goes through such corporate marriage or breakup.

References:

Do demergers unlock value for investors?

Reliance Retail's open offer for Just Dial closes today; details here