A buyout is when a company is bought by another company or a group of investors. A company can be bought out with cash or stock. After a buyout is announced, the stock of the company being bought out may continue to trade for a while until the buyout is finalized, but its price will be tied to the buyout terms, and could additionally be influenced by other factors or developments.
The buyer will usually offer a premium for the shares to induce the stockholders to sell, so the shares of the company being bought out usually jump on the announcement. A buyout must be approved by the shareholders of both companies and may need government approval. These events take time, during which the stock of the company being bought out continues to trade.
If a company is bought out with cash, the price of its stock will stay close to the amount of the buyout offer. For example: Company A stock closes at $28. After the market close, a group of investors or a private equity fund announces a buyout at $36 a share, cash. The following day the stock will open close to and trade around $36. Investors who hold the shares until the buyout is finalized will get $36 a share, but some may decide to sell early to take profits and free up funds for another transaction. Speculators may buy those shares for just under $36 a share: if they buy enough shares and wait for the buyout to go through, they may make a small but sure profit on the difference.
If a company is bought out with the stock of another company, the price of the stock being bought out will be tied to that of the buyer. For example: Company B stock closes at $28. After the market closes, C, another publicly traded company, announces a buyout to be paid for with its own stock using the following formula: 0.7 shares of company C stock for each share of company B stock. The following day, company C stock opens at $51. Since company B shareholders will receive 0.7 shares of stock C, their own stock will trade around $35.70. As company C stock fluctuates, company B stock will fluctuate along with it. However, the supply and demand imbalance or other temporary factors may create minor relative differences in the prices of stocks B and C. Speculators, called arbitragers, may step in to try to profit from these differences by buying stock C and selling stock B, or vice versa, sometimes on different exchanges.
Several factors and developments could affect the buyout price and terms: the government may not approve it, a buyout offer may be amended or fall through or another buyer may offer a higher price.
- "One Up on Wall Street”; Peter Lynch; 2000
- “How to Make Money in Stocks”; William O’Neil; 2009
- Comstock Images/Comstock/Getty Images