Would I Buy It Now? How Stockholders Should Treat Merger News

Over the weekend, AT&T announced a merger deal with Time Warner for $107.50 a share.

This announcement came just a couple of days after my financial advisor called to tell me that British American Tobacco had made a bid to take over RJ Reynolds.

There are some big mergers going on, and that means stockholders face a basic problem:

What do you do when a company you haven’t chosen takes over the company whose stock you own?

It’s an important question. While plenty of times the acquiring company may be a good investment, that isn’t always the case. Enron and Worldcom both went on acquisition sprees, buying out solid companies only to go bankrupt. Lots of investors who’d ridden out the mergers lost their investments.

You need to make sure you aren’t holding on to a bad investment out of inertia. You need to treat the merger just as you would a new stock acquisition.

Do your due diligence. Ask yourself, “Is the new company one I want to own? Would I buy it now?”

Mergers and Me

I’ve had this happen a couple of times to me. In 2006, Lincoln National bought out Jefferson Pilot Corporation. My family gave me some JP stock when I was relatively young, and it made up the vast majority of my investments when the merger happened. I didn’t trust Lincoln National the way I’d trusted JP, though.  I used the opportunity to sell the majority of the stock and diversify.

One of the stocks I bought at that time was Progress Energy. In 2011, Duke Energy bought Progress. I chose to keep the stock when it converted to Duke Energy. It wasn’t a large holding, and Duke Energy seemed like a solid investment. Even though some of the management fallout from the merger didn’t happen according to plan, I’ve continued to think Duke Energy has solid fundamentals and good prospects.

I don’t have a stake in the AT&T/Time Warner merger, but I do own some RJ Reynolds (RAI). And I know nothing about British American Tobacco (BAT). So I have some work to do to figure out whether I’ll vote for or against the merger, and whether I’ll keep the stock or sell it if the merger goes through.

Read the News

When you find out merger news about one of your stocks, make sure you start your analysis with the announcement stories. That will give you the basic information to begin: Who’s buying? Are they in the same business? Why are they making the purchase? Are they buying out a competitor? Entering a new geographical area? Expanding into a new line of their existing business?

Understanding the whys of the merger will help you see how the two businesses will operate as one unit.

In the case of the RAI/BAT merger, BAT already owned a stake in RAI. They are now consolidating. Evidently, some of the impetus for the merger is that BAT hasn’t made much impact in the e-cigarette market. RJR, which spends a lot in R&D, has positioned themselves well in the e-cig market. The post-Brexit pound also impacts the decision. BAT’s stock is doing well because while its headquarters sits in Britain, most of its sales don’t.

It also makes sense to look at the actual offer. According to the Motley Fool, the current proposal states RAI stockholders get a .55 share of BAT for each Reynolds share, plus $24.13 in cash.

After you’ve done the basics, you want to follow the merger as it moves through regulatory hurdles and towards a vote. Some mergers fall apart in talks, some don’t. You want to be aware of the merger timeline and watch for any government concerns or board dissent.

Check the Basics

Now that you know a little bit about the merger, time to look at the buyer. The first place I looked is Wikipedia, which gives you a sense of company products, history and scandals. It pretty much confirms things I read in the initial new reports, putting a little more detail into the mix.

After that, I turn to Yahoo! Finance. You’ll be able to find stock price, basic numbers and ratios, and links to relevant news stories. You can even set up alerts to keep you up to date on the latest news.

British American Tobacco, confusingly enough, refers to itself as “BAT” but that’s not how they are listed on the New York Stock Exchange (where it’s BTI) or the London Stock Exchange (where it’s BATS). Either way, I can get the basic information, but I use BTI so that the numbers are in dollars instead of pounds. I also pull up RAI’s profile for comparison.

The first thing I notice is their Debt to Equity ratio. They have borrowed a lot compared to their equity. They also don’t sit on much cash, so they’ll probably borrow quite a bit to do this deal. On the upside, their operating cash flow is nice and they pay over 65% of profits out in dividends.

Now I have enough background information to go look at the financials.

Would I Buy it Now? How Stockholders should Treat Merger News

Read the Financials

While you can’t tell exactly what the new bigger company will look like, you can make sure that the financials for the buyer look good. So, go to the buyer’s website and download their most recent annual report. While financial statements look backward, you can still tell quite a bit about the company’s health and direction by checking them.

If you know quite a bit about the company, you can skip to the financials or even just grab the SEC filing. If you don’t, though, start with their shiny pretty company propaganda. You’ll find out what the company brags about and prioritizes. Then move on to the stated risks, the financials and the notes to the financials.

Looking at the financials, the first things that I notice is that intangible assets make up almost 1/3 of their total assets. Combined with high debt (17 Billion Pounds on only 31.5 Billion Pounds of Assets), these are areas that need explanation. I turn to the notes.

BAT is in acquisition mode, which helps explain the debt and the big chunk of intangibles (mostly goodwill) sitting on their balance sheet. They also had to pay a fair amount to keep their 42% stake in RAI after it acquired Lorillard. They aren’t paying a bunch in interest, though. Their bonds, which make up most of their debt, have lowish rates.

Maybe BAT is taking advantage of the low interest rates to go on a buying spree with other people’s money. I don’t love the leverage, but at least I understand it. RAI was a more comfortable holding for me. I’m not ready to make a sell or keep decision yet but I know I’ll need to make one. Or will I?

The Merger Vote

Just because the merger has been announced doesn’t mean it will happen. Sometimes regulatory agencies step in and stop mergers, as they did with Comcast and Time Warner last year. Generally this has to do with monopoly concerns, and RAI just merged with Lorillard a couple of years ago. And this particular deal won’t just go through US regulatory hurdles, it will still be subject to the EU.

And then there’s the shareholder vote.While you can’t do anything as a shareholder to determine the regulatory environment, you do get a vote. And you can vote no.

I’ve talked a bit about shareholder votes, and the number of votes you get depends on how much stock you own. Chances are, your vote won’t make a big difference unless the big institutional voters have some doubts.

Occasionally, though, the shareholders can and do make a difference.

It’s unlikely that the shareholder vote will make a difference in this case. BAT owns 42% of RAI’s stock. So unless the deal falls apart due to rejection by the SEC, FTC or EU, this deal looks likely.

Would I Buy It Now?

So I’m left with one basic question: Would I buy stock in British American Tobacco? Because once the regulatory agencies agree, that’s what I’ll own.

While I’m unwilling to make the decision yet, my first look says “Maybe Not.” For now, I’ll wait and track the news on both companies. I’ll start looking for more information and analysis, including investment buy ratings and the articles on Seeking Alpha.

And eventually, I’ll make a decision. If I keep the stock, it will be because I’ve decided British American Tobacco is worth holding. It won’t be just because the merger happened.

If you own a company that another company takes over, you need to ask the same question. Do you like the new company well enough to own it?

Do the research. Crunch the numbers. Get a little advice if necessary. But make a decision rather than letting it be made for you.

What factors go into your decision to buy, hold or sell an investment?

*Part of Financially Savvy Saturdays on brokeGIRLrich. *< and Vickie’s Kitchen and Garden. *

15 thoughts on “Would I Buy It Now? How Stockholders Should Treat Merger News

  1. This is a great article and solid advice. I totally agree with your “Would I buy it now?” maxim. I think that’s a wonderful rule of thumb and essentially hits the nail on the head. Another factor to consider is the closing period. Sometimes these proposed deals take ages to close and i you aren’t excited about the prospects it might be best to sell and move on. I’ve seen stocks linger within a 10 cent trading range for years while waiting for the deals to get finalized. Depending on the premium being paid by the acquiring company, I think this can be a source of opportunity cost too. Either way, and as you said, it’s decision time! Good luck with yours and thanks again for sharing your thoughts.
    Jay recently posted…Trend Following Stock Picks for October 2016 (Part 4)My Profile

    • I hadn’t even thought about the stock deal lingering on. I know I’m not ready to make the call on selling yet (I have more analysis to do) but I don’t want to sit on the decision too long.

  2. The concept of making sure you don’t hold on to a bad investment due to inertia is quite synergistic with my post today, so I hope you don’t mind if I add a link to this in my post. 🙂

    The Enron example is quite sobering and really shows the danger of just blindly holding on to your stock in a merger situation. Thanks for a great step-by-step analysis of how to figure out how to make your decision.
    Matt @ Optimize Your Life recently posted…Why We Have Trouble Making a ChangeMy Profile

    • I have a family member who was happily invested in Portland General Electric only to lose money when Enron fell, so I’m a bit more sensitive to the possible dangers of mergers than most. It’s certainly a sobering consideration of the costs of not reevaluating your decision as conditions change, and not making needed adjustments.

      Reading your post, though, I’m reminded of some other decisions I need to apply the same rigor I hope to show towards this stock decision. There are some areas I’m sure I’ve let drift through inertia.

  3. BTI does pay a nice dividend. Some will say they cut their dividend recently but that’s not true it’s due to currency fluctuations. They are going to start paying quarterly from what I read to keep investors happier. Though a bigger semi annual dividend is nice sometimes
    Doug recently posted…ATT Dividend RaiseMy Profile

    • Yeah, a 65% payout ratio is really nice for investors, and it is a mature industry. I like DRIPs, which is one of the reasons I own RAI in the first place.

  4. Hey, Emily. I’m really out of my element when it comes to individual stocks. I only own two and one just went through a merger. Happily it’s going well. But that’s just dumb luck on my part. I didn’t do any research. Just went along with the deal. Now if I face the prospects of a merger again, my decision will be a little more nuanced. Thanks for the great advice and tutorial.

    • As I told Matt, I have a relative who got burned when Enron took over one of his favorite utility holdings. It’s made me more sensitive to the possible dangers of mergers. But since big ones seem to be going on all the time these days, it’s good to have a basic framework for making decisions in place. I can hope we don’t have to use it again any time soon.

  5. That’s a great question to ask after any change, not just with stocks.
    With stocks, though, we take the easy way out and don’t own any individual companies, just index funds. There’s less time, research, hair-pulling, and stress that way.
    But we do ask ourselves the same question when we’re decluttering or if we’re trying to decide what to do with a gift–if we wouldn’t buy it now, we donate it.
    ChooseBetterLife recently posted…Better Than BeforeMy Profile

    • LOL, probably why we’re so bad at decluttering…we just might overanalyze things a bit.

      Index funds are easier. I guess if I hadn’t had the individual stock experience first, I would just be in them as well now (well, maybe I’d still keep my munis). But I did, and it was so much more lucrative than my first experience with mutual funds, that I’m still more committed to DRIPs.

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