Penny Stock Company Acquisitions and Takeovers - dummies

Penny Stock Company Acquisitions and Takeovers

By Peter Leeds

Other companies acquire penny stock companies quite often. Regardless of the effect this activity has on the share prices in the long run, the acquisition is usually detrimental to the stock of the buyer and beneficial to the stock of the “target” company being acquired.

Unlike mergers and amalgamations whereby companies willingly combine themselves together and often change the combined company’s name, much of its business activities, and management, acquisitions involve one company taking over another. In an acquisition, the buyer usually doesn’t visibly change much, but the company being bought may experience radical changes. Think of it as a big fish eating a smaller fish, or a big company eating a smaller one.

Takeovers are sometimes done against the will of the target company, in which case it is referred to as a hostile takeover. Takeovers differ from mergers, which are always agreed upon by both companies. With a takeover, the company being acquired usually sees its share price increase when the takeover becomes public knowledge.

This increase is due to the premium price that the buyer is offering in order to buy shares. The buying company will see its share price drop when the announcement is made or its intention becomes public knowledge. This is because investors know that the purchasing company will need to:

  • Pay a premium for the target company’s shares. The acquirer needs to own a certain number of shares in the target company in order to make the transaction go through. It entices current shareholders by offering to buy the stock for much more than the current trading price. The company can also raise that offer price even higher if it doesn’t get the number of shares it needs.

  • Deal with acquisition growing pains. Any time a company takes over another company, the acquiring will incur expenses in the process of bringing the two operations together. Even methods of lowering total costs through the acquisition will be expensive to implement at first. The acquiring company may take a year or more to fully absorb the target company and realize any financial or strategic benefits.

Sometimes the buyout makes sense to management of the target company, at which point it will express its support for the acquisition, and generally shareholders will agree and sell their shares at the offered level. Failing an agreeable board of directors, the goal of the buying company is to gain control of 90 percent of the outstanding shares, at which point it can legally force the remaining shareholders to sell.

After a takeover has begun, your choices as a shareholder in the target company are to

  • Sell to the offer. You will be sent information from your broker about how to sell your shares at the premium price. When a stock you are holding jumps up due to the price premium being offered by an acquiring company, it’s generally a good idea to sell and take your money.

  • Do nothing. If the buyer is unable to gain 90 percent of the shares, you keep your stock, but keep in mind if the takeover attempt fails, the shares generally fall back to the prices they were at in the first place. If the buyer does reach 90 percent threshold, your broker will automatically provide your shares to the buyer and give you the requisite money for them.

  • Sell on the open market. You can always sell the shares as per usual on the market.

Penny stocks are acquisition targets more frequently than larger companies, and this can be positive for shareholders. In the short term, acquiring companies will see their share price pulled down. The takeover target will enjoy a significant and almost instantaneous jump in its stock, based on the premium being offered from the buyer.

Why penny stock companies are frequently bought

Penny stock companies are generally easier targets to be taken over by other players in the same industry. Unlike multibillion-dollar corporations, penny stocks are more suitable for acquisition for the following specific reasons:

  • Small size: Smaller companies are proportionately easier to acquire. Based on the lower market capitalization of many penny stocks, they represent bite-sized acquisition targets for bigger companies.

  • Niche-specific: Penny stock companies may have very specific assets — certain customers, employees, or intellectual property — that a larger corporation can grab through takeover without having to fight too hard for them.

  • Fragmented Industry: Penny stocks are often found in newer industries, which typically start off or become very fragmented in their early phases. As the industry consolidates (and they all do), many of the players will be acquired as the bigger companies jostle for market share and the sales lead.

Given the benefits that acquiring a certain penny stock may offer a larger company, takeovers among lower-priced shares make good business sense. But sometimes, especially during times of consolidation for an industry, the penny stock companies may be the ones doing the buying.

Resist a penny stock takeover

Acquiring the right penny stock can be very beneficial to the buyer, although the smaller company may not always be looking to be absorbed or bought out. While staving off a suitor that is several times larger may be difficult, companies can employ a common tactic known as a shareholder rights plan (also called as a poison pill) to possibly prevent any unwanted, or hostile, acquisition.

With a shareholder rights plan, additional shares will be automatically issued to current investors in the event of a hostile takeover. The shareholders then have a larger investment, and the purchaser will need to pay them for their original shares as well as the new shares.

While a shareholder rights plan will make acquisition of the company more expensive, it does not prevent another corporation from buying the shares if it is willing to pay the additional price.