When there is a rumor that a company is in talks to be bought out, there is an initial surge of interest and the stock could spike several percentage points. But is buying the stock after this point profitable? What if the deal doesn’t go through? Here are some things to consider when speculating on a stock acquisition rumor:
The Deal May Not Go Through – This is the obvious. A rumor is a rumor for a reason and is not confirmed by either company. According to Bloomberg, only 14.5% of rumored acquisitions actually occur. Therefore, it is actually more profitable to bet against the rumor. You can read the full article here: Short the Rumor Pays 14% on Takeover Tales That Don’t Come True.
The Timing Could Be Way Off – Thinking of speculating on out of the money stock options? Think again. Even if there is a rumor circulating, the buy out deal may not happen for several months down the road. When you buy stock options, you have to get the timing right, or your position will expire worthless.
The Rumor Can Get The Price Wrong – Sometimes the market is over enthusiastic and the acquisition price is much lower than anticipated. If the rumor drives the stock price up too much, you can lose money even if the buyout occurs. Out of the money stock options are even more risky. With an acquisition rumor these will be pumped up and artificially high. Get the price wrong and you could lose everything.
The Company Can Reject the Offer – If the board of directors does not think the offer fairly values the company, they will reject it. The suitor company can either come back with a higher bid, attempt a hostile takeover, or drop the offer all together. With so many factors to consider, there is a lot of risk on speculating on a second bid.
Even if an acquisition is confirmed, the government can still block it on an anti-trust base. Buy out deals can also be break up over time, even after they are confirmed.