I love a good wedding, and 2006 was full of some winners. Tom Cruise and Katie Holmes. Nicole Kidman and Keith Urban. Pamela Anderson and Kid Rock. Lots of corporate weddings, too, in 2006. Phelps Dodge ( PD) said it would buy two major Canadian nickel miners, Inco and Falconbridge, in a $40 billion transaction that would create the largest mining company in North America. (That's the largest announced mining deal on record, according to deal tracker Dealogic.) AT&T ( T) agreed to buy BellSouth for a mere $66.7 billion. And although the deal was not nearly as expensive, Google's ( GOOG) $1.65 billion offer to buy YouTube was still a jaw-dropper. Globally, there were $3.79 trillion worth of deals last year, up 38% from 2005, according to Thomson Financial. But can it continue? Seems so. Just this past week alone, US Airways ( LCC) jacked up its hostile bid for Delta to about $10 billion. And earlier this month, General Electric ( GE) said it will buy Smiths Group, the U.K.'s third-largest aerospace company, for $4.8 billion. But from the shareholder's point of view, merger and acquisition activity can be confusing. Last week Booyah Breakdown touched on these complications in a
reader's M&A question . But you wanted more! Your questions poured in. So let's tackle what happens when you're a guest at one of these corporate weddings.
Do You Even Want to Be Invited?To start, a merger happens when two companies of equal stature come together to create one large company. These days, that's pretty rare. In most instances, a larger company acquires a smaller one. So when the press says your company is "merging" with another one, you can bet that there's a big company buying a little company, and the little company will soon disappear.
Still, the minute you hear your company is "merging" with another or being acquired, decide if you even want to be a part of the marriage. Let's face it, not all marriages are good ones, no matter if it's consummated in Hollywood or Wall Street. Pam Anderson and Kid Rock called is splitsville after only four months. And mention the AOL- Time Warner ( TWX) deal on Wall Street and see who throws up first. Things just don't always work out the way the people expect. So it's up to you to do some due diligence on the deal. Pull up the annual report of the company that's looking to combine with yours. Read the opening text in the front of the report, and you'll be able to get a feel for the company. The letter from the president and management's discussion and analysis will tell you where the company sees itself. Check if there are synergies in the product lines as well as the internal cultures. Then decide if you see yourself with them.
If you decide this union is headed for divorce court, then drop the stock before the actual merger date. But if you want to go along for the ride, make sure you understand the transaction.
The Straightforward DealsIn any deal you need to know what you're getting and whether the deal is taxable to you. If your company is being acquired, you will most likely lose your shares and receive either cash for your shares, new shares of the big company coming in or a combination of both. With a cash purchase, the buyer just gives cash, and you're done with the investment. So take your money and run. With a stock deal, you'll render your old shares and get new shares in the bigger company. This is where things get hairy, because you'll probably have to recalculate the basis for your new shares. That's accounting-speak for spreading the original cost of your shares of the little company over the new shares you got from the deal. Let's presume you spent $100 for your four shares of the stock that was just acquired. You paid $25 per share. So $25 is your basis in each share. As part of the deal, you got two shares of the purchasing company for every single little share you had. So instead of four little company shares, you now have eight big-company shares. Since you originally spent $100 to get those four shares, you have to spread that original $100 over your new shares. So your new basis in each of those new shares is $12.50 ($100 divided by eight).
Next, is it taxable? If the deal is taxable, you'll owe capital gains taxes on the fair market value of the new shares you get, minus your basis. So in our example, you'll owe tax on the difference between the current share price and your basis of $12.50. If the deal is tax-free, you'll still have to readjust your basis, but you won't have a tax bill until you sell those new shares. That's why a tax-free deal is much better for investors -- it allows them more control over their tax situation. Another tax-free perk is that your holding period is carried over. So if you bought your original shares two years ago, it will be assumed that you've been holding the new shares for two years as well.