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Stock Strategist

The Basics of a Buyout

What happens if one of your holdings becomes an acquisition target?

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While the buyout mania of the past few years definitely lost steam this summer as easy financing options disappeared, we still get questions from readers about what they should do if one of their stocks receives an acquisition offer. Such offers force holders of target firms, many of whom expected to hold those stocks for several years, to make immediately decisions about what to do with those holdings. That can be a tough. One of our readers recently wrote: "I would like to know what generally happens when a company is bought out or merged. Do the shareholders always receive stock in the acquiring firm, or cash; and what is the best way to evaluate my options?" While each buyout offer is unique and needs to be considered on its own merits, we can offer some general answers to that inquiry.

To begin with, buyouts can come in cash, stock, or any combination thereof. The form of currency is important primarily because the target firm's stock will react very differently post-offer based on that factor. When it comes to evaluating a possible deal, we compare the offer price with what we think the target firm is worth. If the offer price is significantly higher than the target firm's intrinsic value, that should be a no-brainer in terms of how target-firm shareholders should feel about the deal (good!). When the deal merely reflects the firm's fair value or even represents a lower valuation, things get a bit trickier.

Julie Utterback does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.