Like a double shot of organic espresso, Amazon delivered quite a surprise to the stock market Friday when it announced plans to acquire Whole Foods Market. For shareholders of both companies, Wall Street’s initial reaction was positive, but that’s not always the case.
Here’s what you need to know about these types of acquisitions and the impact they can have on your portfolio.
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Perception is important
In deal talk, the “acquirer” is the company that agrees to purchase another company, known as the “target.” The terms — and friendliness — of deals can vary widely, but it’s important to understand how a deal is perceived by investors.
In a typical market reaction, the acquirer’s stock falls on news of the deal while the target’s rises. Why? If the acquirer is paying a premium for the other company, which is the case here, investors will readjust how they price the stocks — rewarding the target’s stock price, while lowering the acquirer’s. The difference isn’t always equal and may include perceived challenges in completing the deal, such as approval by the target company’s shareholders.
Market reaction isn’t a perfect science: If a deal is widely anticipated in advance or is contentious, stocks could perform differently.
In this case, both Whole Foods and Amazon shares rose Friday after the $13.7 billion deal’s announcement. The jump in the acquirer’s stock is unusual, though not unprecedented, says Josh Olson, an analyst at asset management firm Edward Jones.
“The market likes this deal, that’s the initial read-through,” Olson says. “The market is saying it doesn’t seem like Amazon overpaid in terms of long-term potential. Investors are rewarding shares of both companies.”
Outlook for Whole Foods shareholders
For Whole Foods shareholders, the end of your investing days are likely nigh. As a result of the all-cash deal, you’ll receive $42 per share after it closes, a 27% premium on the closing price from the day before the deal’s announcement. Whole Foods will no longer have a listed stock after the deal is completed, which is expected to happen in the second half of this year.
The grocer has struggled with same-store sales in recent years, pulling down its stock, so Amazon’s proposal provides a way out for shareholders. Shareholders are unlikely to get a better offer, since few companies have deeper pockets than Amazon or have shown a greater desire to enter the supermarket world. It’s a not a bad conclusion to what has been a very public discussion of the future of Whole Foods.
You also can sell the stock anytime before the deal is completed. On Friday, Whole Foods closed at $42.68, slightly higher than the announced deal price of $42 per share.
Outlook for Amazon shareholders
For Amazon shareholders, the deal looks positive. Besides, there’s little they can do if they don’t like the deal other than sell their Amazon holdings.
However, it’s not been smart to bet against CEO Jeff Bezos so far — he has helped Amazon put up a 49,000% return since its IPO.
The move solidifies Amazon’s longer-term expansion into groceries, which it has flirted with for years. Plus, it potentially allows the retailer to strengthen its online franchise by providing brick-and-mortar distribution points, bringing the company physically closer to consumers. The move may also allow Amazon to expand into adjacent categories such as retail pharmacies, which are mainstays of traditional groceries.
Even if you don’t own either company involved in one of these Wall Street deals, you may not be insulated from the market’s reaction. If investors see an acquisition as disruptive to an industry, they’ll sell competitor stocks. On Friday, other grocery stores and large discount retailers plummeted — for example, Kroger tumbled about 10%. But there wasn’t much reaction among technology stocks.
Before making any quick trades on the news, it’s important to consider what’s at stake. Mergers and acquisitions aren’t undertaken at whim by publicly traded companies — they’re complex deals requiring a lot of money and are subject to regulatory and shareholder approval.
There can be choppiness in the acquirer’s stock price for a year or more after a deal is completed as the integration between companies takes place.
It’s not clear how Amazon will finance the $13.7 billion purchase, but the e-commerce giant has more than $20 billion in cash, good credit and perhaps its most valuable currency, a highly valued stock. Corporate debt remains cheap, so Amazon should be able to swing the deal.
Olson says investors may need to stomach some volatility even though the longer-term prospect for the stock still is positive. He maintains a buy recommendation on Amazon.
“Arguably, the biggest disruptor in U.S. and global business is partnering with another unique disruptor,” he says. “It’s more interesting than a lot of deals we’ve seen lately.”
Finally, trying to time the market with individual stock trades is notoriously difficult (read more about why). For the average investor, it’s better to keep the vast majority of holdings in index funds or exchange-traded funds, whose diversity can better weather volatility than any one stock.
Anna-Louise Jackson and James F. Royal, Ph.D., are staff writers at NerdWallet, a personal finance website. Email: email@example.com or firstname.lastname@example.org. Twitter: @aljax7 or @JimRoyalPhD.
The article How Amazon’s Whole Foods Purchase Affects Your Portfolio originally appeared on NerdWallet.