News leaked on a recent weekend that Cleveland-Cliffs (CLF 5.16%) was looking to buy United States Steel (X +0.00%). When the trading week got underway, some broad details of the deal came out, including a $35-per-share price tag made up of a mixture of cash and stock. U.S. Steel rejected the offer and announced that it was considering other offers.
Although specific to the steel industry, U.S. Steel being "in play," as they say on Wall Street, highlights how unpredictable and shocking acquisition activity can be. Using this situation, let's look at what investors can do when a stock they own is fielding takeover interest.
A big deal with big implications
It is important to understand that Cleveland-Cliffs' offer to buy U.S. Steel is a major event in the domestic steel market. There are really only four big public players in the space: U.S. Steel, Cleveland-Cliffs, Nucor, and Steel Dynamics. When the market opened for trading on the Monday after the news of the acquisition offer broke, every steel company rose, even Cleveland-Cliffs.
Note that it is fairly common for the acquiring company's shares to fall on news of an acquisition since it is the one that has to put out money. But this offer clearly led Wall Street to reevaluate its thinking about every steel company, not just the ones chatting about a pair-up. There are a couple of logical reasons for this.
First, investors seeing any takeover often think, "Who's next?" And if a company is being offered a significant premium, investors think that maybe there's more value in the industry than it is being given credit for. Such industry-wide bumps can be temporary, however, if investors quickly move on to other exciting Wall Street news.
There's also an interesting backstory here. Cleveland-Cliffs, as it exists today, was created by an industry supplier that bought two major domestic steel manufacturers. Adding U.S. Steel would be a third such acquisition and would vault the company into the position of the top steel producer in the region.
And in this particular case, that could be a problem as a merged company would suddenly have materially more pricing power in some key end markets, like automobiles. That created a very real risk that regulators would stand in the way of this particular deal.
Given that U.S. Steel turned down the offer, that won't be an issue (unless Cleveland-Cliffs ups its offer and entices U.S. Steel to say "yes"), but Wall Street is already pontificating about other offers U.S. Steel has received, including a private buyer willing to pay $35 per share in cash.
Individual shareholders can't do anything about incoming acquisition offers, but they might be itching to do something. Let's zoom out.
What can investors do?
As a shareholder, you don't have a say in what goes on with takeovers unless the transaction requires shareholder approval. This would likely come in the form of a special shareholder vote after all the details have been worked out. And even then, most deals get approved. So if a company's board gives its OK, an acquisition is highly likely to be consummated (regulator interference could upend a deal, but that's also out of shareholder control).
That means shareholders, in practice, have just a few options. A lot will depend on the deal in question.
1. Sell on the news
The first and most obvious choice is to cut and run on the takeover news. That could be particularly attractive if the stock moves sharply higher after news of an acquisition is released or leaks.
It is common for the acquiring company to pay more than the pre-announcement share price for its target, often discussed as the "premium." There's a nuance here, though, because there is always a risk that a deal will fall apart before it is completed. And because of that risk, the price of the stock being acquired usually trades for less than the offer price.
In other words, selling on the news and taking the current trading price rather than the buyout price means you could be leaving some money on the table. It could be just a couple of percentage points, so it may not be material enough to worry about. And if you don't like the terms of the deal, which might involve receiving stock in another company, selling right away may be the most logical decision to make.
2. Stick around, hoping for a better offer
Sometimes, a company has multiple potential buyers. U.S. Steel, for example, had two offers in quick succession. One was stock and cash, and the other was all cash. But the company noted that there were still other offers it was considering. If a bidding war ensues, the $35-per-share offered so far could go higher, leading to more profits for shareholders.
Bidding wars aren't all that common, however, so this will likely be an option for a comparatively small number of transactions. That said, it can be pretty exciting when one does break out.
A few years ago, Occidental Petroleum and Chevron were in a bidding war that wound up involving Warren Buffett and Berkshire Hathaway. In the end, Occidental won out, thanks to financial support from Buffett. Still, the energy sector was an unusually hot topic while that event was playing out.
If a higher offer comes about, you will then find yourself back to considering options one and three here.
3. Wait for the deal to happen
The only other option is, basically, to do nothing. In this case, you would get whatever the acquiring company offers. Unlike selling on the news, this ensures you get the full value of any deal. But it also means you could end up owning shares in a new company, which might not be the outcome you want.
You would then have to sell the new stock to take out your cash, likely while others are thinking about, if not doing, the same. That could result in downward pressure on the shares. If you like the idea of owning the new company, this isn't an issue at all. You can happily go forward with a new name in your portfolio.
Don't forget trading costs and taxes
Throughout this process, investors must consider some outside factors. For example, if you decide to sell, you may have to pay a commission for the trade and deal with any tax implications that come about, like capital gains taxes.
Many all-stock acquisitions are structured to be tax-free events, so depending on what you decide to do, this could also be a nonissue. Any cash received in a deal is likely to be taxed in some form, but how exactly will depend on the way the deal is structured. The year in which a deal is completed could end up being a little more complicated for you come April 15.
Longer term, you might also have to deal with the cost basis of your original investment changing. That's particularly true with stock and cash transactions. The company will provide guidance, but the actual implications are personal to you. This could be problematic if you have owned a stock for a long time. But while you are thinking about what to do, make sure you consider the tax and cost impact your choice might have.
Enjoy the Wall Street excitement
A lot of investing news is pretty mundane, like quarterly earnings updates. Merger and acquisition activity, particularly if there is a bidding war, can be exciting for investors. On the one hand, you should enjoy the show as Wall Street commentators discuss the deal and its implications. On the other hand, if you are a shareholder of the company being targeted, you need to make some decisions.
While you will get only a limited say on the deal itself, you will have to decide whether you want to sell on the news, stick around and hope for a better offer, or ride out the transaction. There's no correct answer, as it all comes down to what's right for you.
