When Mergers Disappoint

Why would a company be downgraded and see its stock price fall after it announces that it's purchasing another company? Well, it all depends on the particulars. Let's say you own shares in Office Automation Services Co. (ticker: ZIPZIP), which is growing quickly and doing very well. Both you and Wall Street expect continued rapid increases in sales and earnings.

Then one day ZIPZIP announces that it's buying a typewriter retailer called Typewriter Land Inc. (ticker: QWERTY). Clearly, Typewriter Land is a less-dynamic business. It's likely to slow down Office Automation's progress. This is why some analysts will downgrade Office Automation -- because it's now a less-attractive company. You might not be as eager to hang on to your shares, as well.

If, however, Office Automation announced that it was buying a company that could help it grow even faster, the news would likely draw investor interest, and might send shares up. It all depends on how effectively investors expect the merging parties to work together. Some mergers make great sense, while others are less promising. Some otherwise promising mergers are bad deals mainly because one company significantly overpays for the other, making it hard for the deal to be profitable in the near future. Other mergers have little rationale behind them other than the fact that the executives involved wanted the prestige, excitement, and/or money they could get from a merger.

You can learn more about how the financial world works in our Investing Basics area and in our Fool's School.


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