ML is the abbreviation for a reverse merger, but not all mergers are created equal. Reverse mergers, or RMs, allow exchanges to pursue increases in market capitalization without a concurrent share price increase. Although they are becoming increasingly popular, they’re still only accessible to sophisticated investors who have long-term investing goals in mind like generating capital appreciation and diversifying risk exposure across asset classes with minimum volatility.
How Do Reverse Mergers Work
Upcoming Reverse Mergers involve a private company issuing new common stock (or preferred shares) in exchange for publicly traded securities of another company. Companies conducting RMs can be smaller penny stocks, small cap names with fewer than $100 million in market capitalization, or even large cap companies looking to go private. This is opposed to “traditional” mergers, where two public entities merge into one.
In order to take advantage of RMs, investors need to be able to identify potential targets. This is typically done through technical analysis and due diligence, since a company’s past and future earnings will directly impact its stock price. However, the recent rally in large cap equities has made it easier for investors not familiar with specific companies to perform an evaluation.
Once a potential target is identified, investors need to assess whether it’s a good fit for their portfolio and a logical partner in their investment thesis. Once again, the recent rally has made this an easier process – sometimes companies will jump 20 to 30 percent in the days preceding an RMs announcement.
A few things need to be pointed out before jumping into a market capitalization increase via reverse merger. First and foremost, you need to make sure that your investment thesis makes sense in light of recent market activity. Not every reverse merger is going to work out well. For example, one company recently announced that their RMs were unsuccessful simply because their target company was not worth the risk they were taking on.
Shifting from the short-term trading mentality to a long-term investment view is also important. A company’s prospects for success and revenues for the next 5 years will determine its intrinsic value, which must be evaluated against trading multiples in order to determine a fair price. However, it’s important to realize that this is not always the case, and that there are many variables at play when determining fair value.
Investing in Reverse Mergers
One thing you cannot ignore is market psychology. When you are looking to buy a stock as an investment vehicle, it’s useful to understand the psychology of the market. Money flows into markets in anticipation of changes in things like earnings or dividends. This only intensifies the magnitude of the reaction when those earnings or dividends are announced. In other words, after manipulation by money flows, the stock price will often rise significantly more than it would have otherwise.
When you are looking for a company to target, you’re looking for a company that has strong fundamentals; one that looks like it would be attractive to most investors. For example, high growth companies in hot sectors will attract money flows that could push the stock higher due to appreciation in intrinsic value.