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Value Dilution Caused By Acquisitions - AOL, CompuServe

Quotation

Analyzing the impact of AOL’s potential acquisition of one of its competitors, CompuServe, consider the following quotation:

"That could have cost more than $1 billion at CompuServe's recent price and diluted the value of AOL shares, possibly depressing it in the short term, analysts said." (Washington Post, April 18, 1997)

Answer

Assume that the acquisition makes sense, in that it is expected to create additional value to AOL’s shareholders. Thus, if AOL pays a fair market price for the acquisition, the price of AOL stock should go up by the amount of value creation per share.

A drop, or a dilution, in AOL’s stock price suggests that either AOL would end up paying more than the market value of CompuServe, or that the acquisition destroys shareholder value, that is, it does not make good business sense for AOL to acquire CompuServe.

By Alex Tajirian