In the course of business, listed companies negotiate business deals, investments and co-operations. Though these proposed transactions may or may not proceed eventually, the news might cause the company's stock price to move.
Mr Chin's colleague Mr Wong read in the newspaper that listed company ABC signed a non-binding agreement with an investment company to sell its investment properties. Mr Wong considered this a positive driver to ABC and purchased ABC stock even though its price had already increased by 10% following the news report. Subsequently, ABC issued an announcement terminating negotiations for the proposed sale. ABC stock price then fell back to its original level.
The case shared by Mr Chin is not unusual. Investors who trade based on the news of proposed transactions are exposed to certain risks including a fall-out in agreement and changes in stock price when failing to meet expectations. The uncertainty around transactions under preliminary negotiations are subject to higher risks.
Listed companies need to issue an announcement of the proposed transactions in the HKExnews website in accordance with the disclosure requirements of the "Listing Rules". They sometimes sign a non-binding agreement for the proposed transaction in the form of letter of intent or memorandum of understanding. Non-binding agreements are not formal agreements, and therefore investors should be aware of the following risks.
- Non-closure of deal
As the name suggests, the agreement is not legally binding. Contracting parties do not have legal obligations to go ahead with the proposed transaction. The announcement usually contains the following statement: The agreement is not legally binding, and the proposed transaction is yet to be materialized until signing a formal agreement. Since the proposed transaction may not proceed, investors and shareholders should exercise caution when trading in stock of the company. Contracting parties usually go into due diligence and further negotiations to determine whether to proceed and a formal agreement will be signed if so.
- Adjustments to terms and conditions
The proposed transaction stated in the letter of intent or memorandum of understanding is often in its initial stage and therefore may not include specific terms of trade. Or even if it does, it is still subject to change until a formal agreement is signed. The final terms of the formal agreement may vary with the letter of intent or memorandum of understanding.
News affecting stock prices
Investors need to be cautious when trading based on proposed transaction news especially when the listed company has only signed a non-binding agreement. Moreover, in a stock market with high liquidity and transparency, when a proposed transaction news goes public, the stock price will reflect the news very rapidly.
News trading involves risks and investors should avoid speculating on news to make short-term trading and leveraging decision.