Flowback is the subsequent sale of the acquirer stock by an investor following the successful completion of a stock swap merger. Occasionally, institutional investors may not be permitted to hold foreign stocks as per their investment mandate. They may be restricted to holding only domestic stocks. In a successful takeover, should an acquirer be foreign domiciled and finance the deal with its own stock, it will result in the subsequent ownership of a foreign stock, thus breaching the investment rules. The sale of this position is known as “Flowback” as the stock “flows” back to the country of the bidder.
Theoretically, this situation can occur to any investor in mergers & acquisitions who does not wish to own foreign stocks for whatever reason and chooses to sell upon taking ownership of the acquirer shares. However, in practice the owner of the target stock often decides to sell the target stock in the domestic market immediately prior to the consummation of the deal. This avoids the Flowback situation entirely whilst increasing the merger arbitrage spread. Another way the situation can be avoided or reduced is if the acquirer increases the cash component offered in the deal.
Should the acquirer stock begin trading on a national stock exchange where the current target shareholder is domiciled, possibly in the form of American Depositary Receipts (ADR’s) or an equivalent instrument, it is possible the shareholder may continue to own the acquirer stock within its own investment guidelines.
