|
Published: September 25, 2009
They say what's past is prologue.
So when history starts repeating itself like this, it’s wise to
take notice.
Mergers and acquisitions are picking up after a drought in
activity for much of the past year. On Monday, Dell (Nasdaq:
DELL) said it would buy computer-services provider Perot Systems
(NYSE: PER) for $3.9 billion, or $30 a share, a +67.5% premium
from the previous day’s close.
This deal is one of several Wall Street has been talking about.
Four drug makers are set to merge into two as Pfizer (NYSE: PFE)
buys Wyeth (NYSE: WYE) and Merck (NYSE: MRK) takes over Schering
Plough (NYSE: SGP). Disney (NYSE: DIS) recently snapped up
comic-book powerhouse Marvel (NYSE: MVL), and Kraft (NYSE: KFT)
is trying to buy Cadbury (NYSE: CBY).
This is a beginning.
The likelihood is Corporate America is headed for an
unprecedented period of deal making, which is excellent news for
shareholders.
Mergers and acquisitions in the U.S. are on their slowest pace
since 2003, according to Bloomberg data. The number of deals
crept to a standstill when credit markets were frozen, as most
deals are financed one way or another. Now that credit isn’t
locked up so tight, the number of deals is likely to rise.
Not only is credit easing, but so is Corporate America’s
stranglehold on its cash hoard. Companies went into survival
mode to conserve precious cash during the downturn by cutting
costs. As the economy emerges from this deep recession, U.S.
companies have $1.5 trillion in cash flow. That’s expected to
climb to record levels.
Now for a brief history lesson.
The last time cash flow was this
high was in 2005. Stock valuations
were cheap. With plenty of cash on
hand, companies made a record number
of deals in the next two years. All
told, takeovers soared +32% in 2006
and +13% in 2007. The deals added up
to $3.7 trillion.
Valuations aren’t as cheap now as
they once were, but a two-year
decline in earnings for S&P
companies is projected to reverse
and climb +25% in the next year.
That could mean that executives
think some companies are still
cheap, even with the S&P trading at
a high overall valuation. With
earnings on the rise, investors can
expect companies to put their extra
cash to work and hunt for deals that
can fuel even more growth.
This could be a huge development for
investors who own the right
companies, as the average takeover
premium is about +24%. These heady
gains happen overnight. (Even so,
investors have to be mindful not to
sell too soon. It’s not at all
uncommon for another bidder to
emerge and offer a higher price.)
Picking acquisition targets isn't an
exact science, but here are a few
things to keep an eye out for:
-- Market leaders typically acquire
smaller rivals. This was the case
with the Disney-Marvel deal. Disney
was looking to expand its stable of
characters and were more than happy
to pay a +29% premium for Marvel
shares to do it. A large company
like Disney may decide it's cheaper
to buy a company that owns existing
products rather than to develop new
products on its own.
-- Sectors tend to get hot. Some
companies will pursue a deal just to
keep up with its competitors. This
is what happened with drug companies
earlier this year: Pfizer agreed to
merge with Wyeth, and Merck
subsequently acquired
Schering-Plough. Wyeth shareholders
received a +15% premium;
Schering-Plough’s shares jumped
+34%. The drug sector is a good
current example, but petroleum,
technology and consumer
discretionary sectors have all had
their fair share of M&A activity
over the years.
-- Low-debt. If you buy a house with
a lien, it has to be satisfied
before you can have the deed. And so
it goes with companies: Acquiring
companies must assume their target’s
debt. Companies that don’t have much
debt are cheaper to buy. The reverse
is also true: High debt at an
acquiring company can hinder its
ability to make a deal. Kraft is
experiencing this problem with its
Cadbury proposal. The company is
reluctant to raise its offer out of
worry that the increased debt burden
would threaten the company's
investment-grade rating.
If you missed the +65% gain Perot
Systems shareholders had Monday,
don't worry. The next year is likely
to be one of the biggest deal making
seasons on record. The trick is to
identify strong candidates with
robust cash flow in sectors that are
ripe for activity. There are no
guarantees, but the rewards for
smart investors can be great.
--Brad Briggs
Staff Writer
Street Authority.com P.S. -- Nathan Slaughter, editor of
StreetAuthority’s Market Advisor, is an expert on
takeover targets. He says we could be entering a prime window
for mergers. To learn more about takeover targets and what they
can do for your portfolio,
visit this link.
You'll receive a free report that includes three of Nathan's
favorite takeover targets. |
