M+A

Posted by Jeff Carter
on August 19th, 2010

MacAfee gets bought this morning by Intel. The boards of each company agreed to the deal. Amicable. Yesterday Potash gets a hostile bid for their business. A good old fashioned takeover fight will take place. The cash is building up on corporate balance sheets. Inevitably, mergers have to take place. In a CFO’s eyes, it’s criminal to send the extra cash to shareholders in the form of a dividend!

Trading these kinds of waters becomes a chess game. Instead of looking for undervalued stocks, the market looks for possible takeover plays. Buy the rumor, sell the fact and make some quick cash. At the end of this frenzy, expect some insider trading investigations by the SEC. Some people can’t help themselves, the money is so easy to make.

M+A activity can be misinterpreted by the public as well. Mergers can be seen as a sign of a healthy market. But in this case, the reasons for the M+A moves is because businesses cannot find ways to reinvest in themselves. Much easier to buy the resources they need. Since cash is building up on everyone’s balance sheet, the cost of acquisition is decreased by the cash balance. The real question the public needs to ask is, “Why don’t businesses invest in themselves?”

All this activity should push the market higher. Speculative forces will enter the market, buying stocks on the come. If a deal fails, or doesn’t pan out, the stock will get punished mercilessly. It’s a real gamble to invest this way and if you engage in it-you better be really quick on your feet. A tip, it’s impossible for you to beat the street. They have better access, and better info than you.

Which sectors are ripe for M+A? Tech always. That almost goes without saying. Economies of scale and scope can be achieved quickly. There really is no such thing as a small dominant tech company. All the big guys run the show. Agriculture is probably a good place to look. This sector will be hot far into the future as commodity prices rally. If inflation ever comes, Ag is a good place to be. Land is at a premium too, so companies that do technological research allowing crops to be more abundant with less might be a good target. Financial services will undoubtably see more action. Too many beaten down companies that look cheap. On the other hand, there are companies that are doing well that will look to augment or expand their business. High Frequency Traders might start to buy up small brokerages to get access to order flow. (Think Citadel and ETrade) Other industries that are fragmented and can benefit from economies of scale are good places to sniff around as well.

It will also pay to look at international mergers. Many companies want to get out from under the whip of US taxes and regulation. Buying a foreign company will allow them to funnel activity into that entity via accounting procedures. Not only do they buy a new market, but they get accounting statement relief from the acquisition.

One caveat. Make sure the government doesn’t ban mergers in the sector you are investigating. For example, in the beef packer industry, they mandate fragmentation to ensure a competitive marketplace. The government will only allow them to get so big. Make sure any merger target will pass muster through the Department of Justice.

Once the M+A runs its course, sniff the air and see where the market is. If conditions are similar to today’s, it’s a strong sell.

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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