“Me want more income!” Forget the Cookie Monster, investors are turning into income monsters. Case in point: A new survey released by Legg Mason reveals that two-thirds of affluent investors in the United States peg income investing as their top priority.
Yet their appetite for income isn’t being satisfied. More specifically, they desire an annual yield of 8.5% on average, but they’re only averaging about 6% yields. And more than half of the respondents to the survey said that they’re willing to take on more risk to earn more income. My response? Somebody needs to tell them about the income-generating power of merger arbitrage.
The Two Keys to Merger Arbitrage Riches
Merger arbitrage is a simple strategy that involves nothing more than waiting until after a takeover deal is announced to buy into a company. By doing so, we get to pocket the “spread” between the current price and the purchase price as income. We often earn that yield in less than six months, too.
Better yet, it reduces risk, while still earning above-average yields. Here’s how…
Cash Only, Please. By focusing on all-cash deals, we keep things simple, clean and cost effective. We buy shares of the target company, and then wait. Once the deal closes, our shares are converted into cash at the full offer price. And voilà! We’ve earned our income and can move on to the next opportunity.
Be a Pig, Not a Hog. While double-digit spreads are tempting, they often indicate uncertainty about whether a takeover deal will close. And if a deal falls through, so does our income. That’s why I recommend being a yield pig (because they get fat) and not a hog (because they get slaughtered). Specifically, we need to shun the highest-yielding deals and focus on merger arbitrage spreads of 5% to 8%.
I’m not bringing this up as a public service announcement, mind you. I’m here to live up to my promise to share new opportunities the minute I come across them. And I just found one…
A Sweet Deal Gets Even Sweeter
Back in August 2012, NTS Realty Holdings LP (NYSEMKT:NLP) received an unsolicited offer from its Founder and Chairman, J.D. Nichols, and its President and CEO, Brian F. Lavin, to take the company private for $5.25 per share. At the time, shares were trading hands for just $3, so the offer represented a 78% premium.
Sweet deal, right? Apparently, shareholders felt they were getting shortchanged. And the company formed a special committee and hired an advisor to evaluate the proposal.
They ultimately convinced Mr. Nichols and Mr. Lavin in late November 2012 to sweeten their offer to $7.50 per share – a 144% premium to the price of shares when the original offer was made. The company’s board already approved the deal. But unitholders still need to give the final go-ahead, which will most likely occur at the company’s annual meeting on June 11, 2013 (if not sooner).
The merger is expected to close by the end of June. Based on the current stock price of $7.19, the spread checks in at 4.3%. Now, that’s below our desired yield. However, all we need is for the stock to drop by a nickel for the yield to jump to our 5% minimum. And shares have traded below that level multiple times in the last week.
So if you decide to take advantage of this opportunity, use a limit order to purchase shares for $7.14 or less. And be patient until you get a fill. Rest assured, I’ll keep monitoring the merger activity in the United States and Canada, and I’ll share any other compelling merger arbitrage opportunities as they materialize.