By Matt Doiron
When the acquisition of a company is announced, its stock price usually jumps up close to the transaction price- but doesn't fully reach it. The heart of a merger arbitrage strategy relies on buying the stock of the company to be acquired and earning a small absolute return but a moderate annualized return (a 3% gain over 3 months is almost a 13% annual return), potentially using leverage as well. Merger arbitrage also offers the advantage of being fairly uncorrelated with the market (read more about merger arbitrage plays). As such for some more active investors it's possible that merger arbitrage can be a supplement or alternative to buying high yield stocks. Here are five potential merger arbitrage investments which we think could "yield" at least 5% annualized with no leverage:
IntercontinentalExchange recently received E.U. approval for its takeover of NYSE Euronext (NYSE:NYX) though the deal has to be greenlighted by regulators including the U.S.'s SEC. Shareholders would receive an amount of IntercontinentalExchange shares which would seem to currently be worth over $45 per share, as opposed to NYSE Euronext's current stock price of about $41.20. That makes for an annualized return of over 10% even if the deal is slightly delayed, though there is a risk it will be struck down. We track quarterly 13F filings from hundreds of hedge funds, using the included information to help us develop investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year). We can see from our database that billionaire Leon Cooperman's Omega Advisors owned 4.1 million shares of NYSE Euronext as of the end of March (see Cooperman's stock picks).
Cooper Tire (NYSE:CTB) has received a $35 per share takeover offer from Indian company Apollo Tyres. With a current price of $32.20, that is a potential 8.7% return with the deal being expected to close within the next year. There is a risk here as well- Apollo shareholders are upset with the deal, and that company's stock price plunged 25% after it was announced. The premium offered for Cooper does seem to have been quite high and so this is also a somewhat risky merger arbitrage play, as the stock would likely return to its previous levels if the deal falls through.
Another complicated deal which could potentially offer high returns for investors is Linn Co.'s (NASDAQ:LINE) acquisition of Berry Petroleum (NYSE:BRY). The deal has been delayed until the third quarter of 2012, and even if it is delayed until the end of the year it could still offer a good annualized return: analysts believe that Berry is worth about $44 per share, a 2.8% rise from current levels, and investors could receive over $46 worth of Linn Co stock upon consummation of the transaction. Even the 2.8% figure annualizes to over 5% if the deal closes six months from now.
Fidelity National Financial (NYSE:FNF), a surety and title insurance company, has offered $33.25 in cash and stock (about two-thirds of which would be in cash) for Lender Processing Services (NYSE:LPS). Lender Processing Services is a $2.7 billion market cap company providing software and services to mortgage lenders. At a current stock price of $31.43, the implied return on the shares is 5.8%. It's currently expected that the deal would close this year, but obviously even if there is a delay until Q1 or Q2 2014 there would still be above a 5% annualized return if Fidelity National is successful.
Rounding out our list is Arbitron (NYSE:ARB), which provides audience measurement statistics for radio and mobile media. Nielsen is expected to close a purchase of the company within the next few months at $48 per share in cash. At a current stock price of about $46.85, investors should earn 5% annualized as long as the transaction closes by the end of 2013. Arbitron's shareholders have approved the deal and analysts have suggested that regulators are unlikely to uncover reasons to strike it down.