M&A Activity Is Not a Broad Buy Signal

by: Markos Kaminis

A wave of merger mania has seemingly suddenly swept over the corporate world, and especially the tech sector. Naturally, analytical minds want to know why, and we believe we can help clear that up for investors swiftly. Basically, it has everything to do with a confluence of factors found within the current character of the large-cap technology sector: cash, price and growth. We go a step further today, and give you three 3Par like ideas, and look into how M&A plays with the broader market and the economy.

3Par Deal

Hewlett-Packard (NYSE: HPQ) made a competing bid for 3Par (NYSE: PAR), a data storage company, on Monday. HP upped the ante for 3Par with its $24 per share bid worth $1.6 billion, surpassing Dell (Nasdaq: DELL), which had started the bidding with an $18 offer. HP might soon be re-nicknamed MnA, as it has not skipped a beat since the departure of its scandalized CEO, who by the way, oversaw the deals for 3Com and Palm before he had to go away. HP is not alone in the tech world though in its active M&A efforts, and has only contributed to the market's expectations for more. That was evidenced by trading in PAR and its relatives on Monday.

The high-end storage firm's shares spiked to a level even higher than the latest takeover bid price, all the way to $26 at the close. It seems investors expect a second offer from Dell, or a new bidder to enter the fray for this once semi-anonymous firm (to most of us). Investors seem to have good reason to expect a bidding war too, given the nascent acquisition frenzy within the technology sector.

Tech M&A Frenzy

This latest bidding war only continues a trend that's been increasingly recharacterizing the current marketplace. Just last week, the big news centered on Intel's (Nasdaq: INTC) offer to buy McAfee (NYSE: MFE) for $7.68 billion. Tech M&A activity increased in Q2 2010, on deals by Google (Nasdaq: GOOG), IBM (NYSE: IBM), Apple (Nasdaq: AAPL) and private equity firms Silver Lake Partners, TPG Capital, and Warburg Pincus. A total of 36 tech companies were acquired in Q2, in fact, which compares to 34 in Q1. The latest pace of deal making contrasts highly with the 24 deals that took place in last year's quarter. July was the biggest M&A month in 10 years for $1 billion plus transactions in tech. According to Citigroup (NYSE: C) Global M&A Chief Mark Shafir, we have seen $31 billion in transactions versus $7 billion in all of 2009. Activity is clearly on the rise, and that's a good driver for the tech sector and the investment banks that facilitate the deals. However, it may not offer any reason to infer near-term economic gains nor broader stock market rise.

Rather, it seems to me that it's a product of the industry characteristics within the tech space. There are more than a few large cap tech companies with hoards of cash piling up. These once high-growth names have become cash cows in many instances. Still, all of these firms would like to relive their past glory and fuel future growth by making sweet deals for more robust businesses. By doing so, they seek to maintain or restore the higher P/E ratios that defined their past, and create value for shareholders in the process.

Whether value will be created or not is dependent on the specific stories and corporate leadership savvy and insight at each individual acquiring firm. In some cases, investors will end up wishing management had just paid out cash stores in dividends.

Given the economy and market's recovery to a more stabilized state, though still not confirmed stable, corporate managers have the guts now to buyout firms that may still look like relative bargains to them. It sure would have been nice for many of us if they had that same conviction a year and a half ago, when prices were dirt cheap. Still, we'll give these guys a break, since most of you also thought the world was coming to an end back then and were trading shares down to bottom dollar prices.

So, if capital is a key driver of these acquisitions, then CNBC's research today on the wealthiest potential acquirers might help us also anticipate who they might acquire. The only problem is that it will not, since recent deals have been across tech fields of play. The financial news channel noted Micron Technology (NYSE: MU), Sandisk (Nasdaq: SNDK), and a few others as cash rich. Texas Instruments (NYSE: TXN) is one Wedbush Morgan analyst's big pick to keep acquiring smaller firms for growth. The company has $2.3 billion in cash and no debt. An Edward Jones analyst looked towards Intel and Qualcomm (Nasdaq: QCOM) as rich potential future acquirers. He calls attention to the fact that Intel still has double-digit billions left over, even after it closes its pending deal. But, you'll want to stay away from these firms, since the acquirer's shares usually give back ground on deal announcement.

To benefit from this trend, you have to get into the heads of the corporate managers of the large cap tech companies with cash. You'll need to listen to a few conference calls, especially the Q&A sessions if available. You might call a solid analyst for some insight as well. Mark Shafir, Citigroup's M&A man, continues to look toward security and data storage for acquisition activity. IDC data seems to agree, noting the volume of data out there will increase 44X by 2020. This is not news though, but it seems to finally be finding money. Look at EMC's (NYSE: EMC) chart since the tech bubble bust, and you'll get what I mean.

3 Names to Consider

The market is a smart cookie, and smart money led some stocks on the PAR news today. Compellant (NYSE: CML), Commvault (Nasdaq: CVLT) and Isilon Systems (Nasdaq: ISLN) were three names that jumped by double-digit percentages. So, the market may already be giving us ideas, since these three companies are involved in relative businesses to 3Par. Of the three companies, ISLN's chart seems to show solid operational gains reflected in a steadily rising price chart. You'll need to do a little research here, but the chart jumps out at me for starters. I also like the rising EPS estimate trend in ISLN, but as far as valuation is concerned, CVLT looks most balanced. Again, some more due diligence would be needed to find value, if it exists. I would never invest in these stocks before a good deal more research work. Also, it's generally not wise to make a long-term investment, or to buy a stock, based on acquisition hope. Since these shares have jumped sharply now, I would be cautious in the near-term with regard to any long-term investment strategy.

The Broader Read

The fun also seems to be spreading to other industries, likely at the soft prodding of investment bankers. Potash (NYSE: POT), for instance, today spurned a bid by BHP Billiton (NYSE: BHP) on expectations for a better offer. The company is reportedly talking to others, including for instance China Sinochem. Campbell Soup (NYSE: CPB) is reportedly considering an acquisition of Britain's United Biscuits, or just its biscuits business. Campbell has been relatively active of late, acquiring artisan bread maker Ecce Panis last year. Heck, even banks are back to buying apparently, as HSBC (NYSE: HBC) is reportedly in exclusive talks with Old Mutual PLC (OTCPK:ODMTY) to take a majority stake in South Africa's fourth largest bank, Nedbank Group.

UBS' (NYSE: UBS) Art Cashin said the deal activity is a good sign for the market, but I don't agree. Cashin says the fact that they're using cash for acquisitions indicates that they view their own stock undervalued, and therefore not the best currency to use to acquire. That would be a positive, except for the fact that corporate managers regularly view their own stock as undervalued. Now they are putting their money where their mouths are in using cash here, but just the same... So I'm not banking on this factor to look toward general market rise. And there's a golden rule I like to quote on the Street that might apply here: "Just because a stock is cheap does not mean it can't get cheaper." Cashin also points to the fact that companies are buying now as a positive sign for stocks generally. This has not proven true in recent history, and you already know my economic view, so be careful about getting trigger happy beyond specific picks on solid study.

Article should interest investors in NetApp (Nasdaq: NTAP), Western Digital (NYSE: WDC), Seagate (NYSE: STX), Brocade (Nasdaq: BRCD), STEC (Nasdaq: STEC), Xyratex (Nasdaq: XRTX), Imation (NYSE: IMN), Quantum (NYSE: QTM), Voltaire (Nasdaq: VOLT), Hutchinson Technology (Nasdaq: HTCH), Dot Hill Systems (Nasdaq: HILL), OCZ Tech (Nasdaq: OCZ), Lasercard (Nasdaq: LCRD), Overland Storage (Nasdaq: OVRL), Sonnen (OTC: SONP.OB), Dataram (Nasdaq: DRAM), Alanco (Nasdaq: ALAN), Trimol (OTC: TMOL.OB), VMWare (NYSE: VMW).

Disclosure: No positions