A few weeks ago, SA published an article of mine entitled, "Mergers And Acquisitions: Beating the Odds (With Acquirers)". In it, I explained that while M&A's have a lot of sex appeal, for acquirers and their shareholders, most fail to deliver. This implies that acquirer-investors should focus on high probability combinations and defer decisions on the rest.
Nice Payoff for Sellers
However, M&A's generally pay off nicely for the sellers with analysts reporting an average gain of 25% to 35% to the shareholders of an acquiree. The statistics confirm what those of us who watch the ticker see almost every week - stocks of acquirees rise immediately and often significantly as M&A's are announced before the bell. Indeed, as I was drafting this article, on Monday, May 15th I caught site of news that Thermo Fisher Scientific (NYSE:TMO) intends to acquire Patheon (NYSE:PTHN). Patheon's stock was up 33% on the day over its previous close.
Avoid Insider Trading
But as it was with Patheon and is with most other acquirees, there's a problem. That is, there are only three ways to come up roses - luck, clairvoyance, or insider information and no, no, no, with respect to the latter. Look, I'm not an attorney; if you're concerned that you are flirting with insider trading you should seek the counsel of one. However, I can point readers to this SEC page that begins to explain the topic. I can also remind investors that they may put themselves in jeopardy if they trade on non-public information they receive from a tipster as Martha Stewart found out the hard way.
Quick anecdote. In 2008, as the financial markets were collapsing, I was called to D.C. to interview for the position of CIO at the SEC. I vividly recall their foreboding granite and glass waiting room off the entrance to their headquarters near Union Station. After I was escorted upstairs to an interior conference room, a half a dozen or more people filed in including their CAO, various senior managers and a couple of lawyers. Following a quick round of introductions, one of the attorneys turned to me and asked rather harshly, "What is the purpose of the SEC?" After I responded, "In a nutshell, to protect investors and the markets.", she snapped, "And, how do we fulfill that purpose?" I kept it together and replied, "Essentially, by ensuring transparency; am I missing something?" She finally cracked a smile and the interview continued. I share this story to emphasize that if the SEC is serious about their mission in the context of an interview for a staff position, imagine how serious they are when it comes to insider trading.
So, given that acquiree-investors must avoid trading on inside information - and they can't rely on clairvoyance or luck - the question becomes, 'How can we capitalize on public information?' Three ways:
- Identify opportunities wherein an announced acquisition offer is not fully reflected in the market price of a stock.
- Make a calculated bet that a credible and publicized rumor of acquirer interest in a target may come to pass.
- Jump in when a suitor is rebuffed against the assumption that the acquiree will clean-up their act or be back 'in play'.
Scenario #1, Monsanto
SA contributor, "Special Situations and Arbs" recently wrote an article entitled, Top Merger Stocks Held By Fund Managers (Mid-Q2 2017 Edition). This piece points investors to Scenario #1 opportunities wherein an acquisition price is not fully reflected in the market value of the stock. One position that I own showed up on the list, Monsanto (NYSE:MON). After an on-again off-again courtship, the company struck a deal last year to be acquired by German giant, Bayer (OTCPK:BAYRY).
At $128 per share, Bayer's offer represented a 21% premium for Monsanto shareholders at the time it was finally announced in 2016. However, the stock price did not pop because of doubts that the two organizations could consummate their union, as envisioned, against some 30 required regulatory approvals. The gap is slowly closing as approvals come in. I'm up 12% so far with the prospects of about doubling that gain if/when the deal closes at the intended price.
Scenario #2, Suez
In the second scenario, investors bet that an 'out there' rumor of an acquirer's interest in a target may have some validity and come to pass. I introduce you to Suez Environnement (OTCPK:SZEVY), a French company DBA United Water in the U.S. For me, investment in fresh water sourcing and management is of paramount importance because of climate change, population growth, and demand-supply imbalances for resource. Those who have read my earlier articles know that I own Suez's ADR's in addition to those of Veolia Environnement (OTCPK:VEOEY).
A few years ago, all but 35% of Suez Environnement was divested by the French utility conglomerate, GDF Suez. GDF Suez subsequently renamed itself ENGIE (OTCPK:ENGIY) and, curiously, subtly, let it be known a few months ago that it might be interested in reacquiring its former water/waste operation.
In a sense, this 'rumor/news' was of no consequence to me because, as I said, I was already an investor in Suez. However, since the item began circulating, SZEVY has risen 24%. I am very interested to see if a deal transpires and to learn more about the strategic intent of ENGIE who, under strong leadership, perhaps has designs on becoming a climate change powerhouse.
Scenario #3, Unilever
In the third scenario, one jumps in when a suitor is rebuffed. For those who missed it, earlier this year Warren Buffett, through Kraft Heinz (NASDAQ:KHC), made a takeover bid for Unilever (NYSE:UL), (NYSE:UN). On Friday, February 17th, Unilever shares opened almost 15% up on the news. However, within four days, Unilever's CEO, Paul Polman, blew off Buffett. On Tuesday, February 21st, UL/UN gave back half the gain and I promptly established a position in UL for $44.51.
Why, you say? - this was a failed M&A. Yes, it was, but I reasoned that in Unilever's desperation to remain independent it would begin to drive shareholder value in earnest. In spades, that is what's happening. Since March, the company has announced actions to reposition its brand portfolio and it has raised its dividend while embarking on a stock buyback program. In other words, this 'non-M&A' is behaving like an M&A and, if Unilever does not sustain the momentum, I believe it may be back in play not long after the U.K.'s mandatory six-month timeout period expires before the end of the year. In three months, I'm up 21% on the investment.
The Stuff of Alpha
In the three scenarios above, we see the stuff of alpha. Here is a table comparing the price performance of the three scenarios, from their respective 'news' dates, to the S&P 500. For good measure, I've thrown in the annual dividends of the three targets, again compared to the index:
|Scenario||Discount to Offer||M&A Rumor||Acquirer Rebuffed|
|Gain v. After||+8.7%||+24.3%||+21.4%|
|Gain v. After||+12.6%||+5.4%||+1.2%|
|B/W v. S&P||-3.9%||+18.9%||+20.2%|
|B/W v. S&P||-0.14%||+1.89%||+0.66%|
The Suez and Unilever scenarios have, so far, handily beaten the S&P 500. I was both early and late to the party on Monsanto having bought positions in July of last year and then again in February. The stock is lagging the S&P but, as noted earlier, it stands to rise more if the deal closes with Bayer.
Taking another perspective, these three scenarios, all grounded on publicly-available information, may get investors to the bottom end of the premium range for all M&A's. And, in the cases of Suez and Unilever, it's possible that there is even more upside. At the same time, readers take caution that things can backfire and perhaps materially - in the world of M&A nothing is over until the deal closes and the gain booked.
A Few Final Thoughts
I generally don't own stocks speculating on M&A takeout that I wouldn't own absent such considerations. For reasons enumerated in my earlier articles, I am especially drawn to the business prospects of Monsanto and Suez never mind that they may be acquired. I'm less excited about the standalone prospects of Unilever because it's not my kind of investment. That said, it's a fine company (that is becoming even finer) and I'm okay owning its stock.
A couple of articles back, SA published a piece of mine that touched on forecasting. In it, I referenced an influential book for me entitled, Superforecasting: The Art and Science of Prediction, by Philip Tetlock & Dan Gardner. This work explores how people who take in a lot of information and repeatedly tune their views can foresee the future better than those who don't, at least in the near term.
Tetlock & Gardner's advice is worth heeding in the context of identifying potential M&A targets. It is why I watch the pre-market LED ticker for an hour every morning as I am working out. It is why I take in information from a wide range of sources most having nothing to do with M&A. Just as mergers and acquisitions usually fail for acquirers, they usually succeed for acquirees. Success as an investor comes from staying alert to both sides of the equation.
(P.S. I was called back for a second interview with then Chairman Cox, but I didn't get the position at the SEC. During our one-on-one, he asked me what I thought about his "IDEA System", a platform to allow investors to analyze standardized corporate financial data. I told him that the idea was a bridge too far because it required imposing a common chart of accounts on all companies. Walking out of the lobby that afternoon, I ran into one of people who grilled me in my initial panel interview. He asked me how my meeting with the Chairman went. I told him that I probably wouldn't be offered the job because I said that the IDEA system was a bad idea. The staffer started to laugh and nodded knowingly as we shook hands for the last time.)
Disclosure: I am/we are long MON, SZEVY, UL, VEOEY.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Always do your own due diligence in consultation with a competent financial adviser who puts your interests ahead of their own. (All my proceeds from contributing to SA go to charity.)
Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.