How to Profit from Takeover Targets

by Investment U Research

Takeovers are one of the fastest ways to strike it rich on Wall Street. And the returns can be staggering.

OptionsXpress was an obscure online trading company once upon a time. If you weren’t an options-trading geek, you probably didn’t know much about it. However, once word spread about its takeover, the price exploded. In less than three months, investors saw a 1223% gain as speculators drove up its stock price.

Buyout targets can deliver strong or even exceptional returns – sometimes, in only a few days. And most investors never hear about them. But these gains aren’t just for the barons of Wall Street – nor should they be.

Anyone can pocket thousands of dollars in these transactions without doing anything more complicated than buying stocks.

You just need to be patient, and know what to look for…

Five Characteristics of a Takeover Target

Spotting and taking advantage of these opportunities may be the most difficult part about them. But companies that are takeover candidates have some elements in common.

It’s these similar fundamentals that can make it easier to find and profit from them:

Company Size – Small to mid-sized companies make the best targets for buyouts. It grows increasingly more difficult to take over big companies – there are few firms that can afford to. Large-cap firms are simply too big to be bought.

Cash Reserves – The best targets usually have large cash reserves. This cash is then used to pay down the large amount of debt that the acquirer generally takes on to finance the deal. In addition, these companies usually have low amounts of debt and lots of equity. These assets are the true “prize” of a takeover.

Ownership – Lots of inside ownership can help facilitate buyouts because management has an incentive to sell. In addition, when ownership is concentrated amongst a few large shareholders, getting the voting majorities needed to approve the transaction becomes much easier.

Valuation – When a target is priced at or near its tangible asset value per share, it becomes more attractive to potential acquirers.  The closer a company is to its book value, the easier it is to break up and sell off parts at a profit if needed. A low price-to-earnings (P/E) ratio is a good indicator that a company is selling for less than its worth.

Performance – Surprisingly, buyout targets generally have poor recent performance. And the reason is this: If you are buying a company, it is much easier to turn around lackluster management and performance than it is to improve upon a top-performing firm. Something as simple as changing the “coach” can improve a companies “game.”

Let Buyers Pay You a Premium

In a sense, all we’re doing is chasing a premium…

Large companies swallow up small companies every day. In fact, many use acquisitions as a primary strategy for growth. Why spend lots of money trying to get new customers, when you can buy someone else’s for less?

But taking over a competitor isn’t a simple matter that can be done quickly or inexpensively. It can take months. In addition, the board of directors must get shareholder approval to proceed.

For two public companies to merge or for one company to buy out another, they must account for enough shares to make the transaction go through. And they need to compensate the major stockholders who could block the deal.

In order to do so, they generally must offer a higher price than the company is currently trading for, called a “premium.” By paying this premium to shareholders, they compensate them for agreeing to the deal.

It’s this premium that instantly makes the stock more valuable, driving stocks prices through the roof. But the best part is that they must offer this premium price to all shareholders, not just the big boys.

These developments are so profitable that just a hint of a buyout causes an immediate bounce to prices. Just a whisper about a potential takeover is enough for speculators to drive up the price just as fast.

Look at Yahoo! (Nasdaq: YHOO). When Microsoft (Nasdaq: MSFT) announced it was interested in pursuing a merger, the price shot up over 50% in one day. And that was just on speculation – no merger took place.

Another Easy Way to Profit

Every week, there are about 682 transactions related to takeovers, mergers or acquisitions taking place.

Company insiders and the barons of Wall Street make thousands of dollars from these transactions. It’s called “skimming.” And why would they stop? No matter what’s happening in the markets, the financial machine is constantly humming with deals.

In a six-month period:

Goldman Sachs advised on 237 takeover transactions worth $833 billion. Allowing the bankers to “skim” approximately $4.1 billion. While Morgan Stanley advised on 229 deals worth $798 billion, some $3.9 billion went to the bankers.

Citigroup advised on 269 deals worth $748 billion. About $3.74 billion was siphoned off into the bankers’ accounts. Over that same period, other big banks announced an additional $2.88 trillion in deals. Yet investors didn’t have a clue.

Warren Buffett calls these transactions the “elephants.” Normally, they’re associated with takeovers, mergers and acquisitions (M&A), and leveraged buyouts (LBOs).

Call them what you will but these transactions are a daily thing on Wall Street. And their profit potential is open to anyone ­- anyone who knows what to look for.

[cfsp key=”research”]