Mergers and acquisitions are picking up across all sectors as confidence in the economy improves.
With company prices relatively low and private equity firms shut out, corporations with access to capital are making strategic acquisitions to bolster their competitive positions.
Last week, Agilent Technologies (A) agreed to buy Varian for $1.5 billion. Also in the technology space, International Business Machines (IBM) has agreed to buy Chicago-based predictive analytics software provider SPSS (SPSS) for $1.2 billion.
In the healthcare sector, France’s Sanofi Aventis (SNY) is shelling out $4 billion to Merck (MRK) to take full control of its 50-50 animal health joint venture Merial. Sanofi is also buying India-based vaccine maker Shantha Biotechnics for $781 million.
In energy, pipeline operator Targa Resources Partners (NGLS) is acquiring Targa Resources’ natural gas liquids business for $530 million. Wireless service provider Sprint Nextel (S) is buying Virgin Mobile USA (VM) for $420 million. In airlines, Southwest Airlines (LUV) has entered the scene with the intention of overtaking Republic Airways (RJET) and acquiring struggling carrier Frontier Airlines (FRNTQ.PK).
The increase in the number of mergers and acquisitions provides investors with unique ways to profit from such activities.
Profit from mergers and acquisitions
One way to benefit from increased M&A activity is to take long positions on potential targets. The second way is to capture the spread between the final price paid by the acquirer for the acquisition target and the prevailing market price for the target. This spread arises because the target stock often trades at a discount to the offer price. The magnitude of the spread depends on factors such as the uncertainty associated with the deal, interest rates, and investors’ risk appetite. The two methods above are usually more suitable for institutional investors.
A less common, but effective way for retail investors to benefit from M&A action, is by buying shares of investment banks that may benefit from increasing M&A. Goldman Sachs (GS) and Morgan Stanley (MS) are examples of independently listed investment banks in the US. These companies, along with European banks such as Credit Suisse Group (CS) and Deutsche Bank (DB), have a wealth of experience in sectors such as geographic regions such as Asia, which promise increased M&A activity.
The credit crunch has also allowed certain commercial banks to bolster their investment banking capabilities. Bank of America (BAC), JP Morgan Chase (JPM) and Wells Fargo (WFC) are relatively well positioned to earn a significant share of their M&A gains. However, exposure to residential and commercial real estate may negatively affect the share price performance of these banks.
Mutual Fund and ETF Investors
Investors looking for bundled products that can benefit from M&A have a few options to choose from.
In the mutual fund space are Fidelity Select Brokerage & Investment Management (FSLBX) and The Merger Fund (MERFX).
FSLBX is more of a mainstream vehicle that targets investment banks, asset managers, and exchanges. MERFX is somewhat unconventional in that it seeks to profit from arbitrage spreads.
ETF investors can check out SPDR KBW Capital Markets (KCE), iShares Dow Jones US Broker-Dealers (IAI), and Claymore/Clear Global Exchanges, Brokers & Asset Managers (EXB). While KCE and IAI do not include foreign companies, EXB invests in companies around the world.
In 2009, all previous investments except MERFX vastly outperformed the S&P 500. MERFX earned about half as much as the S&P 500 with much less volatility than the benchmark.
