The Mergers and Aquisitions Boom

When I worked as a Sales Trader on ING's Hedge Fund desk, a big chunk of my time was dedicated to risk arbitrage.

Here's the simple meaning...

I was involved in the simultaneous purchase of shares in a target company and the sale of shares in its potential acquirer.

It was all about taking educated, well-researched risks on companies likely to be taken over by a much bigger operation.

If the takeover fails, the arbitrageur (me, back in the day!) could lose a great deal of money... but call it right and it's a big pay day!

So I was always on the look out for potential takeover targets.

When I'd spot a prime target I'd take out a long position (that the price would go up) for my clients and short (that the price would go down) the potential bidding company.

The trades had to be timed precisely in order to take full advantage of the proposed acquisition – and sometimes pulled at the drop of a hat should things fall apart.

So here's the trick...

When takeovers occur, more often than not the target company’s shares rise sharply and the bidding company’s fall. Time it right and all you have to do is wait for the cash to roll in!

Now I wouldn’t advise a private investor to invest in this way. This kind of strategy can be very risky, particularly if the rumour of a takeover bid turns out to be just that - hearsay.

In that scenario you'll see the target’s share price fall away very quickly. And unless you are able to constantly keep an eye out you may not escape in time.

The risks are great but so are the rewards if rumour turns out to be true.

So what company could be on the verge of a takeover right now?

Let's take a look at one possible target...

A market worth $3.33 trillion... and rising

Gallaher leapt forward just before the weekend on news of a possible bid approach from Japan Tobacco.

Gallaher is the fifth largest cigarette group in the world, valued at a staggering £7.7 billion.

They make well-known brands like Benson & Hedges, Silk Cut and Mayfair, and have long been the subject of takeover talk in the City.

Shares in Japan Tobacco bucked the trend rising 4.8% - but this is no more than speculation at the moment.

Companies such as Altria Group and British American Tobacco (BAT) could also fund a bid. As expected, all four companies have declined to comment.

Mergers and Acquisitions (M&A) can certainly take a long time to come to fruition, if they get past mere rumour at all.

In the dim and distant past (nearly six years ago now), I was trading BAT against Gallaher and I was doing very nicely for my clients. The correlation was right and at the time these two tobacco companies were trading in opposite directions.

There was huge speculation then, which after a round negotiations and talks amounted to nothing.

M&A's were in boom mode then, and it looks like we're just getting started again now...

20 November was not the first day to be dubbed “Merger Monday”, but it was one of the more spectacular. In a frenzied 24 hours on 19 and 20 November, firms announced some $75 billion-worth of deals.

And there was no let-up for ebullient bankers as the week wore on: Qantas, Australia's flag-carrying airline, said it had been approached by a group led by a bank and a private equity firm, possibly valuing it at up to A$11 billion ($8.5 billion).

Such activity has helped push the value of mergers and takeovers announced this year above the $3.33 trillion record set in 2000 at the apex of dotcom mania.

The new M&A boom still in its early stages

The current M&A boom has a lot further to go. This should help the markets to perform well, when earnings growth is slowing somewhat.

According to Neptune Capital: "History suggests we ought to be pretty cautious, as this often coincides with market peaks... (But) we consider we are still in the relatively early stages...

"This year, 75% of deals were paid for in cash, while in the 90’s it was 40%. Premiums are around 16%, while in the 90’s they were 40%…There is no sign of huge euphoria.”

The volume of global mergers is growing at a staggering rate, hitting an all-time high of $3.39 trillion (£1.72 trillion) so far this year.

The boom has been driven by low interest rates, liberal credit markets, coupled with high confidence among chief executives, and of course rising stock markets.

What the Penny Sleuth ultimately wants to do for you

But Neptune adds: "Protectionism is coming through... (It) is a more worrying trend that we are going to see across the developed world."

This has the potential to hinder M&A activity but the outlook for stocks in 2007 looks rosy.

We could well see - as we used to say in the City - the ‘Goldilocks’ scenario appearing...

This is where economic growth is neither too hot nor too cold.

The economy seems to be fairly stable, and I think we’ll see the market do better than people expect.

I love the intrigue of M&A... it's like finding the missing pieces of a jigsaw puzzle.

And that's ultimately what we at the Penny Sleuth want to do for you.

We'll be your detective and seek out potential targets before anything happens.

This should work from two angles... the first that we'll spot great little companies with the potential to do extremely well. The second that it’s so good it'll become a target for a much bigger fish...

Be sure to tune in tomorrow to see how you can benefit from the frenzy of M&A activity in the small-cap market.

Best regards,

Melissa Carroll

for The Penny Sleuth