Investing

The Dangers of Chasing Hopeful Merger and Buyout Stocks

Every time the economy gets good again, and every time the stock market gets high again, waves of mergers and acquisitions begin taking place. The stock market’s bull run is now more than five years on from the March 2009 bottom. We have seen multiple mergers that are well into the tens of billions of dollars. This leaves investors wondering which companies could be the next buyout targets — and which stocks they can buy to make easy money from the next big merger.

24/7 Wall St. has identified many would-be buyout candidates over the years. The number one caveat or statement that we would always make is simple: when you buy a stock, you sure better be buying it because you like the company’s prospects rather than because some larger company or private equity group may be trying to buy that company or one like it.

Chasing mergers is nothing new. M&A rumors are in the financial media, or in subscription Web services, or they are talked about on Twitter or on message boards and in chat rooms. Barron’s talked up 10 merger candidates in its May 26, 2014 edition. Some of these companies screen out as “cheap” value stocks and some fit in as strategic plays.

Again, you better on be buying a stock that has prospects for the years ahead you like. Frankly, some of the Barron’s picks do not shield any would-be M&A chasing investor (or trader) from risks. Some may in fact be raw value traps.

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AMC Networks Inc. (NASDAQ: AMCX) has enjoyed its run higher with a boost coming from the likes of “Mad Men” and “The Walking Dead.” Barron’s identified it as a merger hopeful in the media consolidation trend taking place. A buyer may feel comfortable that its stock has pulled back, but a buyer also has to wonder if the success of “Mad Men” (the show is ending) and “The Walking Dead” can last forever. Fortunately there is a lot more to the media powerhouse, and the $4.4 billion market cap might not be too much for some media owner or distributor to want to own.

Xerox Corp. (NYSE: XRX) was another pick from Barron’s, but frankly a value stock buyer will recognize immediately that this may be nothing more than a value trap. Xerox has been unable to grow, and growth ahead remains elusive. Still, it is worth $14 billion, and a would-be buyer might not care to buy such a hard-sell company with limited growth prospects, even if it does trade at only about 11 times expected earnings. Over half of the company’s sales are now from outsourcing and services, but there is a stigma to this old world company. All caveats aside, even Xerox’s rivals might just go it on their own rather than pay up, even after its stock has outperformed the market in the past 12 months.

Jazz Pharmaceuticals Inc. (NASDAQ: JAZZ) is yet another biotech merger hopeful identified by Barron’s. Investors have cleaned house investing in biotechs, up until recently, and many mergers have taken place in this space over the years. Jazz’s market cap of $8 billion would be an easy purchase in size for more than a dozen biotech and pharma outfits. The lesson in biotech M&A chasing is twofold. One risk is that some biotechs never get acquired due to price or due to concerns about a drug or a pipeline, and the second risk is that a poor study result or even a nasty side-effect can destroy billions of dollars in value in a very short time. Our guess is that eight or nine out of 10 biotech stocks have been the subject of merger or buyout rumors at some point in their history as a public company.

Alaska Air Group Inc. (NYSE: ALK) was another buyout candidate discussed by Barron’s. This $6.7 billion market cap regional airline just saw its stock hit new all-time highs. It is one of the last independent carriers out there that has not been bought or amalgamated into a larger carrier, and the big airlines have even started consolidating among themselves. Airlines trade with higher multiples now that consolidation has created less competition, but this one isn’t cheap at 14 times earnings at its all-time high. If the economy turns south or if the major carriers have risen too much, then investors might merely be paying up for a maturing story.

Citrix Systems Inc. (NASDAQ: CTXS) was the other technology stock (if Xerox is a tech company) mentioned by Barron’s. This software company is worth $10 billion, and it has been mentioned as a potential candidate and even had buyout rumors for years now. Barron’s also pointed out a takeover screen that Merrill Lynch ran recently. This is one that could easily be consolidated, but the company’s management might demand too much of a premium. Even after shares pulled back 20% from their high, the stock is still worth about 20 times earnings. Some companies may want its revenue growth, but no buyer is going to get Citrix on the cheap — to the point that acquiring this will only be cheap for a buyer that either has more cash than it can figure out what to do with, or whose own stock is expensive enough that it looks cheap on a relative value basis.

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24/7 Wall St. admits that owning the next buyout stock can be very rewarding. Just don’t get stuck holding the bag in a value trap or in a position that the market dictates is too expensive to be bought at a price that the buyout candidate’s management team can agree to. And never forget the one rule of investing in companies like this: you better be buying because you like their prospects as standalone businesses rather than just on a hopeful buyout whim.

The waves of M&A have been mind-numbing of late. The raw size is enough to prompt even the less creative investors to wonder if they should be trying to find the next potential buyout candidate.

AT&T Inc.’s (NYSE: T) acquisition of DirecTV is worth close to $50 billion in equity value. This is a strategic buy, and AT&T moves into being a top dog in telecom, wireless and pay TV. Imagine when all of your bills for wireless, landline (yes, some people still have them) and satellite TV are finally consolidated into one bill with just one due date.

Comcast Corp.’s (NASDAQ: CMCSA) purchase of Time Warner Cable, with divestitures expected, is another strategic buyout for more market share. Its price tag is close to $70 billion in enterprise value. The difference here is that Comcast also owns NBC, so it is now a content owner and distribution source.

Pfizer Inc.’s (NYSE: PFE) would-be buyout of AstraZeneca is a strange one in Big Pharma. It is a cross-border tax strategy, worth more than $120 billion in enterprise value. The deal is on hold and may be dead, and politicians in the United States want make deals of this sort much harder to accomplish.

The Allergan and Valeant buyout is another one up in the air. That deal is worth potentially more than $50 billion in enterprise value, and it has two purposes. First, it is tax-efficient. Second is that it is part of the roll-up strategy that Valeant Pharmaceuticals International Inc. (NYSE: VRX) wants to pursue.

Caveat emptor!

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