The word “merger” can be music to an investor’s ears. Mergers often mean one company is offering more than the prevailing rate for the stock of another company, and the investor who accurately predicts when and if to buy or sell a stake in the company being acquired can make a bundle.
For instance, when CBS announced plans last June to take over QVC home-shopping network, QVC stock jumped 16 percent, to $38. By the time the subsequent bidding war was done in late July, QVC stock was selling for $44.25.
Investors who played their cards right made a tidy profit. But can you still profit if you’re just a normal Joe or Jane who happens to own stock in a company being acquired?
Definitely, but it takes a little savvy and maybe professional help to make the most of the situation.
“It’s a little like a crap shoot,” says Tom Adair, a personal financial adviser in Chicago. “It’s very difficult for the experienced investor, let alone the amateur, to predict what is going to happen.”
When a company aims to acquire another, it generally first brings a proposal to the leaders of the target company, Adair says. If they like it, and can agree on terms, it’s considered a “friendly” acquisition and the board recommends to stockholders to accept the offer.
If the target company’s board doesn’t like the offer, the acquiring company may still pursue a “hostile” acquisition by going directly to the shareholders with an offer.
In either case, stockholders receive a letter outlining the offer, says Keith Bradley, an assistant vice president at Harris Trust and Savings in Chicago.
If you think the offer is a good deal, you sign a “letter of transmittal” and send it with your stock certificates to a third-party depository, such as Harris, which will hold the stock until the deal is consummated. If you sign the letter and a better deal comes along, you can switch to the new deal, Bradley says. And if you don’t sign any deal, but one still goes through, you’ll get the same payment as the shareholders who did sign.
So, waiting for the deal to conclude is one way to make money on a merger. But that’s not your only option, and possibly not your best.
Depending on how the professional investors see the deal, there may be a safer, quicker way to make money on a merger: Sell your stock on the open market shortly after the proposed merger is announced.
If the offer from the acquiring company is lucrative enough-they are often 50 percent or more above the current stock price-and the professionals think it will really pan out, the stock price will immediately jump. If you sell your stock then, you’ll get close to the same amount of money, and you’ll eliminate the risk of the deal falling through.
“My rule of thumb is to sell once an offer has been announced. Unless you’re a professional arbitrageur, you should immediately take the profits,” says James Cramer, president of Cramer & Co., a money management firm in New York.
If you’re daring, you may prefer to wait and see if another company comes along and makes a better offer, such as in the QVC deal. In the 1980s, such bidding wars were common and stockholders who had the nerve to hang on made a lot of money.
“But what we’re seeing in the last year or so are the initial offers being friendly, and they tend to be fully valued,” says Gerald W. Perritt, owner of Chicago-based Investment Information Services, an investment newsletter publisher and money management firm. “You haven’t seen too many cases of one company offering something and somebody coming along to sweeten it.”
Perritt says if the initial offer looks fair, sell early: “If it’s a cash offer, you’re going to be out of the stock anyway, so my thought is dump it on the market now rather than wait for the deal to go through. The price usually moves to within a quarter or half a point of the cash offer anyway, and you don’t wait two or three months. You let the arbitrageurs make that last 25 cents or 50 cents, and you look for places where you could put that cash to work much better.”
If the company seeking to acquire your company wants to offer stock instead of cash, or a combination of the two, then things can get a little more complicated, Perritt says.
You can still sell on the open market, of course, but if you feel the union of the two companies will create a new company that earns significantly more money, you may choose to stick it out instead and remain a shareholder.
“The question we have to ask ourselves here is, Do we really want to be part of the new company?” Perritt asks. “So our focus tends not to be on the company that is being taken over but on the acquiring company.”
Among things to look for are how good a “fit” the two companies make and how deep into debt the acquiring company will have to go to conclude the deal.
Your stockbroker will be able to help you analyze those factors, says Bruce Bittles, a market strategist at J.C. Bradford & Co., a brokerage in Nashville.
“I think the first thing a shareholder should do is contact his stockbroker,” Bittles says. “The stockbroker will talk to his research staff and (pass the information on).”
Whether it’s a hostile or friendly offer may also play into the equation. A hostile takeover may raise the bid, especially if another suitor comes along, Bittles says. But the resulting merged company may exhibit strained relations among personnel from both previous companies, possibly hurting the bottom line.
On the other hand, “if it’s a friendly offer, the management of the company is basically putting themselves up for sale, and they are actually telling the shareholders it’s in their best interest to tender their stock,” Bradley says.
Whether a deal is hostile or friendly does not mean the same thing every time. Keeping your eye on the price of your stock will quickly tell you what the pros think.
You may also want to consider your tax situation when assessing the offer, Bittles says. If you accept a cash buyout or sell on the open market, any profits will be taxed as capital gain. If you take stock in the acquiring company, you won’t have to pay taxes until you sell those shares.
