by admin August 10, 2011 Comments Off

One very profitable form of value investing is to find announced mergers or acquisitions that have been made and determine the annualized return. To do this you need to have both an announcement and a closing date, and to know how much the deal is worth. You also should have a sense of the probability of the deal going through as it is occasionally risky because if the del doesnt go through your stock could drop below where it was prior to the announcement of the deal.

To figure out an annualized gain you must take the closing price and determine the number of shares. You would buy the shares of the company being acquired for more than the current price, and lock in the profits by shorting the amount of shares that you will receive by the aquiring company.

So if company B buys company A for $10 per share and its worth $8 per share, you wouldnt need to short company B because its a cash offer. But if company B is worth $9 per share and the merger results in company A shareholders receiving 1.25 shares, you would short 1.25 shares for every share of company A you buy. To figure out your return you would multiply 1.25 (the number of shares received) by $9 (the price per share of the company at the moment) subtracted by $8 (company As share price). In this case your profit would be $3.25 per share on an investment of $8 per share.

However, sometimes its better to just play one side of the merger and not the other. For example, lets say you recognize that a company that you really like such as Google overpays for a company. However, Google is currently undervalued already. Rather than buy google directly, you could buy shares in the acquisition company.

Here is a very useful merger arbitrage tool. What I failed to mention here is that once a deal is announced there is a certain closing date. This is important because if you have a 10% return in 1 month it is better than a 15% return in 2 months or even a 20% return in 2 months, because your compound annual return is higher. However, if there is a very good return in a longer period of time, it doesnt hurt to lock it in, if you think there wont be another opportunity like it and by taking the shorter term deal you may miss out.

Personally, I like the idea of using mergers and acquisitions as a way to acquire a company at a discount. So I am going to first look at the acquiring companies that the deal is profitable for

Then you want to compare based on fair value and annualized return of the all cash offers and then sort the deals

in order

HRBN,CRU,CSR,CEG,PAET,TAM,VSEA,OXPS,MHS,CFSG,FTLK,ABVA,PNNW,BBBB,KCI,CNU,SMOD,CEPH,NSTC,EM,ENP,CONM,CLFC

However, many of these are better off if you just play the arbitrage and sell them instantly.

This makes CRU and TGE and GRAN the best if you are planning to short the acquiring companies to lock in the profit, or anticipate that you will be able to sell it immediately upon the acquisition.

Of course, this may change drastically in a short amount of time, due to the opportunity, so always keep your eye out for opportunities and the prices at which it would make the opportunity attractive relative to the other arbitrage opportunities out there.

This also assumes the deal will go through, there is a chance it wont, so keep this in mind. Additionally if credit contracts, there is possibilities of the company not being able to finance the deal even if they want to so keep interest rates in mind and libor rates and borrowing costs.

Its wise to research and only select deals that have a high probability of going through. Only using those that have been announced is an important first step because that means there is at least an intention on one or both sides for a deal. The remaining steps would take quite a bit of detail to explain, however, there is a great book available on amazon that explains the basics of mergers and arbitrage called Warren Buffett and the Art of Stock Arbitrage: Proven Strategies for Arbitrage and Other Special Investment Situations. If you want to get started, this is a great book to read to start with.