Mergers can give you stellar profits

THE financial rumour mill went into overdrive on Friday after whisperings that Rupert Murdoch, the chairman of News Corporation, the global media group, was thinking about buying back BSkyB, the broadcaster he helped to found in 1990.

It was mooted that Murdoch might even be willing to pay up to 735p per share, a 20 per cent premium on where the stock was trading on Friday. A feverish mood gripped the markets, and turnover in BSkyB’s shares on Friday was four times larger than normal, pushing the price up from 570p to 598p.

The BSkyB excitement came at the end of a week when M&A was on everybody’s lips. Tullet Prebon, the UK based inter-dealer broker, announced on Wednesday that it was “in preliminary talks with a third party” about an offer for the company. The markets didn’t need any more detail than that to push the stock higher: Tullet Prebon’s surged nearly 25 per cent after the announcement.

Typically, in M&A, the market tends to reward the target company and punish the acquirer. For example Prudential, the UK insurer, saw its share price fall 25 per cent earlier this month when it announced it was buying US insurer AIG’s Asian operation.
“The rumours tend to cause bouts of volatility in the financial markets,” says David Buik of BGC Partners. “And this volatility gives investors the opportunity to make substantial gains.”

But how can spread betters take advantage of these big moves in the markets?
Before you do anything you should make sure you’re hedged, says Manoj Ladwa, senior trader at ETX Capital: “You can’t put all your eggs in one basket when your trading strategy is based on a rumour. If it comes true, great, you’ve made stellar gains, but if it doesn’t then you need to cut out of the position pretty quickly.”

Stocks tend to experience big moves at the early stages of negotiation, says Ladwa: “The stock can flag a bit after an initial move, but then news flow about the state of negotiations between the companies involved drive further appreciation in the stock price further down the line.”

This was the case with Kraft, the US food company, which bought UK confectioner Cadbury earlier this year. From Kraft’s initial offer for the company in September 2009 to the time the deal was agreed in the middle of January, Cadbury’s stock price rose by 35 per cent.

To benefit from these moves you need to get in early and be willing to take a long-term view. David Jones, chief market strategist at IG Index, recommends that investors do research in advance and try to identify companies that have good takeover prospects over the medium-term. If you find a company that ticks that box, then think about a longer-term strategy. You can spread bet on futures contracts as easily as you can on short-term contracts. “Because interest rates are low, the cost of financing a longer-term spread betting position for a number of months is fairly inexpensive,” says Jones.

Spread betters should also cast their net wider than just the takeover target if they want to trade a merger and acquisition (M&A) strategy, says Ladwa: “When these rumours pop up they can impact the entire sector.” This happened last Wednesday. After the Tullet Prebon announcement, its competitor in the inter-dealer broker market, Icap, saw its share price rise nearly 7 per cent.

If the best way to profit from M&A activity is to get in early, then where should spread betters be looking for potential opportunities? Equity analysts at UBS, the Swiss investment bank, believe that the European insurance sector looks most ripe for a wave of M&A this year. Aerospace and non-food retailers could also see some takeover activity.
UBS argues that two factors will fuel takeover activity. The first is sluggish economic growth in the developed world, which will make companies keen to synthetically boost their growth figures through acquisitions. The second is that banks which were bailed out during the financial crisis want to get rid of their insurance units, which are not part of their core operations.

Analysts at UBS expect Royal Bank of Scotland and ING, the Dutch bank, to dispose of their insurance departments this year. But it expects insurers such as Swiss Re and Allianz, which have healthy-looking balance sheets, to be on the prowl for acquisitions, especially in Asia and Eastern Europe as they look to expand their operations to lucrative emerging markets.

An M&A-based trading strategy can be be risky though, so investors need to beware. If a takeover collapses, as they can do, then stock prices can retreat very quickly. If you think a takeover rumour is implausible then don’t be afraid to go against the market, says IG Index’s Jones: “Sometimes a contrarians view is the best.” For example rumours last year that coach operator National Express was in the running to be taken over by a Spanish firm turned out to be untrue.

Profits can be made during a takeover process, but keep calm and avoid catching market fever.