It Pays to Have Potential Takeover Targets in Your Portfolio. Here’s How to Find Them, and How to Handle Them.
It’s every investor’s dream to own a stock that rises rapidly, and there’s no more rapid source of share price gains than when a company becomes a takeover target. That dream can become a reality for many investors who own diversified stock portfolios, because attractive acquisition targets exist in every industry: media, chemicals, banks and more.
If you’re lucky enough to own a stock that becomes a takeover target, it would be wise to have a plan already in place, so that the excitement of the moment does not interfere with your decision on whether to hold the stock for further gains or take the money and run.
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Generally speaking, you should aim to sell your takeover target soon after the buyout offer emerges and the share price shoots upward. That’s because after the initial run-up, which takes just a day or two, there’s usually very little remaining upside to the share price, and it could easily take 6-18 months for the buyout to be completed. If you continue to hold the stock, that means your capital is inactive, not providing you with growth potential during that entire waiting period. Keep reading, and I’ll discuss some common scenarios that can affect your decision to hold vs. sell the takeover stock. But first, you’ve got to own the takeover stock!
How to Buy Stocks That Become Attractive Takeover Candidates
My stock selections are always screened for double-digit future earnings growth, relatively low price/earnings (P/E) ratios and low-to-moderate debt levels. As a result, I end up owning financially-healthy, growing companies that are undervalued.
Now imagine that you run a big company, and you’re looking to acquire a smaller company in order to boost your profits, your product assortment or your competitive advantage. Do you want a company with rising profits, or a company with stagnant or falling profits? Do you want a company with lots of debt, or minimal debt? Do you want a company with an expensive stock, or an inexpensive stock? By screening my stock selections for good balance sheet characteristics, I not only end up lowering risk in my stock portfolio and increasing my odds that investors will be attracted to my stocks – thus buying them and driving the share prices up – but I also increase the odds that I will own shares of a company that a bigger company might want to acquire!
Can debt-ridden or money-losing companies also be takeover targets? Of course they can. My stock selection process can help my odds of success, but that doesn’t cancel out all other stocks’ odds of success. I’m just playing the odds in a manner that can help my portfolio succeed, whether my stocks become takeover targets or not.
Is the Buyout Offer a Rumor or a Fact?
If a stock buyout is just a rumor, the stock price could climb, based upon the market’s expectation of a buyout. It’s not unusual for rumors of a buyout offer to emerge a couple of days before the actual offer. But other times, the rumor fizzles along with the recent stock price gains. If your stock runs up on a rumor, you could use a stop-loss order to protect your capital against a share price reversal, and lock in your profit, or you could buy a put option as an insurance policy.
In early February 2018, a rumor emerged that Allianz was interested in buying XL Group (XL), an insurance stock I used to own in my Cabot Undervalued Stocks Advisor Growth Portfolio. XL shot up 12% immediately. There was no further news for four weeks, until suddenly investors learned that XL had agreed to be bought by Axa (AXAHY), at which point XL shares shot up another 30% in value, much to my subscribers’ delight.
If a buyout is happening, the stock price of the takeover target will often rise quickly to the buyout price. However, sometimes the stock rises to a point below the buyout price. In those cases, there’s a certain amount of doubt as to whether the buyout will receive approval due to anti-trust concerns.
Will there Be a Competing Offer?
A competing buyout offer is not a very common scenario. If another offer is in the works, it usually materializes within a few days of the first M&A announcement.
Check research reports to see whether analysts think there’s a reasonable possibility of a competing buyout offer emerging. Don’t check social media websites where investors are excitedly chatting with each other. Those folks are just like you: regular investors, not industry insiders or Wall Street analysts. They might portray their hopes and dreams as facts, telling everybody on Twitter that a famous company is going to up the ante in the takeover scenario; but the truth is, they literally have no idea what might happen. If they actually knew that a competing takeover offer was in the works, they would be sharing insider information, and that could send them to prison. So disregard investors on social media.
Instead, read the research reports from Wall Street analysts that are published on your brokerage firms’ websites. The analysts study your company and its competitors every day of their working lives. They know which smaller companies could appeal to bigger companies, which companies can afford to make an acquisition, and whether alternate takeover scenarios are a possibility. This is a key reason why I keep an investment account at a major Wall Street company instead of keeping all of my liquid assets at a discount broker. The clients of discount brokers don’t have access to the type of incredibly useful research that I get through my Wall Street brokerage account.
If there are potential additional suitors, you might make more money by waiting a few days or weeks before selling your shares in the target company.
Four weeks of excitement and intrigue came to a close on May 9, 2019 when Chevron Corp. (CVX) officially bowed out of the battle to purchase Anadarko Petroleum (APC), ceding the honor to Occidental Petroleum (OXY).
The drama began on April 12, 2019 when Chevron offered to buy Anadarko for $33 billion in a 25% cash/75% stock deal worth $65 per share. Then on April 24, Occidental made a competing offer to buy Anadarko for $38 billion in a 50% cash/50% stock deal worth $76 per share. There was additional intrigue involving Warren Buffett, CEO of Berkshire Hathaway (BRK/A) and Total SA (TOT), the French energy conglomerate.
Ultimately, Chevron decided not to outbid Occidental in the quest to purchase Anadarko. The Anadarko shareholders who held their stock during those four weeks ended up earning lots more profit than shareholders who sold upon the first buyout announcement on April 12. Interestingly, APC traded up to $76 during the excitement of the negotiations in early May, but never traded that high again during the months that shareholders waited for the deal to close. Again, I want to reiterate that after the initial run-up – give or take a couple of weeks – the share price of the takeover target usually stagnates until the deal closes and investors receive cash or stock, as promised.
Is the Buyout Price Fair?
Sometimes the buyout offer comes in at a ridiculously high price. Other times, analysts are left wondering why such a low price was accepted by the targeted company. It’s not your job to decide what price is fair. It’s your job to decide whether to keep or sell your stock, based on the actual buyout price.
When XPO Logistics (XPO) announced an acquisition of Con-Way Inc. (CNW) in September 2015, analysts were stunned at the low price. When Danaher (DHR) announced the purchase of Pall Corp. (PLL), I thought they paid far too much for the company. Either way, it’s not my job as an investor to decide what should happen. It’s my job to look at the facts, accept them, and make a decision.
What About Hostile Takeovers?
In the case of a hostile takeover attempt, the first price is often rejected. That happened in March 2018 when a German company, Knauf, offered to buy USG Corp. (USG) for $42 per share. USG turned Knauf away with disinterest.
USG shares rose to $40, not to the buyout price of $42. What investors should have known was that Knauf would likely come back with a higher offer, so as to entice USG to say “yes.” Knauf eventually revised their buyout offer to a higher price, and USG agreed to be acquired.
What Happens to My Stock as I Wait for the Buyout to be Completed?
Your stock will jump in price on the day the merger is announced. It could climb higher than the buyout offer, as Broadcom (BRCM) did when Avago (AVGO) announced its intended acquisition; or it could climb to a price below the buyout offer, as Pall Corp. (PLL) did upon the Danaher (DHR) purchase announcement.
You can sell your stock on the open market, any day between the announcement and the close of the merger transaction. You will receive the market price for the stock, which could be above or below the price of the buyout offer.
Alternately, you can keep your stock, and wait for the acquisition to take place. I reiterate: That waiting period could easily take six to 18 months, during which time you’ll likely watch your capital stagnate. I repeat that statement often, because it shocks me, the number of people who hold their takeover stocks for months on end, thinking that it will somehow magically rise in value. Hellooo? The stock already rose to the approximate buyout price! Why on earth are you still holding it? You were given a gift. Accept the gift, say “thank you,” and move on!
Another risk in waiting for the completed merger is that the acquisition might not receive U.S. or foreign government approval, in which case the merger would fail and the targeted company’s stock price would fall. That’s exactly what happened to Broadcom’s (AVGO) takeover attempt of Qualcomm (QCOM) in March 2018. As it became more and more clear that the deal might not receive approval, QCOM gradually fell from $67 to $49. Imagine being the shareholder who did not sell at $67 and also did not use a stop-loss order or a put option to protect their capital!
Let’s say that the buyout is valued at $50 per share, and you did not sell your shares on the open market. Sometimes the investor receives $50 cash, or $50 worth of stock in the acquiring company, or a combination of the two. If you own your stock in a brokerage account, the brokerage firm promptly handles the exchange of stock/cash for you. There’s no red tape.
Do I Want to Own Shares in the Acquiring Company?
Let’s say that ABC Company is purchasing XYZ Company. If you wouldn’t normally buy shares of ABC Company because the stock’s fundamentals do not meet your investment criteria, then sell your XYZ stock and reinvest the capital in a more appropriate stock.
Also, how’s your tolerance for detail when filing your Federal tax return? If you accept the new company’s stock in a taxable account, you’re eventually going to have to report the transaction down the road, when you sell the new company’s stock. Most investors do not keep good records of their cost basis, and cost basis gets complicated when stocks are involved in mergers. If you detest complicated income tax paperwork (or detest paying an accountant to do extra work), then seriously consider selling your takeover stock, rather than accepting shares in a new company.
Cabot Undervalued Stocks Advisor has spotted many a takeover target over the years and our subscribers have been able to grab quick double-digit gains in a matter of months or sometimes just weeks. These stocks included: Axiall (AXLL), Cavium (CAVM), Chemtura (CHMT), Harman (HAR), KLX Inc. (KLXI), SanDisk (SNDK) and XL Group (XL).
To see how we did it and how you can profit in the months and years ahead, click here to join my advisory today!
*This post has been updated from an original version published in 2016.