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 is becoming a reality for many investors who own bank stocks. Changes in federal regulations have opened the long-locked doors to mergers and acquisitions (M&A) among small- and mid-cap banks, which were shut out of M&A deals in recent years by rules that were really meant to control large-cap banks.
Now that regulators understand that small banks are different from large banks, they’ve adjusted their approach to bank oversight. As a result, a banking landscape that would have otherwise delivered intermittent M&A activity over the years is now producing sudden and frequent buyouts and mergers.
Already in 2019 we’ve seen announcements of a merger between TCF Financial (TCF) and Charter Financial (CHFC), and a BB&T Corp. (BBT) buyout of SunTrust Financial (STI).
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If you’re lucky enough to own a bank 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.
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. Expect volatility. You could use a stop-loss order to protect your capital.
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?
Check news and 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. Instead, read the research reports from Wall Street analysts that are published on your brokerage firms’ websites, or tune in to credible news media with commentary from major Wall Street investment icons.
If there are potentially additional suitors, you might make more money by waiting a few days or weeks before selling your shares in the target company. In June 2018, it became clear that Walt Disney Company’s (DIS) plan to buy most of the assets of 21st Century Fox (FOXA) might be interrupted by a competing offer by Comcast (CMCSA). Investors who waited before selling their shares eventually received a much higher buyout price.
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.
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.
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?
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. (That waiting period could easily take six to 18 months, during which time you’ll likely watch your capital stagnate.)
The 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 become 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 to protect their capital!
Let’s say that the buyout is valued at $50 per share. 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 New Company Now that It’s No Longer a Takeover Target?
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 place.
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 paying an accountant to do extra work), then seriously consider selling your 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.