How to Profit From the Next Wave of M&A Deals
Since March 23, the S&P 500 Index has staged a remarkable rally. Depending on how the last week of April goes, it could be one of its best months ever. In a moment, I’ll explain a rare investment opportunity created by this extraordinary sequence of events.
At the start of this week, the SPDR S&P 500 ETF Trust (SPY) was down less than 12% this year. Usually, that would be bad news. But it is impressive considering the index was down more than 30% just five weeks ago.
The S&P 500 is the most widely tracked index in the world. For that reason, most investors pay close attention to how it performs. If that is the only index you follow, you may think the overall stock market is well on its way to recovery.
It’s not. In fact, the rest of the stock market is still in pretty rough shape. At the start of this week, the SPDR S&P Mid Cap 400 ETF Trust (MDY) was down 24.5% while the SPDR S&P 500 Small Cap (SLY) has lost 29.6% so far this year.
That is a huge discrepancy in performance. It illustrates the extent to which Wall Street is afraid a lot of small companies may not survive the coronavirus pandemic. And for good reason. Most small businesses lack the financial resources to cope with a crisis of this magnitude.
It’s not that smaller companies produce inferior products or deliver poorer services. In many cases, just the opposite is true. However, they often survive on cash flow since they do not have sufficient assets to use as collateral for loans.
Right now, a lot of small businesses are teetering on the brink of collapse. Yes, the federal government has made billions of dollars available for them to pay their idled employees. But that money may soon dry up at which time many of these companies will be out of options.
You can bet the merger and acquisition (M&A) sharks on Wall Street are sharpening their pencils. They know there may be an unprecedented wave of corporate restructuring triggered by the coronavirus pandemic and they are ready to strike.
As an investor, correctly guessing which small companies will be acquired could be quite lucrative. Over the past 10 years, the average premium paid for a hostile takeover is 35%. That number could easily rise to 50% this year given how artificially low some stock prices have fallen.
If that sounds excessive, consider Alphabet’s (NSDQ: GOOGL) offer to acquire Fitbit (NYSE: FIT) six months ago. Last October, FIT was trading below $4. On November 1, Google LLC (an operating subsidiary of Alphabet) revealed its intention to buy Fitbit for $7.35 per share.
That 80%+ premium was a huge payday for anyone that bought FIT in the weeks leading up to that announcement. But the $2.1 billion purchase price was chump change for Alphabet, which holds more than $100 billion in cash.
By the way, that deal still hasn’t closed. Quite frankly, I don’t understand why anyone would want to own FIT at its current share price near $7. If this deal closes, the best you can hope for is to make another 35 cents in profit. But if it falls apart, the downside risk could be 10 times that amount!
Stock as Currency
I believe there are many other small-cap stocks like Fitbit out there ready to be acquired. I also believe there are a lot of big companies that can use their stock as currency instead of having to pay cash.
The math is simple. The average large-cap stock is now 25% more valuable than the average small-cap stock since the start of the year thanks to the coronavirus. That spread is essentially “free money” that can be used to finance an all-stock acquisition without incurring debt or depleting cash.
Of course, the tricky part is figuring which small businesses are likely to be acquired. Normally, you might study balance sheets to determine which companies are vulnerable to a takeover. However, now just about every small-cap stock is fair game.
Instead of looking at financial statements, think about strategic fits. For example, a big drug company like Johnson & Johnson (NSYE: JNJ) may take advantage of its recently inflated share price to buy a small biotech firm such as Arena Pharmaceuticals (NSDQ: ARNA).
It isn’t just tech stocks and drug companies that will be having all the fun. I expect increased M&A activity across all sectors of the economy. I hold small gold mining company B2Gold (NYSE: BTG) in the Personal Finance Growth Portfolio. One of the big miners such as Barrick Gold (NYSE: GOLD) or Newmont (NYSE: NEM) may want to buy BTG to acquire its rapidly growing gold inventory.
I’ll admit guessing which small company may be on its way to the auction block is not my forte. But I know someone who has studied that market closely and can help you identify the next takeover target.
He’s my colleague Nathan Slaughter, an investment strategist who’s an expert at pinpointing investment opportunities in corporate takeovers.
Nathan has developed a proprietary screen that uncovers how Wall Street rigs certain stocks that are involved in M&A activity…so you can jump in before they shoot up.
In fact, Nathan is ready to reveal his latest winning stock trade. Do you want in? Click here now.