The Investment U e-Letter: Issue # 729
Friday, November, 2007

Mergers and Acquisitons (Part 1): Here’s How to Take Advantage of The Takeover Frenzy
by Alexander Green, Chairman, Investment U; Investment Director, The Oxford Club

Is anything more exciting for a stock market investor than the sudden news that one of his holdings has received an unexpected takeover bid? Typically, after mergers and acquisitions, a company’s stock shoots up immediately… and then rival bidders often emerge in the days ahead, driving the stock higher still.

It’s a profitable scenario that has played out hundreds of times over the past two years.

Fortunately, one of my colleagues at The Oxford Club, Louis Basenese, makes a specialty of uncovering takeover candidates before the first bid is made. He even edits The Takeover Trader, a fast-paced trading service that targets prime takeover candidates.

Recently I sat down with Louis to ask him about the state of the takeover market, where it’s headed and the three things he looks for in a buyout candidate.

The Current Mergers and Acquisitions Market

Alexander Green: It’s been well publicized that corporate takeover activity is at a record. Just how big is the takeover activity that’s happening here compared to the past?

Louis Basenese: Put simply, we’re at record levels. But nowhere near a peak.

Last year, worldwide deal volume hit $3.8 trillion, enough to surpass the previous record of $3.4 trillion set in 2000. Interestingly enough, though, the bulk of the activity (almost 35%) happened in the fourth quarter.

This late-year strength has continued into 2007, with deal volume for the first nine months topping $3.6 trillion, a 50% increase compared to the same period a year-ago, according to Thomson Financial.

What’s Causing the Takeover Boom?

AG: What are the factors driving all this takeover activity? And does the credit crunch threaten to grind it all to a stop?

LB: The primary driver is an abundance of cash, both on the balance sheets of corporate America, and in the form of cheap financing.

When it comes to cash, we’re near record levels, equal to roughly 6% of the S&P 500’s market cap. Compare this to the last boom, when cash was close to 2.5%, and there’s plenty of money left to fuel the current one.

As for cheap financing, we all know this firsthand, as our mailboxes have been stuffed for years with no-interest or low-interest credit card and mortgage offers. And it’s no different for corporations.

They can take their healthy cash positions and multiply their buying power by taking advantage of historically low interest rates. Again, if you go back to the last mergers and acquisitions boom, interest rates were about 1.5% higher, suggesting there’s plenty of room before borrowing costs become prohibitive to deal activity.

Another factor is, of course, the stage of the economic cycle we’re entering…

Historically, mergers and acquisitions activity picks up as organic growth rates slow. As you’ll recall, last quarter was the first time in 14 quarters that S&P 500 earnings growth dipped into single-digits. For the second quarter, an even greater slowdown is expected.

During such times, it’s typical for companies to try to avoid, or lessen, the slowdown by making strategic acquisitions, especially ones that are immediately accretive.

As for the credit crunch, it dried up private equity financing almost immediately. But I consider it temporary and actually a positive development.

Now, strategic buyers can get back to their acquiring ways. Before the credit crunch, they were forced to sit on the sidelines as private equity shops pushed the offer prices up for compelling takeover targets to unjustifiable levels.

We’re already seeing this play out as the majority of the recent deals involve strategic acquisitions. In fact, just this week Dell acquired EqualLogic. The week before, Nycomed purchased Bradley Pharmaceuticals. And there are countless other examples.

It’s also worth mentioning new sources of financing keep popping up. Buyout funds are increasingly going directly to hedge funds. We witnessed this with Hellman & Friedman’s $1.8 billion purchase of manufacturer Goodman Global.

China is also providing liquidity. Three of the five lenders for Bain Capital’s purchase of network equipment maker 3Com called the People’s Republic headquarters.

3 Ways to Find Companies Ripe for a Takeover

AG: What factors do you use in determining which companies are likely takeover candidates?

LB: For starters, I can never downplay the importance of credible rumors. Just like we all have trouble keeping personal secrets, so too do Wall Street’s elite.

And since due diligence starts months in advance of any takeover announcement, there is plenty of time for information to slip out. My cherished contacts from my time on Wall Street are invaluable here.

When it comes to more objective, fundamental criteria, I look for the following:

• Industries that are consolidating. Takeovers come in spurts, and often remain within particular industries. By focusing on those undergoing the most rapid consolidation, it’s easy to narrow the field of possible investments down quickly.

• Insider buying. No one knows a company better than the insiders. And if they’re preparing the company for a sale in the next year, an increase in buying often indicates the same.

• Undervalued assets. At the end of the day, a company is acquired because it owns a particular asset, whether it’s market share, a new product, distribution channels, etc. And these assets, which are valuable to the acquirer, are often undervalued by the market.

AG: Thanks, Lou.

LB: My pleasure.

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