There’s a method to merger madness

Profit by purchasing the stock of a potential takeover candidate

Merger mania may be painful to the executives of a company being acquired, but other investors can benefit from their pain.

In fact, it’s just those kinds of opportunities that professional investors look for when trawling for stocks that are good takeover candidates. By buying a stock that’s languishing for competitive reasons investors can, in effect, own larger, better-run companies by holding onto underperformers that are ripe for the picking. Furthermore, when a company is acquired, the firm taking it over pays a premium over the target’s current stock price. Then, according to the terms of the deal, shareholders get a portion of the shares of the acquiring company-in most cases, a more valuable stock.

The past few years have been boom times for mergers and acquisitions. In 1998, $1.6 trillion, or 12,238 merger deals were announced, up from $901.4 billion comprising 11,174 transactions in 1997. And $1.1 trillion in mergers comprising 7,349 deals have been announced through September 7, nearly as much as the total dollar value last year.

Fund managers and analysts say there is no clear-cut way to calculate when a company will become a takeover candidate. But certain signs-like a sagging stock price (lasting a period of 12 months or more), weak earnings and poor management-can help pinpoint the next takeover candidate.

Dawn Alston Paige, CFA, a portfolio manager who runs the Midcap Value Fund for Loomis Sayles & Co. in Bloomfield Hills, Michigan, points to price wars as one of the many factors that can spur consolidation activity in an industry. "When price pressures drive out the profitability of an industry, look for consolidation," she says. Paige points to Birmingham, Alabama-based banking firm AmSouth Bancorporation’s (NYSE: ASO) takeover of Nashville, Tennessee-based First American Corp. (NYSE: FAM) as an example.

Poor management is another major contributor to takeover bids. Investors should look for a management team that knows what to do with the company’s assets.

In general, investors trying to stockpile growth companies should look for firms with superior earnings growth relative to the Standard & Poor’s 500. One measure of a firm’s strength is its historical performance and sales. Additionally, stocks that are exceeding the profits of their peer group are firms that investors can securely hold on to.

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Urge to Merge

The ’90s are shaping up as the decade of the megamerger. So far this year, already $1.1 trillion in mergers have been announced, according to Securities Data Co., a Newark, New Jersey firm that tracks investment banking activity. Here are the five largest mergers of 1999, ranked by deal size.

Target

Acquirer

Size of Deal*

Date Announced

AirTouch Communications Vodafone Group PLC

$65.902

1/18/99**