How to Ride the Merger Tide
Last week's record bid for MCI shows the merger wave rolls on; small investors can profit, but shouldn't get greedy.
Profits may drive stock prices in the long term, but mergers have fueled much of the 1990s bull market.
"Forget the merger mania of the 1980s, when Ronald Reagan was president." 1997 - with Democrat Bill Clinton in the White House - "is set to become the biggest year ever for mergers and acquisitions," says Richard Peterson of Securities Data Company in Newark, N.J.
If you own shares of phone giants WorldCom or MCI, there's a strong likelihood you are smiling. WorldCom bid a record $30 billion last week for MCI, and Shares in both firms rose sharply.
"The cumulative impact of mergers is substantial," says Hildegard Zagorski, an analyst at Prudential Securities in New York. "They suggest to traders that there is still value left in the market," and that you might want "to get aboard" to share in the upward ride.
But for small investors, as for the corporations that do the deals, making money on mergers is no sure thing.
Not all deals pan out. Consider that British Telecommunications, which had bid $18 billion for MCI, also came out of last week a big winner. The reason: Many investors worried that buying MCI wasn't a good deal - even at a lower price than what WorldCom plans to pay.
The rationale for mergers in the 1990s is simple.
"With interest rates relatively low, it's cheaper for companies to buy a business than to grow one," Mr. Peterson says.
And the deals keep spinning.
July through September saw $202 billion in mergers and acquisitions, a quarterly total surpassed only during the same period in 1995, Peterson says.
Total merger activity this year is expected to top out at well over $650 billion, above the record $649 billion set in 1996.
Who wins from merger activity is more uncertain.
Lawyers and underwriters profit. But whether the small investor can share in the gains is more problematic.
Part of the dispute comes from the nature of mergers, specifically, whether the takeover firm used stock or cash to make the acquisition, and whether the takeover was friendly or hostile.
By one study, cash deals ended up better for investors who held on for five years after a merger than buyouts financed by stock. And hostile offers beat friendly offers. Maybe executives think harder when they're paying cash or upsetting the target firm.
"Whenever a firm uses stock as a currency to take over another company, that usually says that the stock is overvalued - has gotten ahead of itself - and the company management knows it," says a market technician at Everen Securities in Chicago. "It also suggests the market is overvalued."
"Companies use their stock [in takeovers] when it is most valuable," he says. But that means there could be some backward sliding by the stock of the acquiring company after the merger takes place. Whether that occurs at WorldCom is unknown at this point (see story, right).
"If you hold stock that is suddenly affected by a merger - say you own WorldCom stock or MCI stock - then you hold onto your shares as long as you can until you make the best possible gain," says John Markese, president of the American Association of Individual Investors in Chicago.
Thus, individuals who held their MCI shares after first learning about a prospective linkup by MCI and British Telecom have probably been rewarded, because they stand to reap more money per share through the WorldCom/MCI linkup.
Sometimes, the big gains come quickly, before companies take on the hard task of integrating their operations and boosting profits.
"If an offer is attractive, you might want to cash out your shares and turn a hefty gain," Dr. Markese says. But "if you find that the combined company will be attractive and grow over time, you hold on to your shares" for the longer term
Also factor in whether the company is using stock to do the deal - as WorldCom is doing - or cash, Markese says.
But when one deal leads to speculation about others, don't rush out and buy shares based on rumor, Markese says. "Trying to pick who wins and loses in a merger is almost impossible. It is very difficult for small investors to profit from mergers," he says.
"If you are involved in a merger, your focus should be on the acquiring company," says Robert O'Hara, a vice president of the National Association of Investors Corp. in Madison Heights, Mich.
"Examine the fundamentals of the acquiring company," Mr. O'Hara says. "If they are as good or better than fundamentals of the firm that is being acquired, you may want to hold on to your stock."
One cautionary example is the Merger Fund, a no-load mutual fund formed in January 1989 to profit from mergers.
So much money poured into the fund that it was closed to new investors in May 1996. It now has assets of $443 million. The returns for investors? Just 7.94 percent this year through Aug. 31. The fund's best year was 1993, when it posted a 17 percent gain.