How To Profit From Corporate Mergers

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It?s the ultimate sugar rush ? a stock you own surging 20 percent or more in a day because it?s become a takeover target. But if you?ve been in withdrawal for a while, a new wave of merger mania might bring some of those sugar highs back.

It isn?t surprising that mergers and acquisitions dried up during the market crash in 2008 and the rough times early this year. But in the past few months, corporate America has been all over the front pages, with more than $300 billion in proposed deals, including Dell?s bid for Perot Systems and Disney?s planned acquisition of Marvel Entertainment. Analysts expect that over the next year, companies will use some of the record $700 billion in cash they?ve hoarded to boost their businesses in a sluggish economy by buying someone else?s.

The tricky part: finding the top takeover targets before their stocks have popped. Companies with good brands that have fallen on hard times might be attractive candidates, especially if they offer a strategic fit to a rival. Carsten Stendevad, head of the financial strategy division of Citigroup, says strong firms could be looking to take out rivals struggling with shaky balance sheets and depressed stock prices.

But speculating on takeover candidates can end badly, too. One of Wall Street?s? favorite sports is spreading rumors that a company is ?in play,? driving up its share price. But stocks tend to dive when the talk proves exaggerated (as is often the case). Shares of video game maker Electronic Arts spiked nearly 10 percent one day this fall, for example, as word spread that Microsoft was about to make an offer; EA?s stock then flopped the next day, after Microsoft publicly denied the rumor.

Stock picking isn?t the only way to go, though. Instead of trying to identify corporate prey, some mutual funds buy shares of targeted companies after a deal has been announced. By then shares have surged, but the stocks often still trade at a discount to the offering price until the deal has gone through, meaning the funds can make money on that spread. The strategy, known as merger arbitrage, delivers ?nice, stable returns,? says Michael Shannon, co-manager of the $2.1 billion Merger Fund. Indeed, the fund is up an annualized 4.3 percent over the past five years, beating the broader stock market. Investors might not get their sugar rush, but they might not crash as hard either.

FUNDS THAT PLAY THE M&A GAME

AQR Diversified Arbitrage (ADANX)

New fund buys stocks, closed-end funds and convertible bonds.

Arbitrage Fund (ARBFX)

Looks for deals among small and midsize firms; tries to avoid hostile takeovers.

Merger Fund (MERFX)

Buys takeover targets after deals are public but still below the offering prices.

2009 Copyright The New York Times Syndicate